Even the Most Fiscally Fit States Have Pension Problems

In its recently released “Ranking the States by Fiscal Condition” report, the Mercatus Center at George Mason University found that even the most financially sound states still face significant pension challenges.

The report ranked Florida, North Dakota, South Dakota, Utah, and Wyoming as the top five states by fiscal condition because they have relatively high levels of cash, low unfunded pensions, and strong operating positions.

“While these top five states are considered fiscally healthy relative to other states because they have significant amounts of cash on hand and relatively low short-term debt obligations,” said the report, “each state, especially Wyoming, faces substantial long-term challenges related to its pension and healthcare benefits systems.”

The report evaluated pension plan liabilities and assets based on the most recent actuarial reports of the plans that states offer to their employees. This also includes pension plans that states manage but do not contribute to directly.

“Although a state does not bear the entire financial responsibility for many of the multiemployer plans, state and local entities are connected through fiscal relationships,” said the report. “If a state-administered but locally funded pension plan were to experience distress, the municipality might seek state aid or pension reform measures from the state.”

As of fiscal year 2015, the Governmental Accounting Standards Board (GASB) requires states to report their net pension obligation as part of their long-run liabilities. The report cites this as an improvement in accounting because it requires governments to recognize unfunded pension liabilities on the balance sheet, thus making the long-run liability metrics a more meaningful measure of a state’s long-run fiscal health.

“Despite this, some problems remain in the reporting of pension liabilities,” said the report. “Most states continue to assess the value of their pension obligations using risky asset returns, thereby understating the full value of pension liabilities.

The GASB suggests plans apply a blended rate to value liabilities. For the portion of the plan liability that is backed by assets, plans may use the expected return on plan assets. The tax-exempt 20-year high-grade municipal bond yield may be used to value any unfunded portion of the liability.

“A shortcoming of this approach is that it continues to use a return on a mixed portfolio of assets to value the funded portion of the liability,” said the report. Of 144 plans surveyed, the report found that only 13 plans applied the blended rate to value their pension obligations. “Most plans continue to use the expected return on assets to value liabilities, resulting in little change in the size of plan liabilities.”

In addition, state financial statements only recognize the portion of the pension liability for which the state government is responsible. The net pension liability does not measure the entire unfunded liability of the entire pension plan.

“Top-performing states tend to exhibit fiscal discipline in the form of having high levels of cash, maintaining revenues that exceed expenses, and keeping debt levels low relative to resident income,” said the report. “These factors can easily be threatened if a state relies too heavily on narrow tax bases and volatile revenue sources, or if pension plans are not adequately funded, leading to persistently large and growing liabilities.”