Public Pensions Using Various Methods to Improve Funding

The CRR found that offsetting the failure to pay their full Annual Required Contributions (ARC), states and localities have taken two types of actions to shore up their finances: general reductions in payroll costs and specific changes to improve the viability of pension plans.   

First, in response to the drop in revenues, states and localities are starting to freeze employee salaries and lay off workers. According to the report, both these steps will have an indirect, but important, impact on the existing pen­sion liability. Currently, actuaries generally assume a 4.5% growth rate for wages. Given the current environment, it is likely that future wage growth will be lower. Reducing the wage growth assumption by one percentage point reduces the pension liability by about 2%, the report says.  

Laying off workers also affects the current liability measure because benefits will be based on the worker’s salary at termination, which is lower than the projected retirement salary assumed in the calculations.   

States and localities also have undertaken a num­ber of changes specifically to improve the funding of their pension plans. On the benefit side, 20 states have adjusted the benefit formula and/ or the retirement age for new employees. These changes are limited to new employees because states’ case law or their constitution generally precludes reducing future benefits for current employees. As a result, these changes will slow the growth in liabilities going forward but have no impact on the existing liability.   

According to the report, a handful of states have attempted to cut the cost-of-living adjustment (COLA) for current retir­ees; these actions have resulted in lawsuits and the outcome is unclear. If the efforts succeed, they will reduce the current liabilities to the extent that higher COLA assumptions were embedded in the calcula­tions.   

On the contribution side, states have considerably more leeway to make changes and have raised both employer and employee contributions. Once these additional contributions kick in, they should reduce the shortfall on the ARC payments and improve the funding outlook.