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In Missouri and around the country, elected officials, taxpayers, and financial markets have expressed concerns about the financial health of defined benefit pension plans for state and local government workers. Public employees also are concerned, as many rely heavily upon these plans for income in retirement.
These pension plans have come under increased scrutiny as funding levels havedropped and required contributions have risen. According to standard actuarial accounting, the average public pension funding fell to about 75 percent in 2011, versus 103 percent in 2000. The Annual Required Contributions that state and local governments make to public pensions have more than doubled in nominal terms since 2001, a period in which prices rose by only about 25 percent. Public sector pensions, asof mid-2011, were underfunded by approximately $885 billion, based on accounting rules that the Governmental Accounting Standards Board established and applied to a large sample of plans from the Public Plans Database.
A similar pattern holds for the Missouri public employee pensions, which serve state and local government employees. Annual required contributions have risen and measured funding health has declined. Most Missouri public employees participate in one of five retirement plans:
Together, they report unfunded liabilitiesas of 2012 of $11.1 billion and a combined funding ratio of 81 percent.
However, reports from academic economists and nonpartisan governmentagencies imply that the true state of public sector pension funding is far worse than suggested in official plan disclosures. The accounting rules U.S. public sector pensions follow are more forgiving than those required for private sector pensions or public sector plans in other countries. So-called “fair market valuation” more fully reveals the value of public sector plan liabilities and shows that public employee plans are far less well-funded than commonly understood. In Missouri, the market valuation approach shows combined public employee plans to be only 46 percent funded, with unfunded liabilities approaching $54 billion.
While state and local governments around the country have enacted reforms to public sector pension plans- including contribution increases, less generous benefits for newly hired employees, and in some cases, reductions in cost of living adjustments (COLAs) for current beneficiaries – accurate accounting of public employee pension liabilities shows that elected officials must do much more to make these plans financially sustainable. Even if policymakers change the terms upon which future benefits are earned – a step which is both politically and legally problematic – the fact that existing pension liabilities are all but guaranteed implies that their true value is significantly higher than reported in public pension financial statements.
This paper describes how public employee pensions currently measure their financial health; discusses the consensus among economists that current accounting rules significantly understate pension liabilities and overstate pension funding levels; and describes how pension financing would appear using accounting rules similar to those required for private sector pensions or for public employee plans in other countries. Following that is discussion of objections to fair market valuation. Finally, we discuss the costs and benefits of potential reforms, including shifting to defined contribution or cash balance pension structures.
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