The financial soundness of pension systems for state and local government workers has been a topic of much debate. In recent work, Robert Novy-Marx and I have argued that the use of GASB rules to discount future benefit payments results in present value measures of liabilities that are too low to reflect the true economic liability faced by state taxpayers. At the same time, a number of states have enacted changes designed to reduce the liabilities associated with their pension systems. Most of these changes affect new employees only, and hence have no impact on standard liability measures, which do not consider future employees. However, some changes, such as the reductions in the cost of living adjustments (COLAs) passed by Colorado and Minnesota this year, do affect existing plan members and hence do affect the economic present value of current state pension liabilities.
Today, Novy-Marx and I have released a draft of a new paper, “Policy Options for State Pension Systems and Their Impact on Plan Liabilities.” In this paper, we examine the present value of state pension liabilities under existing policies and separately under several sets of hypothetical policy steps. In particular, we consider changes to COLAs, full retirement ages, early retirement ages, and buyout rates for early retirement.
We find that even relatively dramatic policy changes, such as the elimination of COLAs or the implementation of Social Security retirement age parameters, would leave liabilities around $1.5 trillion more than plan assets under Treasury discounting. This suggests that taxpayers will bear the lion’s share of the costs associated with the legacy liabilities of state DB pension plans.
Click on the image below to access the complete study: