Disagreement Over Long-Term Pension Costs | Eastern North Carolina Now

    Publisher's note: The author of this post is Austin Pruitt, who is a Research Intern for the John Locke Foundation and contributor to the Carolina Journal, John Hood Publisher.

    RALEIGH     A major problem is facing state employee pension plans. While many private corporations cut back pension programs due to limited funding or decreasing contributions, pension systems for government employees rarely change.

    The problem arises when public funding must be curbed to account for retirees living longer or in times of economic uncertainty. Coming out of the Great Recession, we have seen both in recent years.

    With private-sector companies, liabilities must be offset with corporate assets for stable balance sheets. Government does not operate this way. Assets for a public pension plan come from taxpayers, so the unfunded liability burden falls on the shoulders of citizens.

    The Pew Charitable Trusts released a study finding that the nation's state-run retirement systems had accrued $968 billion in unfunded liability by 2013. This means that there is close to $1 trillion total in unfunded liability on states' public pension balance sheets.

    Each state discloses an amount needed to reach contribution adequacy, or an amount that includes expected cost of benefits earned and an amount needed to sustain the pension fund based on the discount rate. This is known as the Annual Required Contribution. Pew notes that only 24 states set aside at least the 95 percent of this adequacy number in 2013. North Carolina was one of those states.

    The public pension system's deficit is not a number that many researchers agree on. In fact, State Budget Solutions asserts that unfunded liabilities have actually hit $4.7 trillion in 2014, up from $4.1 trillion in 2013.

    Where do the contrasting figures come from? The significantly disparate numbers are derived from different economic valuation methods used to calculate the present values of the pensions' liabilities.

    In order to determine the amount necessary to fund a healthy pension system, states must decide on a discount rate to use in the estimation of a pension's present value. More simply, the discount rate is used to anticipate the expected increasing value of the pension over time by discounting the presently required assets to fully fund the system's future liability.

    Since public pension funds are invested, many research organizations use the expected investment rate of return as the discount rate. That rate is often 6 percent to 8 percent. However, State Budget Solutions asserts that a rate around 2-4 percent is more realistic. Overestimating the discount rate means that states may not be contributing enough to pay benefits to retirees.

    The contrasting unfunded liability amounts are a result of the use of these differing discount rates. The Pew study used the 6-8 percent rate and State Budget Solutions the 2-4 percent rate. The lower discount rate is approximately equivalent to the yield of a 15-year U.S. Treasury bond, which is considered a similar liability and therefore should be used in pension calculations.

    The estimation of the necessary funding for the public pension system should be based more on the nature of the risk of liabilities, rather than any assets, and risk associated with government pension payments is minimal. This is because governments cannot file for bankruptcy like private companies. Public pensions are a contract between the government and retirees, and funded by taxpayers.

    The major pension shortfall has been studied extensively, and most researchers and economists acknowledge its existence. The two reports mentioned above illustrate the disagreement regarding the extent of the problem.

    Using what it believes to be a more appropriate research method, State Budget Solutions is confident in its pension numbers. In citing a 2012 Boston College study, the group asserts that the average state pension system was about 75 percent funded in 2011 and projected to rise to about 82 percent funded by 2015.

    Economists and citizens should be aware that although these percentages do not sound all that alarming at first glance, the remaining shortfall could be up to around a quarter of U.S. gross domestic product.