The viability of a public defined benefit pension plan is best judged by its fiscal sustainability rather than its overall liabilities, according to a new report by the National Conference on Public Employee Retirement Systems.
The report, written by Michael Kahn, director of research at the NCPERS (pictured right), found fiscally sustainable pension plans have higher funding levels and lower contribution levels than plans more focused on lowering their liabilities. Fiscal sustainability refers to the ratio between debt and overall assets. When it’s stable, a debt is considered sustainable. Despite this, public sector plans in the U.S. are often criticized on the basis of liabilities alone.
“The fundamental error that critics of public pensions commit over and over is to compare 30-year pension liabilities — that is, liabilities that are amortized over 30 years — with one-year state and local revenues.”
This tendency to question the viability of public sector pension plans on the basis of a single year’s budget can have devastating consequences for public sector plans. In an interview about the report, Hank Kim, executive director and counsel for NCPERS (pictured left), points to the example of the Oklahoma Public Sector Retirement System.
“Soon after the global financial crisis, Oklahoma closed its plan for state employees. Effectively, [critics] used the GFC and the mismatch of 30 years of liabilities versus only a year of state revenue to pressure the state into closing the plan.”
According to the report, which based its findings on figures from 2018, the unfunded liabilities of U.S. public pension plans were about three per cent higher than the sustainable level. Balancing the liabilities of all public pension plans would cost about US$141 billion or 0.8 per cent of U.S. gross domestic product.
The report also argued that pension plan sponsors can help keep their plans stable by conducting sustainability valuations. These valuations, conducted on an ongoing basis, allow for fiscal adjustments to be made to keep the ratio between unfunded liabilities and economic capacity stable.
“The sustainability valuation is a new tool to provide context on the affordability of public pensions. It works by measuring the capacity of the plan sponsor,” says Kim. “There are a number of good tools to measure costs of pensions. These existing tools are valuable, but they don’t provide context. What was missing was a measure of affordability. Sustainability valuation provides the context and should be used in conjunction with existing cost measurements.”