What The Wild Stock Market Means For Public Pensions

As governments deal with paying for Covid-19 expenses amid falling tax revenue and shrinking budgets, there’s another big bill waiting for them: pension debt.

And many could lean on taxpayers to help.

Pension plans haven’t released their annual earnings yet, but a recent report from Moody’s Investors Service notes that “investment returns…have almost certainly fallen well short of targets.” 

The ratings agency estimates that when pension plans tally up their total performance between July 1, 2019 and June 30 of this year, most systems will post returns in the range of 0% to 1%. This is considerably below their annual return targets of around 7%. 

This makes two straight years of pension systems missing their targets, although last year it was just narrowly. In 2019, plans with more than $1 billion in assets earned a median return of 6.79 percent for the fiscal year ending June 30, according to the firm Wilshire Trust Universe Comparison Service.

When plans miss their targets, pension systems’ unfunded liabilities — or debt — increases unless governments raise their own annual payments into the system to fill the gap. Moody’s estimates that government pension bills next year could increase by 15%, just to keep their funding levels even. 

That translates to hundreds of millions of dollars more for governments. For Kentucky, whose annual pension bill for its state employees’ plan is about $1 billion, that could mean an additional $150 million. And paying that wouldn’t help its fiscal status of having less than 17% of the money it needs to meet its total liabilities in the future. It simply would keep the plan from falling even further behind.

Investment returns are critical to public pension systems because annual payments from current employees and governments aren’t enough to cover yearly payouts to retirees. As it stands, roughly 80 cents on every dollar paid out to retirees comes from investment income.

An increase in unfunded liabilities has ripple effects for taxpayers. Governments unable to stabilize their pensions or afford the higher bills may ultimately lean on their constituents. Many did so after the investment losses of the 2008 financial crash that ultimately wiped out about 25% of public pensions’ market value.

Chicago, for example, has more than $45 billion in pension debt, and less than 30% of the money it needs to ultimately meet its liabilities. In 2016, it increased property taxes to generate an additional $588 million per year to put into its pension system. It’s municipal plan has still been losing money every year.

Kentucky went the other way and cut spending on things like education and health and human services to redirect money into its retirement system.

Even if a payment hike is phased in, which is often the case, it’s a big increase that most governments will be ill-equipped to handle because state and local revenues aren’t expected to recover for another three years. But delay is also costly. Because of the way pension accounting is done, every year a government skimps on a payment or investment returns fall short of expectations, a pension’s funded ratio gets worse. 

It’s for these reasons that state and local government unfunded pension liabilities have more than doubled since the Great Recession. It’s simply hard to catch up when the stock market falters. In 2007, pension debt totaled about $1.6 trillion according to the Federal Reserve, or roughly 11% of US GDP. In 2019, unfunded liabilities reached $4.1 trillion, about 19% of GDP.

It’s likely we’ll see those numbers climb even higher in the coming years.