State pension crisis: Funding gap reached a record high of $1.4 trillion in 2016

The Pew Charitable Trust released an analysis of state pension obligations as of 2016, the most recent year for which complete information is available for all 50 states. Pew found the gap between what states owed retired workers and the actual amount saved jumped substantially over 2015:

In 2016, the state pension funds in this study cumulatively reported a $1.4 trillion deficit—representing a $295 billion jump from 2015 and the 15th annual increase in pension debt since 2000. Overall, state plans disclosed assets of just $2.6 trillion to cover total pension liabilities of $4 trillion.

Investment returns that fell short of state assumptions caused a major part of the increase in the funding gap. The median public pension plan’s investments returned about 1 percent in 2016, well below the median assumption of 7.5 percent—a disparity that added about $146 billion to the debt.1 Assumption changes—primarily states lowering the assumed rate of return used to calculate pension costs—accounted for another $138 billion in increased liabilities.

Here’s a chart produced by Pew showing the funding levels of various states:

As you can see, there are a few states (New York, Wisconsin, South Dakota, Tennessee) with funding levels above 90% but the majority are much lower with the average at just 66 percent. The Associated Press notes that pressure to fund these liabilities eventually cuts into other programs, not just at the state level but also at the local level:

While the study looks only at pension funds with major state-government involvement, systems run by cities, counties, school districts and other local entities have had similar problems. Just this week, the Chicago suburb of Harvey, a city with a history of underpaying its pension obligations, announced deep layoffs in its police and fire departments. Officials blamed their rising pension obligations.

Larger cities and school districts across the country also have had service cuts or freezes over the years to pay for rising costs for their retirees.

Pew says that pension funds were well-funded until about 2000. Around that time, many states increased pension benefits without a way to pay for them. In some states, such as California and Illinois, courts usually find that the government must honor those commitments.

The problem is expected to look a bit better in 2017 thanks to the stock market surge. However, the Pew report also notes that states are increasingly moving to riskier investments in an attempt to make up lost ground, meaning that any future drop in the market could lead to significant losses.