Underfunded N.C. state pension programs

The good news for North Carolina employees and businesses? N.C. appears to have the third-healthiest pension fund differential in the country according to investment research from Morningstar. The bad news? It’s still underfunded. Before I delve into the importance of this phenomenon, let’s tear down some of the verbiage.

A public pension program, by its simplest definition, entitles eligible employees to a stream of income (“pension”) upon retirement. When I talk of a state’s underfunded pension program, I am explicitly referring to the lack of sufficient monetary allocation by that state to fund future pension obligations.

So what happened with the constitutional requirement that states maintain balanced budgets? Well, most public pension funds are defined benefit programs as opposed to defined contribution programs. These defined benefit programs create legal obligations to pay future benefits. Future pension obligations are not explicit debt obligations that need to be accounted for in the state’s same-year budget. However, continuously underfunding these obligations leads to future debt even if it isn’t accounted for in the state’s same-year accounting statements.

In North Carolina, we have a fund that is quite healthy. Workers have paid into the program, along with the state government, in order to ensure that N.C. workers receive the benefits to which they are legally entitled. In most other states and municipalities, however, the equivalent public pension programs lack sufficient funding to cover the costs of all of the obligations that these programs will incur in the future. The states of Kentucky and Illinois, for example, currently maintain pension funds that are capable of covering only a little more than half of their underfunded liabilities. The city of Chicago maintains underfunded liabilities at a magnitude of 10 times its revenue. The Los Angeles Times released an article just a few weeks ago discussing how “years of overoptimistic stock purchases and inadequate contributions have left it [California Public Employees Retirement System] terribly vulnerable, and just a few years of down markets could leave it insolvent.” Outside of state and municipal governments, some corporations also have underfunded pension obligations—something to keep in mind for investors while performing valuation calculations.

But let’s focus on the public pension deficits. How did this even happen? It appears that, prior to the financial crisis, state governments overestimated the present value of their future cash flows based on investments they had made. The high projections for future gains based on these investments led state governments to make lower contributions to their pension funds with the expectations of higher returns in the future that would allow them to cover these gaps. When these investments went south during the financial crisis, the pension programs lost out. Even when markets recovered, states discovered that their contribution obligations had increased, still leaving a gap between the return on their investments and their underfunded liabilities. More recently, we have even seen the desperation of state pension funds to invest in higher risk, higher return ventures in an attempt to recoup losses, which has only further endangered state programs.

So why does any of this matter to us? In the long run, it is likely that you and I, the future employees and retirees who will pay into and derive support from these pension funds, might be affected by current inadequacies in the system. It is not yet clear what policies certain states and municipalities will employ in order to ameliorate the deficiencies in this system, but we know that as legal obligations, these pensions will have to be fulfilled one way or another. Perhaps heavier taxes, reduced government spending on other programs or altered benefits might be the choice. We have seen states challenged in court for attempts to reduce benefits or increase contribution requirements. The possibility of bailouts for states and municipalities that cannot cover their pension obligations is also being discussed, but generally, experts in the field believe that bailouts would provide the wrong incentives to local governments. In any case, this is a serious concern for our generation, which might be left with the consequences of the failures of this obligatory program.

It is no secret that there is an urgent need for pension contribution reform in order to ensure that the contractually-specified post-employment income of future workers is fulfilled without sacrificing the interests of future generations and business. This issue will come into play sooner or later. It just hasn’t quite hit us yet.

Ajay Desai is a Trinity freshman. His column runs on alternate Tuesdays.