A new analysis by Aon Investments USA Inc. (a market consulting company), commissioned by the Florida State Board of Administrators (SBA), predicts that the Florida Retirement System, FRS, is on track to eliminate all unfunded pension liabilities by 2042. Lawmakers reformed the system in 2011 by introducing a defined contribution (DC) option called the Investment Plan, and subsequently made it the default retirement plan for most new hires in 2018. These reforms have helped FRS make progress in closing what was a nearly $40 billion funding shortfall after the Great Recession.  

The latest reporting from FRS now gives the system an 83.7% funded ratio (up from 70% in 2009), indicating that the state has made progress but still needs to stay the course to return to its pre-recession, full funding status. According to Reason Foudnation’s recently released Annual Pension Solvency and Performance Report, one bad year in the market (0% returns in 2026) would essentially undo that progress, bringing the system’s unfunded liabilities back to an estimated $40 billion overnight. 

Florida has a long way to go before catching up with its public pension promises 

If market outcomes over the next two decades resemble those of the last 20 years, FRS won’t achieve full funding anytime soon. The pension system’s 24-year average return since 2001 is 6.4%, falling short of the plan’s 6.7% assumption. According to Reason Foundation’s actuarial modeling of FRS, this seemingly small 0.3% shortfall would push the date for reaching full funding out by another three years. 

Another major recession would also significantly derail the system. Reason Foundation’s modeling indicates that an investment loss in 2026 similar to that of 2009 (a 20% loss) would result in a funding ratio of 62%, and it would take 15 years just to climb back to today’s funding levels. The full funding date would extend well beyond 2055 in that scenario. 

Lower market returns would also drive up the annual costs of FRS, which taxpayers and lawmakers should be wary of. In 2024, employers contributing to the FRS pension paid an amount equal to around 12.7% of payroll (totaling $5.6 billion statewide annually). If everything goes as planned, with returns matching the system’s assumptions, this cost will remain relatively stable and drop significantly once the system is free from pension debt. Under the scenario of a major recession, annual costs will need to rise to as high as 22.9% of payroll to maintain full pension benefit payments. 

A recession would necessitate much larger government contributions 

When it comes to public pensions, policymakers can hope for the best, but they need to prepare for the worst. At a minimum, they should structure pension systems to withstand the same market pressures and funding challenges that created today’s costly pension debt.

Florida lawmakers should consider these risks as they weigh proposals to expand benefits. During the 2025 legislative session, lawmakers saw (and rejected) a proposal to unroll the state’s crucial 2011 reform by again granting cost-of-living adjustments (COLAs) to all FRS members.

Reason Foundation’s analysis of the proposal warned that even under a best-case scenario, the move would add $36 billion in new costs over the next 30 years. A scenario in which the system sees multiple recessions over the next 30 years would have driven the estimated costs of the proposed COLA to $47 billion.

For a pension fund that is still many years away from having the assets to fulfill existing retirement promises, the last thing it needs is to double down on more costs and liabilities. 

Current proposals to cut taxes in the Sunshine State should also factor into any consideration of granting additional pension benefits to public workers. A new group of bills introduced in the state’s House of Representatives signals that lawmakers intend to offer several property tax-cutting measures to voters on the 2026 ballot. It is safe to say that the idea of increasing pension costs on Florida’s local governments while simultaneously facing the prospect of reduced tax revenue is ill-advised.  

Through prudent reforms, Florida has made some laudable progress in improving the funding of its public pension system. However, the state is still several years away from achieving the end goal of all these efforts, and any level of market turbulence would push the finish line out by decades. Policymakers need to be aware of Florida’s long-term pension funding strategy and avoid any proposals to add to the costs and risks imposed on taxpayers through new pension benefits. 

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State pension plans continue to carry the majority of the nation’s public pension debt, holding $1.29 trillion in unfunded liabilities, compared to local governments’ $187 billion in debt, Reason Foundation finds.

The median funded ratio of this report’s sample of pension plans stood at 78% at the end of 2024, a 3% increase from last year. This indicates that, while public pension funding has improved over the previous year, governments have still saved only 78 cents of every dollar needed to provide promised retirement benefits.

Reason Foundation’s stress tests also suggest that public pensions remain vulnerable to market downturns. A single economic recession could significantly increase their unfunded accrued liabilities, potentially raising the state and local total of public pension debt to as much as $2.74 trillion by 2026.

The Pension Solvency and Performance Report provides a comprehensive overview of the current and future status of state and local public pension funds. As the nation navigates another year marked by significant economic fluctuations and demographic shifts, this report assesses the resilience and adaptability of U.S. public pension systems. This analysis ranks, aggregates, and contrasts public pension plans based on their funding, investment outcomes, actuarial assumptions, and other indicators.

In addition to 24 years of historical data, the 2025 edition of Reason Foundation’s Pension Solvency and Performance Report includes financial and actuarial data from the pension plans’ 2024 fiscal year, the most recent year for which most government pension plans have reported data.

This edition of the report ranks public pension systems from best to worst across five core dimensions: funded status, investment performance, contribution rate adequacy, asset allocation risk, and probability of meeting assumed returns. Together, these measures reveal which states have positioned their public pension systems for long-term stability and which remain vulnerable to rising costs, market volatility, and political shortfalls in funding discipline.

Unfunded public pension liabilities

In recent decades, public pension systems in the U.S. have seen a significant increase in unfunded liabilities, particularly during the Great Recession. Between 2007 and 2010, unfunded public pension liabilities grew by over $1.15 trillion—an 809% increase—reflecting the financial challenges faced during that period. Despite some improvements in funding ratios over the last decade, these pension liabilities have continued to rise, underscoring ongoing financial pressures on state and local governments and taxpayers.

As of the end of the 2024 fiscal year for each public pension system, total unfunded public pension liabilities (UAL) reached $1.48 trillion, with state pension plans carrying the majority of the debt.

Nationwide, the median funded ratio of public pension plans stood at 78% at the end of 2024. Still, stress tests suggest that another economic downturn could significantly increase unfunded liabilities, potentially raising the total to $2.74 trillion by 2026.

Funded ratios of public pensions

The funded ratio of public pensions, which indicates the percentage of promised benefits that are currently funded, has experienced considerable fluctuations. After returning to 96% funded in 2007, the funded ratio of U.S. public pension systems fell to 64% during the Great Recession. Although funded ratios have recovered somewhat, they remain susceptible to market downturns.

A stress test scenario for 2026, assessing the impact of a 20% market downturn, indicates that the average funding level of public pension plans could fall to 63%. This could lead to critical underfunding for many pension plans, raising concerns about their ability to fulfill future obligations.

Changes in investment strategies

Over the past two decades, investment strategies of public pension funds have shifted notably. Allocations to traditional asset classes, like public equities and fixed income, have decreased while investments in alternative assets, such as private equity, real estate, and hedge funds, have increased. This shift reflects a strategic move for pension systems trying to achieve higher investment returns in a challenging market environment.

By the end of the 2024 fiscal year for each pension system, public pension funds managed approximately $5.49 trillion in assets, with a significant portion now invested in alternative assets, such as private equity/credit, and hedge funds. While these alternative investments may offer the potential for higher returns, they also introduce greater complexity and risk.

Investment performance

Public pension funds have faced challenges meeting their assumed rates of return (ARRs). Over the past 24 years, the national average annual rate of investment returns of pension systems has been 6.62%—still below what the plans had assumed. The average assumed rate of return for public pensions has been gradually reduced from 8.02% in 2001 to 6.87% in 2024.

Failing to meet their overly optimistic assumed rates of return has contributed to a significant increase in unfunded liabilities, requiring additional pension contributions from state and local governments, i.e., taxpayers, to maintain funding levels.

Investment returns themselves have varied widely, with public pension plans posting very strong gains in 2021 (25.4% returns), in contrast to large losses in 2009 (-12.9% returns on average) and further losses in 2022 (-5.1%). This volatility between expected rates of return and actual investment returns has created budgetary challenges for governments and taxpayers.

Employer contributions and cash flow

Employer contributions continue to dominate pension funding, while employee rates remain stable. In 2024, the total contribution rate was 28.8% of payroll, with employers covering 21.6% and debt amortization alone consuming 15.7%. More than half of all contributions—54%—went to paying down past pension debt rather than funding new benefits.

Net cash flows improved modestly, narrowing to -1.7% of assets, but systems remain reliant on strong investment returns to cover ongoing benefit payments.

Conclusion

Despite a year of substantial market gains and improved funding ratios, systemic risks remain for public pension systems. Far too many pension plans continue to rely on optimistic return assumptions, volatile markets, and a heavy reliance on taxpayer contributions to manage their legacy debt. Without sustained public pension reforms and more disciplined funding policies, today’s limited progress could quickly reverse.

This report was produced by Reason Foundation’s Pension Integrity Project, an initiative to conduct research and provide consulting and insight about the public pension challenges our nation grapples with.

Webinar

To dive deeper into the findings, watch our pre-recorded webinar below, where Reason Foundation’s Pension Integrity Project team details the report’s findings, explains key trends, and unpacks what these results mean for state and local governments, public employees, and taxpayers.

Related:

Study: Illinois, Connecticut, Alaska, Hawaii, New Jersey and Mississippi have the most per capita pension debt

The public pension plans with the most debt, worst investment returns of the year

The post Report: State and local pension plans have $1.48 trillion in debt appeared first on Reason Foundation.

At the federal level, despite Congress and the Trump administration recently passing a bill that will add trillions to the $37 trillion national debt, President Donald Trump has also moved to cut some spending by extending a federal hiring freeze through mid-October 2025. Even after this date, federal agencies will be restricted to hiring one new employee for every four departures, in an effort to reduce the size of their workforce. This push to downsize the federal workforce gained recent momentum when the Supreme Court lifted a lower-court injunction, clearing the way for federal layoffs under an executive order issued in February. The Supreme Court ruling affirms the administration’s authority to proceed with large-scale job cuts across various departments, including agriculture, state, commerce, and health and human services.

At the state and local level, governments must typically address their budget deficits. Louisiana Gov. Jeff Landry issued an executive order instituting a hiring freeze across all state government departments and agencies. The measure aims to achieve approximately $20 million in annual savings to address revenue shortfalls and protect essential services.

In Colorado, Gov. Jared Polis proposed hiring freezes and reductions in state programs to address an anticipated $1 billion deficit, driven by economic conditions, recent tax breaks, and rising Medicaid costs.

At the local level, Los Angeles Mayor Karen Bass unveiled a proposed $13.9 billion municipal budget for fiscal year 2025-26, which includes more than 1,600 layoffs and the consolidation of four city departments to eliminate a nearly $1 billion deficit.

Orange County, California, interim Chief Executive Officer Michelle Aguirre ordered department heads to implement a hiring freeze, reduce discretionary spending, and lower service levels over a three-month period.

This pattern of tightening public sector payrolls across all levels of government could contribute to a larger long-term trend that public pension systems need to monitor and address. Hiring freezes and workforce reductions could create a technical challenge for public pension plans: When payroll growth falls short of actuarial assumptions, it can lead to an underestimation of the amount of money that needs to be saved today to pay for pension benefits promised to workers.

Pension systems rely on an assumed rate of payroll growth to calculate their annually required contributions. Most systems use a “level-percent of payroll amortization method,” which bases their contribution planning on the assumption that future payroll growth and salaries will increase at a level rate. When actual payrolls fail to grow at the assumed rate, the calculations used to determine a government’s contributions to the pension plan end up short of what is actually needed.

Missing on this assumption leads to unforeseen unfunded liabilities (pension debt) and necessitates future cost increases. To avoid this, public pension plans need to either lower their payroll growth assumptions or transition to a method that is less sensitive to payroll fluctuations.

One method that some pension systems have adopted to insulate their plans from this particular risk is to remove the payroll growth assumption altogether. This can be done by switching from the “level-percent” amortization method to the “level-dollar” approach when calculating the annual required contributions. Using a “level-dollar” approach means that plan actuaries simply apply the dollar amount needed to amortize pension debt without connecting this payment to the assumed payroll. This results in a more secure method of pension funding, as it means that, at the very least, the plan has one less assumption imposing risks for underfunding.

Adopting a “level-dollar” amortization method can be done in several ways. Michigan lawmakers directed their pension for teachers to use a level-dollar method to amortize any debt on their new tier of benefits in 2017.

Arizona’s plan for public safety employees applied a level-dollar policy with a new tier of benefits beginning in 2017, and all tiers began using level-dollar for any new debt starting in 2020. By removing the payroll increase assumption from their amortization calculations, these plans have removed the impact that an increasingly volatile and unpredictable hiring rate has on their long-term funding viability.

Workforce reductions are necessary, but they also raise potential technical challenges for public pension systems. The impact of these trends can be lessened by pension plans making proactive changes to payroll assumptions. To uphold both fiscal sustainability and the retirement promises made to public workers, state and local governments should consider adjusting their payroll growth assumptions or removing them altogether from the funding calculation by adopting level-dollar amortization policies.

The post How government workforce reductions can impact public pension debt appeared first on Reason Foundation.

The tool has incorporated the data released by public pension systems since our original report was published in September 2024. Public pension systems that ended their fiscal years in June or July of 2024 have been updated. With these additions, the total unfunded public pension liability was $1.61 trillion, up from $1.59 trillion. Correspondingly, the median funded ratio across public pension plans decreased marginally from 76% to 75.8%.  

With the additional data, Reason Foundation’s stress-test projections for public pensions have worsened slightly. For example, under a major market shock, defined as a 10% loss, comparable to the Great Recession of 2007-2009, or the temporary stock market decline after President Donald Trump’s ‘Liberation Day’ tariff announcement, unfunded liabilities are now projected to reach $2.29 trillion by 2025, up from our previous estimate of $2.16 trillion.  

Total public pension assets were $5.07 trillion, a slight increase from the $5.05 trillion previously reported.

The average assumed rate of return for public pension systems fell marginally from 6.89% to 6.87%, continuing the gradual shift toward more conservative investment expectations amid current economic conditions.

Overall, the updated data reinforces previously identified public pension trends. Insufficient public pension contributions, ongoing asset-liability mismatches, and improving, but still overly optimistic, investment return assumptions are ongoing issues for pension systems.

A significant addition to the tool in this mid-year update is the introduction of the state tracker. While previous versions provided individual state and plan data in separate sections, the state tracker now consolidates all relevant public pension data into a single, easily navigable area. This integration enables direct comparisons of pension funding ratios, investment returns, and liabilities across states within one unified interface.

Structural refinements to enhance clarity and ease of use have also been made. Navigation labels have been streamlined, with sections previously titled “Funding Health & Risk Assessment” simplified to “Funding Health” and “Asset Allocation & Projected Returns” shortened to “Asset Allocation.” These changes aim to improve the user experience, especially those accessing information on mobile devices or smaller screens. 

We hope these updates to the Annual Pension Solvency and Performance Report can help inform policy discussions and decisions around pension funding strategies at the local, state and national levels. 

The post With additional plans reporting, total unfunded public pension liabilities in the U.S. grow to $1.61 trillion appeared first on Reason Foundation.

Public pension systems rely heavily on investment returns, which account for over 60% of the revenues needed to pay for promised retirement benefits. Sustained periods of investment returns coming in below expectations directly impact the solvency and sustainability of pension systems, so it is crucial for plans to not only set realistic return rate assumptions but also apply what investment gains they get from the good years to be prepared for the bad years.  

In 2024, most pension plans reported investment performance above their long-term assumed rates. The Georgia Teachers’ Retirement System emerged as a top performer with a 14.5% return during its 2024 fiscal year, easily surpassing its long-term assumed investment return of 6.9% and its benchmark of 13.88%. The Louisiana State Employees’ Retirement System also delivered strong results, achieving a 14% return for the fiscal year that ended June 30, 2024. The highest-performing investment type for the Louisiana plan was U.S. Equities, which returned 21.8%. Global Multi-Sector/Opportunistic assets followed with a 14.3% return, while Non-U.S. Equities and Emerging Market Debt contributed returns of 13.6% and 9.7%, respectively. 

Each public pension uses its own risk profile and investment strategy, resulting in a range of outcomes each year. Even in years that generate, on average, good investment returns, there are plans that still fall low on the distribution. For example, the South Dakota Retirement System reported only a 5.9% return in 2024, falling short of its 13.81% benchmark and 6.5% assumed return. Over the past three years, South Dakota’s annualized net return has been just 3.62%, well below expectations. 

In general, public pension investment performance has become more uniform in 2023 and 2024 compared to the massive range of outcomes experienced in 2022. The improvement in 2024, with investment returns concentrated around the mean value of 9.9% compared to the average assumed rate of return of 6.9%, mirrors broader equity market trends, where a select group of large technology companies has generated significant market gains.

In 2023 and 2022, public pension plans earned 6.9% and -5.0% on average. 

However, it is important to understand that while returns have become more concentrated among pension plans, this does not necessarily indicate reduced risk or greater reliability. This narrowing of outcomes reflects cyclical market forces, as portfolios remained tethered to tech-sector dominance with undiversified correlations. It also increases systemic risk, as a single shock could ripple across the entire system because pension plans are exposed to the same drivers. 

As of 2023, total unfunded liabilities across state and local pension plans reached $1.59 trillion, with state pension plans holding the lion’s share, according to Reason Foundation’s Annual Pension Solvency and Performance Report.

Stress testing indicates that a recession could exacerbate this figure, potentially raising national unfunded pension liabilities to $2.71 trillion. This highlights the urgency of using additional funds to prepare for potential market outcomes.

In periods when investment returns exceed expectations, policymakers must reserve those gains to act as a buffer for future market downturns. They must resist the temptation to use recent gains to justify new or improved benefits, as cutting out a plan’s upside returns will leave it in a tough spot when fortunes reverse.  

Given recent favorable returns and projected budget surpluses, policymakers should prioritize using recent gains to strengthen their financial footing by accelerating efforts to eliminate unfunded liabilities. Unfunded pension obligations are debts, the cost of which rises significantly the longer a government takes to pay them off. Any effort to address unfunded liabilities (either making supplemental payments or establishing faster amortization schedules) lowers long-term costs on government budgets by reducing mounting interest on that debt, which accounted for 25.6% of added unfunded liabilities from 2000 to 2022. 

To mitigate future risks, it is also prudent to lower the assumed investment return rate, as most public pension plans have been doing over the last decade. While such a move will increase the actuarial costs of future pension benefits and result in additional calculated unfunded liabilities in the short term, it sets a more realistic expectation for asset growth and dramatically reduces the chances for unexpected costs down the road. Historically, underperforming investments accounted for 27.7% of added unfunded liabilities from 2000 to 2022. Adjusting return rate assumptions now will reduce the likelihood of future funding shortfalls and better prepare plans for economic downturns. 

The strong equity returns of 2024 provide a real opportunity for policymakers. They should resist the call to use these returns for additional retirement benefits, especially when most public pension plans remain dangerously underfunded. Instead, they should use this opportunity to improve the long-term stability of public pension plans.

By using these gains to make surplus payments to pay down unfunded liabilities and by adopting more realistic investment return assumptions, public pension systems can safeguard retirement benefits while reducing future risks. This strategic approach ensures that public pension systems remain resilient despite economic uncertainties and continue to fulfill their promises to retirees and taxpayers. 

The post Public pension plans should capitalize on strong investment returns to build long-term stability  appeared first on Reason Foundation.

While allocating these surpluses to new programs is tempting, doing so would establish higher annual budget obligations and likely exacerbate government deficits in the long run. Instead, states should focus on investing these surpluses prudently by paying down expensive long-standing debts, particularly by paying for unfunded pension obligations. 

The National Association of State Budget Officers (NASBO) survey indicates that most states are projecting continued growth in general fund revenues and a slowing in spending for 2025, though a few large states skew the aggregate growth rates. Thirty-three states reported that their 2024 general fund revenues exceeded original estimates. For the 2025 fiscal year, general fund revenues are projected to reach $1.2 trillion—a 1.6% increase from 2024—with 34 states projecting revenue growth.  

On the expenditure side, general fund spending for 2025 is projected to be $1.22 trillion, a 6.2% decrease from 2024. This decrease is largely driven by significant reductions in California (-9.6%) and Florida (-16.5%) and a missed estimate in Virginia. Still, 27 states are budgeting for general fund spending increases, with a median annual growth rate of 1.1% for fiscal 2025. 

With ongoing growth in general fund revenues and better-managed spending, states’ rainy-day fund balances and total balances are strengthening. A rainy-day fund, or budget stabilization fund, is a reserve to cover budget shortfalls during economic downturns. The total balance of a state budget typically includes the leftover general fund (or ending balance) and the rainy-day fund.

In 2024, 33 states are expected to add to their rainy-day fund balances. As the chart below shows, the median rainy-day fund balance as a share of spending is projected to rise from 13.2% in 2024 to 15.0% in 2025, up from 7.9% in 2019 and just 2.0% in 2010. Total balances, including ending balances and rainy-day funds, are projected to reach 23.2% of general fund expenditures by the end of 2025—double the level seen in 2019, NASBO finds. 

These increased balances have helped many states manage fiscal uncertainties and ease long-term budgetary pressures. While rainy-day funds are intended to buffer against revenue shortfalls, surplus general funds are often used for one-time investments, such as paying down debt, making additional pension payments, or taking other proactive economic measures. 

For example, in Connecticut, the state’s rainy-day fund, known as the Budget Reserve Fund, reached its cap of $3.3 billion in 2023, enabling the state to make additional contributions to its retirement systems, including the Teachers’ Retirement Fund (TRF) and the State Employees’ Retirement Fund (SERF). In 2020, the funded ratios—the pension plans’ assets compared to their liabilities—for SERF and TRF were 36.0% and 51.7%, respectively. By 2023, these had increased to 50.4% and 58.1% due to an accumulated $5.8 billion in additional contributions. 

Similarly, Arizona has taken steps to pay down its public pension liabilities, particularly in its Public Safety Personnel Retirement System, or PSPRS. In 2020, the funded status for the pension system’s tier 1 and tier 2 members was 46.9%. Over the next three years, additional contributions from the state and local employers surpassed $5 billion, raising the funded ratio to 66.3% in 2023 and gradually reducing contribution rates from 56.2% in 2020 to 46.0% in 2023.

According to new actuarial modeling from Reason Foundation, the most recent $4 billion infusion into PSPRS (the combined extra contributions from 2022 and 2023) is projected to yield between $863 million and $2 billion in taxpayer savings over the next 30 years, depending on investment performance. 

As states continue to manage budget surpluses and bolster their reserves, they have a unique opportunity to address long-term fiscal challenges. By prioritizing the use of surplus funds to pay down public pension obligations, states can ease future fiscal strain and strengthen their financial stability for the long term. This prudent approach ensures that states are better prepared to weather economic downturns and fulfill their obligations to public employees, ultimately securing a more stable fiscal future. 

The post States should use budget surpluses to pay down public pension debt appeared first on Reason Foundation.

Reason Foundation’s 2024 Pension Solvency and Performance Report provides a comprehensive overview of the current status and future of state and local public pension funds. As the nation navigates another year marked by significant economic fluctuations and demographic shifts, this report aims to assess the resilience and adaptability of U.S. public pension systems. This analysis ranks, aggregates, and contrasts plans by funding health, investment outcomes, actuarial assumptions, and many other indicators.

This report marks the inaugural edition of an annual series by Reason Foundation’s Pension Integrity Project, dedicated to addressing the problem of unfunded public pension liabilities that threaten the fiscal stability of many states, cities, and counties. The objective of this analysis is to deliver clarity and foster a deeper understanding of the challenges confronting U.S. public pension systems, public workers, state and local governments, and taxpayers. The main findings are prominently highlighted in bullet points at the beginning of each section.

Unfunded pension liabilities

Public pension systems in the U.S. have seen a significant increase in unfunded liabilities, particularly during the Great Recession. Between 2007 and 2010, unfunded liabilities grew by over $1.11 trillion—a 632% increase—reflecting the financial challenges faced during that period. Despite some improvements in funding ratios over the last decade, these liabilities have continued to rise, underscoring ongoing financial pressures.

As of the end of the 2023 fiscal year for each public pension system, total unfunded public pension liabilities (UAL) reached $1.59 trillion, with state pension plans carrying the majority of the debt.

The median funded ratio of public pension plans stood at 76% at the end of 2023, but stress tests suggest that another economic downturn could significantly increase unfunded liabilities, potentially raising the total to $2.71 trillion by 2025.

Funded ratios of public pensions

The funded ratio of public pensions, which indicates the percentage of promised benefits that are currently funded, has experienced considerable fluctuations. After peaking at 95% funded in 2007, the funded ratio of U.S. public pension systems fell to 63% during the Great Recession. Although funded ratios have recovered somewhat, they remain susceptible to market fluctuations.

A stress test scenario for 2025, assessing the impact of a 20% market downturn, indicates that the average funding level of public pension plans could fall to 61%. This could lead to critical underfunding for many pension plans, raising concerns about their ability to meet future obligations.

Changes in investment strategies

Over the past two decades, investment strategies of public pension funds have shifted notably. Allocations to traditional asset classes, like public equities and fixed income, have decreased while investments in alternative assets, such as private equity, real estate, and hedge funds, have increased. This shift reflects a strategic move for pension systems trying to achieve higher investment returns in a challenging market environment.

By the reported 2023 fiscal year end for each pension system, public pension funds managed approximately $5.05 trillion in assets, with a significant portion now invested in alternative assets such as private equity/credit and hedge funds. While these alternative investments may offer the potential for higher returns, they also introduce greater complexity and risk.

Pension system investment performance: Overly optimistic assumptions, underwhelming returns

Public pension funds have faced challenges meeting their assumed rates of return (ARRs). Over the past 23 years, the average annual return has been 6.5%—well below what plans had assumed. The average assumed rate of return for public pensions has been gradually reduced from 8.0% in 2001 to 6.89% in 2023. Failing to meet their overly optimistic assumed rates of return has contributed to a large increase in unfunded liabilities, requiring additional pension contributions from state and local governments to maintain funding levels.

Investment returns themselves have varied widely, with public pension plans posting solid gains in 2021 (25.3%) contrasted with large losses in 2009 (-13.0%) and 2022 (-5.0%). This volatility between expected and actual returns has created budgetary challenges for employers.

Employer contributions

As unfunded liabilities have grown, the burden on employers—primarily state and local governments—has increased. Employer contributions to public pensions have risen steadily since 2019, driven by the need to address rising amortization costs associated with unfunded liabilities. In contrast, employee contributions have remained relatively stable, placing more financial responsibility on government budgets.

Despite these increasing contributions, many pension plans continue to operate with negative cash flows, where benefit payments exceed contributions. However, some progress in recent years suggests that pension managers are beginning to address these financial challenges more effectively.

Conclusion

Public pension systems face significant challenges as they navigate rising unfunded liabilities, variable investment returns, and increasing financial demands on government budgets. Without meaningful pension reforms and more realistic assumptions about future investment returns, many public pension plans may encounter further financial difficulties in the years ahead.

This report was produced by Reason Foundation’s Pension Integrity Project—an initiative to conduct research and provide consulting and insight about the public pension challenges our nation grapples with.

Full Study: Annual Pension Solvency and Performance Report

The post Annual pension solvency and performance report appeared first on Reason Foundation.

The Case for Connecticut’s Fiscal Guardrails: How to Protect Public Pensions and Taxpayers examines how they have improved Connecticut’s creditworthiness, making it less expensive for the state to borrow money to finance necessary projects. Moreover, the guardrails have reversed decades of pension underfunding, reducing the risk that Connecticut will face tax increases to make the pensions’ minimum liability payments during a recession.  

The interactive Reason Foundation-Yankee Institute CT Pensions Dashboard explores various economic scenarios for reducing the state’s public pension debt. The study and dashboard are built upon dual pension models of the State Employee Retirement System, SERS, and the State Teacher Retirement System, STRS. The models account for the assumed rates of investment returns, payroll growth rates, cost-of-living adjustment provisions, and mortality assumptions, among dozens of other variables.

Connecticut Pensions Dashboard

The post How Connecticut pensions can save $7 billion in interest costs over the next 30 years appeared first on Reason Foundation.

In 2017, Connecticut faced a severe budget crisis that prompted significant fiscal reforms known as the fiscal guardrails. These reforms established mechanisms to control spending and revenue streams, directing a share of revenue to a Budget Reserve Fund (BRF).

The BRF is capped at 15% of the state’s revenue, with any surplus above this cap allocated to Connecticut’s largest and most underfunded pension systems: the State Employee Retirement System, SERS, and the State Teacher Retirement System, STRS. These supplemental contributions, in addition to the yearly Actuarially Determined Government Employer Contributions (ADEC), have resulted in the allocation of $7.7 billion from budget surpluses to the pension funds since 2017. This strategic approach to pension debt amortization has already decreased annual required contributions by approximately $170 million, positioning both pension plans on a path toward full funding.1

The surplus contributions have markedly improved the financial health of Connecticut’s pension plans, but challenges remain.

SERS and STRS have membership bases covering approximately 5.6% of the state’s population. Since the fiscal guardrails were implemented, SERS, with 57,327 retirees and beneficiaries, has seen its funded ratio increase from 36% in 2016 to 50.4% in 2023. Despite this improvement, SERS still faces $20 billion in unfunded liabilities.

Similarly, STRS, with 39,843 retirees and beneficiaries, improved its funded ratio from 56% in 2016 to 59.8% in 2023, but still has $16.4 billion in unfunded liabilities.

The modeling in this Yankee Institute-Reason Foundation report indicates that if no economic recessions happen in the next 30 years, SERS and STRS could achieve full funding by 2046 through traditional state employer contributions alone. However, if the state continues to make additional annual contributions of at least $1 billion for SERS and $800 million for STRS from surplus revenues, full funding could be reached nearly a decade earlier, by 2037 and 2038, respectively. This acceleration of the pension debt payment would save Connecticut $6.77 billion in interest costs over 30 years, accounting for inflation.

The stress testing modeling scenario indicates that the occurrence of two economic recessions before 2053 could impede full funding, with STRS reaching only 90.3% and SERS 86% by 2053. Even with supplemental contributions, two recessions and their subsequent impact on state revenue could leave SERS with $4.4 billion and STRS with $3.9 billion in unfunded liabilities — and increase total pension contributions dispersed until 2053 by $51.48 billion.

While recessions may delay SERS and STRS from becoming fully funded, supplemental contributions will still move SERS and STRS into firmer financial standing.

The fiscal guardrails have reversed decades of pension underfunding, improving Connecticut’s creditworthiness and financial stability.

This stronger financial position reduces the risk of future tax increases and allows for responsible tax reforms or increased social spending. Therefore, keeping the fiscal guardrails intact is a responsible fiscal policy that benefits the state’s employees, residents, businesses, and taxpayers.

Revoking the guardrails would breach bond covenants, part of Connecticut’s legal documentation with bondholders — putting the state in technical default. This could trigger the downgrading of its bond rating, permanently increasing borrowing costs and stifling the state’s ability to raise capital from private markets.

This report by Yankee Institute and Reason Foundation evaluates Connecticut’s fiscal reforms and their impact on the state’s public pension systems, particularly SERS and STRS. It provides an in-depth analysis of these pension funds’ historical context, status, and outlook—highlighting the fiscal guardrails’ impact.

The study also includes the interactive Reason Foundation-Yankee Institute CT Pensions Dashboard, capable of exploring a wide range of economic scenarios related to reducing pension debt, available at ct-pensions.reason.org.

The study and dashboard are built upon dual pension models of the State Employee Retirement System and the State Teacher Retirement System that account for the assumed rates of investment returns, payroll growth rates, cost-of-living adjustment provisions, and mortality assumptions, among dozens of other variables.

Full policy brief: The case for Connecticut’s fiscal guardrails

Connecticut Pensions Dashboard

The post The case for Connecticut’s fiscal guardrails appeared first on Reason Foundation.

This analysis focuses on 12 state-run public pension plans, representing two primary groups of public workers—teachers and general employees. These plans were chosen primarily because they are relevant to the Pension Integrity Project’s engagement with policymakers to improve the solvency and efficiency of public retirement plans. Politically, these pension plans are all in red or purple states, but this information is relevant to all states because all public pensions are experiencing similar trends in employee separation, and there is little variation in the assumptions used to estimate costs.

We analyze expected withdrawal and retirement rates from these 12 pension systems to find the likelihood of a newly hired public employee (age 30) continuing in various retirement systems over time. Given typical vesting periods for defined benefit (DB) pensions, our analysis shows that most newly hired public workers are unlikely to receive any significant return on their pension contributions.

This graph plots retention probability derived from the withdrawal and retirement rates declared by actuaries of the 12 pension plans in our sample. These rates, which are determined based on historical data and future expectations for each plan’s workforce, reveal much about the dynamics of public employment.

Finding 1: Public employees often leave before vesting

A newly hired employee with a DB plan will likely not remain in their role long enough for their retirement benefits to vest. Combining the 12 plans reviewed, approximately 62% of public workers leave before vesting in their pension plan.

Consider the Teacher Retirement System, TRS, of Texas, which has the highest assumed retention rates in this sample. Even though the plan vests benefits after only five years of service, only 57.8% of newly hired members entering at age 30 will still be in service by this time.

Conversely, the Public Employees’ Retirement System, PERS, of Mississippi has one of the lowest assumed retention rates in the sample and yet requires eight years to vest pension benefits. Mississippi’s actuarial assumptions indicate that only 20.4% of age-30 new hires are expected to remain in service until then.

According to a 2022 Equable study, the average minimum vesting period for a state-defined benefit pension plan is 6.9 years. Public safety plans, on average, require eight years of service, with several plans stipulating 10 years or more of service for retirement benefits entitlement. The average pension vesting requirement for teachers and public school employees is 6.4 years. This means that, across the board, most public employees must often serve around seven years to fully vest their benefits. However, for the plans in our sample, only 35.9% of new hires reach seven years of service.

In short, only a minority of new hires into a plan remain long enough to vest.

Finding 2: Approaching vesting does not increase retention

In the retention curves, we do not see a pronounced change or plateau as employees approach or pass their vesting milestones. This indicates that—according to actuarial estimates based on historical data—public employees do not stay marginally longer in their roles to ensure they vest in their pensions.

This makes sense from the point of view of employees who have not been in their roles for decades because their pension benefits, even if fully vested, are often only accessible far into the future and are insufficient to sustain them through retirement. Most growth in a defined benefit pension occurs in the last few years of service. As the retention graph shows, a minority of newly hired public employees reach 15-plus years of service. For the 12 plans studied, only 24.8% of workers reached the 15-year mark. For those fully vested but not close to 15 years of employment, the expected annual retirement benefit is not enough to provide adequate retirement security, and each additional year of service only slightly increases that amount.

Vesting requirements do not appear to impact public employees’ behavior, suggesting that factors other than pension benefits likely influence their decisions to stay or leave public employment.

Finding 3: Turnover is concentrated among new employees, so pension enhancements are unlikely to improve recruitment and retention

The retention curves illustrate that turnover is heavily concentrated among new employees, with the sharpest drops in retention probability occurring in the first few years of service. Most workers who depart public employment tend to do so early in their careers.

The curve tends to plateau after a decade or two of service, revealing that employees who served for longer tenures are increasingly likely to stay until retirement.

Thus, enhancements to retirement benefit formulas (such as multipliers or years of service) are likely counterproductive to improving public employee turnover. Such benefit enhancements reward those later in their public careers, where retention probability has stabilized.

Since most turnover in public offices is concentrated among newer, less-tenured employees, employers should focus on improving the early years of employment to reduce turnover. Addressing commonly cited grievances and providing desired benefits—such as flexible schedules, remote work options, or higher salaries—are likely more effective in retaining employees.

Finding 4: Only a minority of public workers tend to earn significant pension benefits

Finally, this analysis demonstrates that only a minority of public pension participants will earn substantial lifetime retirement benefits. Most new hires—who leave before vesting—will only get back their contributions upon leaving, but not the significant amounts contributed by their employers to their retirement plans. Even among public workers whose pension benefits do vest, most will go with meager lifetime guarantees that will be significantly diminished by inflation by the time they reach retirement age.

Pensions are designed to accommodate career employees, with benefits becoming most optimal in the later years of a long stint working as a teacher or public worker. However, as this analysis demonstrates, this situation is the exception for the modern public employee, not the rule. Proponents of pensions argue that pensions motivate employees to stick around, but with lengthy vesting requirements and the undeniable majority of new hires leaving before they can enjoy the full advantages of a pension, this is more akin to gating off crucial retirement benefits for most public workers.

With most newly hired public employees leaving before vesting in pension plans and turnover concentrated on the first few years of service, it’s clear that current structures are misaligned with today’s employment patterns. Policymakers should keep the revealed preferences of public employees in mind as they design more sustainable and effective compensation and pension systems that keep and reward talent in the public sector.

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Incorporating non-fiduciary objectives into public pension investment decisions is not a novel concept; the recent push for economically targeted investments (ETIs) represents another example of politically driven intervention putting alternative priorities above responsible considerations like retirement security and the affordability of taxpayer-backed benefits.

This issue has come to the forefront recently in Philadelphia and Jacksonville, where policymakers have intervened in pension fund investment strategies, advocating for allocations toward local projects and businesses.

In Philadelphia, the Philadelphia Public Banking Coalition proposed that the city’s pension fund allocate $168 million—equating to 2% of its portfolio—toward local economically targeted investments, including affordable housing, renewable energy projects, and cooperative development initiatives. Proponents of this plan believe these investments would match but potentially exceed the investment returns of current asset classes, posing less risk compared to the public pension fund’s ventures into derivatives.

In Jacksonville, the office of Mayor Donna Deegan has suggested using pension funds to bankroll significant renovations planned for the city’s municipal stadium. The renovation of the stadium and the development of a surrounding “sports district” are projected to reach up to $2 billion, and the city is considering novel financing strategies. Among these is the proposal to borrow from the Police and Fire Pension Fund and other city employees’ pension funds—all of which collectively hold $5 billion in assets. The idea is to provide a loan that would fulfill the pension funds’ investment return objectives while saving the city from conventional financing costs. 

However, the assumption that pension funds can meet their investment return targets while contributing to the local economy through ETIs is questionable at best, and there have been notable examples of recent ETI losses.

For example, in Pennsylvania, an investment in a local automobile plant resulted in a combined $40 million loss for the state and teacher pension funds. The Kansas Public Employees Retirement System incurred a $73 million loss due to investments in a steel mill and a savings and loan association, both of which later failed. The Connecticut Retirement and Trust Funds also faced a $20 million loss after buying a significant stake in Colt, a firearm manufacturer that declared bankruptcy three years after the purchase.

Economically targeted investments were more common in the 1980s and 1990s before more data and better investment professionals began populating more public pension boards. A 1995 report from the CFA Institute stated that public pension portfolios that engaged in ETIs and other socially focused investments typically underperformed by 43 to 246 basis points annually. Further substantiation from a 1998 study by Marquette University Professor of Finance John R. Nofsinger shows that pension plans investing in ETIs experience notably lower abnormal returns compared to those that avoid such investments. 

Achieving the lofty investment return rates set by public pension plans is already a significant challenge, particularly when viewed against the backdrop of diminishing funded ratios. As of March 2024, the average assumed investment return rate has decreased to 6.91%, a drop from the 7.95% observed in 2007.

In Jacksonville, the pension plan’s investment return assumption has been adjusted downward from 6.625% to 6.5% in 2022, coinciding with the plan’s funded ratio of just 56.93%.

Similarly, Philadelphia has encountered a decline in its pension system’s funded ratio, falling from 60.9% funded to 55.5% within a year. Philadelphia also reduced its assumed investment return, which was adjusted from 7.95% in 2012 to 7.4% by 2022.

These figures highlight pension funds’ growing difficulty in reaching their financial targets, compounding the stress on their long-term sustainability and ability to pay for promised liabilities.

While some politicians may be tempted by calls for public pensions to invest in local economies, a pension board’s duty is to maximize investment returns to fully fund plan members’ benefits and minimize taxpayers’ expenses. Public pension managers must prioritize this duty to earn solid investment returns so they do not compromise workers’ retirement security or overburden taxpayers with debt and rising costs.

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To address growing unfunded liabilities and an evolving workforce, the Alaska legislature closed the state’s two DB pension plans to new public worker hires beginning in 2006. Despite no new members entering the public pensions since then, the annual costs of the Teachers’ Retirement System, TRS, and the Public Employees’ Retirement System, PERS, have continued to grow. This growth would have been far worse had new hires continued to have their obligations added—and subsequently underfunded—in the previous DB system.

Now, citing challenges with recruiting and retaining public workers, legislators, and union advocates are proposing a bill (Senate Bill 88) that would move all members back into the severely underfunded DB pension plan, which could saddle Alaska’s state government budgets with a $9.6 billion price tag.

Proponents of this proposal claim new and prospective hires will theoretically respond to a supposedly better retirement benefit, thus improving the state’s recruitment efforts and ability to keep teachers, police, and other valued public workers. A detailed evaluation of many employment situations by the Pension Integrity Project reveals that this proposed return to pensions would not improve the retirement benefits being offered for most employees, casting major doubt on the desired outcomes of SB 88.

The following tool created by the Pension Integrity Project displays the year-by-year accrual of retirement benefits for a wide variety of Alaska workers in different fields and starting at different ages. The outputs generated in this analysis represent the first annual benefit that a participating member will have earned by each year of employment. The interactive tool allows the users to adjust the entry age (a person’s age when they start employment), assumptions on investment and market returns, and wage growth.

Alaska policymakers should also consider the Supplemental Benefit System-Annuity Plan (SBS-AP) in their evaluations. The SBS-AP replaces Social Security for most of the state’s public employees. The interactive tool allows the user to toggle the SBS-AP on or off to see the impact of this supplementary plan on benefits earned. Currently, teachers do not have access to the SBS-AP like the rest of the state’s workers, which greatly hinders this group’s retirement savings. A new proposal—House Bill 302—would rectify this by making the SBS-AP available to teachers, greatly improving their current DC benefit.

Click Here for the Full Tool:
Alaska Defined Benefit vs Defined Contribution Analysis

This comparison of DB and DC retirement benefit accrual shows that the value of the DC annuity would exceed that of the legacy DB plan for many years of a worker’s service. In most cases, the value of the DB benefits would only surpass the DC plan’s benefits in a worker’s later years of service (after 27 years of service for a non-teacher hired at age 30, for example). Data suggests a worker staying on the job long enough for the defined benefit plan to be better for them is  uncommon in today’s workforce:

• According to assumptions used by the Alaska Public Employees’ Retirement System, PERS, and the Teachers’ Retirement System, TRS, about 50% of new public safety members and 70% of new teachers and other members leave the system within 10 years; and 
• About 60% of new public safety members and 77% to 85% of new teachers and other members leave their jobs within 20 years (assuming an entry age of 25). 

This analysis shows that, while a small group of workers could enjoy an improved retirement benefit by reopening the defined benefit plan, the vast majority of Alaska’s public employees would be better served in the existing defined contribution plan.

Notes on Methodology

• To calculate the annual annuity for defined contribution plans, Reason Foundation’s analysis applies the assumed return to the required contribution amounts for the average starting salary of $80,435 for public safety members, $59,581 for teachers, and $57,949 for other members. 
• In situations where a member would fulfill the requirements for full pension benefits (based on either age or years of service), the analysis assumes the member would also use existing DC savings to purchase an annuity at that point. This can come after just 20 years of service for public safety members and teachers, which (depending on entry age) can mean beginning guaranteed benefits through annuities at an unusually early age, thus generating a significant reduction in the comparable annual benefits from the DC savings. This assumption can be toggled off in the tool with the “DC Annuitization at 60: Off” button.
• The annuity payout rate is the interest rate used to convert the DC balance into an annuity. We assume a life expectancy of 85 for the annuitization calculation.
• To calculate the annual annuity generated by the defined benefit plan, the analysis applies the selected variables to the plan’s existing benefit calculation.

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The issue has recently arisen in Missouri and Pennsylvania, where policymakers have intervened in the investment strategies of their states’ public pension funds to try to apply pressure or to simply send a message about growing domestic concerns with the Chinese government.

While pressure to adopt non-fiduciary objectives into investment decisions of public pension systems is not new, recent calls to throw public funds into the fray on China-related geopolitical matters are the latest example of political overreach.

In Missouri, this issue reached a critical juncture when the Missouri State Employees Retirement Fund board was pressured into divesting from Chinese-owned companies after it had initially rejected calls to do so.

Until 2023, the pension fund had invested approximately $200 million in China, distributed across three investment categories: equity in publicly traded corporations, stakes in privately owned enterprises, and holdings in funds that diversify into multiple stocks and securities. Liquidating the publicly traded equities is anticipated to result in a loss of around $1.3 million for the pension fund.

The Missouri public pension fund’s financial health is already in jeopardy, with its funded ratio dipping to a precarious 58% in 2023. In an effort to mitigate the impending financial disaster, the pension board voted to ramp up the employer contribution rate—which comes from taxpayers—substantially from 16.97% of pay for all years to 28.75% of pay in the 2025 fiscal year, 30.25% of pay in fiscal year 2026, and 32% of pay thereafter.

Pennsylvania’s story is similar, with its state legislature urging the divestment from Chinese companies affecting the State Employees’ Retirement System, SERS, and the Public School Employees’ Retirement System, PSERS. Both public pension systems already have funded ratios well below the U.S. average, at 61.6% funded for PSERS and 68% funded for SERS as of 2022. The employer contribution rate has already exceeded 30% for the teachers’ pension, further straining government finances.

The politicization extends beyond state pension funds to Congress and the academic world. Rep. Greg Murphy (R-NC) introduced the Protecting Endowments from Our Adversaries Act (PEOAA), which aims to penalize private university investments in Chinese entities through hefty excise taxes. This proposed federal legislation underscores the broader issue at hand—the potential for significant financial repercussions when investment decisions are motivated by politics rather than economic rationale.

The funding of public pension plans is already a massive problem. Total state pension debt has surged to $1.3 trillion as of 2023, with only incremental improvements in funded ratios of public pension systems over the years. From a low point of 63.5% funding in 2009, projections for 2023 show public pensions making a gradual improvement to 76% funding. Yet, this means that most state pension plans cannot fulfill the promises made to public workers entirely. State pension funds being 76% funded means they have the assets to pay only 76 cents of every dollar owed to their beneficiaries.

Some U.S. public pension funds turned their attention to China in pursuit of higher yields as interest rates have remained low in Western countries for a prolonged period. This move aimed to meet the ambitious target rates of investment return of some pension systems, which stood at an average rate of return of 6.93% in 2022, a reduction from the 8.07% return assumed in 2001.

China’s significant presence in global benchmarks makes it an indispensable market for benchmark-conscious investors like pension funds. Holding the largest share in the MSCI Emerging Markets Index and the FTSE Emerging Index at 28.39% and 31.03%, respectively, China offers a crucial opportunity for diversification. 

The core mission of public pension plan management should be to generate robust investment returns that fulfill the retirement promises made to workers without overburdening taxpayers. The abuse of pension funds, using them to achieve political objectives, subverts the primary goal of securing a stable retirement for workers. Such a strategy is irresponsible and perilous, risking both the retirement income of public employees and the tax dollars of citizens who will ultimately bear the brunt of underfunded public pension systems.

This tug-of-war between political agendas and fiduciary duty furthers the worrying trend of using public pension funds as a tool to exercise political leverage. Some blue and red states continue to apply political pressure on their public retirement plans by calling for divestment from industries like fossil fuels or even divesting from companies state lawmakers perceive to be antagonistic to fossil fuels. This politicization only makes it harder for pension funds to uphold their fiduciary duty to make decisions based solely on maximizing the return at prudent levels of risk. Whether the interests are environmental or geopolitical doesn’t matter, any political pressure applied to the managers of public pension funds to shirk their fiduciary duty has a cost. 

The post The risky political push to force public pensions to divest from China appeared first on Reason Foundation.

Unfortunately, Assembly Bill 245 does not directly address the primary problems contributing to growing pension-related costs in local governments across the state, including Milwaukee. Truly solving these public pension issues and avoiding additional tax hikes will require emulating the successful public pension reform that has help steer the statewide Wisconsin Retirement System, or WRS, back to a path of affordability and sustainability.    

According to those who worked to pass it, Assembly Bill 245 is crucial to prevent the city and county of Milwaukee from facing bankruptcy and making significant cuts to essential public services like police and fire departments. As per the Wisconsin Policy Forum, a nonpartisan research organization, the city of Milwaukee is expected to experience a $24.2 million budget deficit in 2024, even factoring in $84 million from federal taxpayers via the American Rescue Plan Act (ARPA). This budget deficit is anticipated to grow to $114.3 million by 2025 and $133.7 million by 2028. Similarly, Milwaukee County may have to double or triple its current borrowing limit of approximately $46 million for non-airport projects to address its most pressing costs and financial needs over the next several years.

A Wisconsin Department of Revenue analysis estimates that the city of Milwaukee will generate an additional $193.6 million annually from the newly passed sales tax in AB 245. This type of tax will be new to residents because the city does not currently have a local sales tax. Additionally, Milwaukee County is expected to receive an additional $72.6 million annually through its extra sales tax of 0.375%, adding to its current sales tax rate of 0.5%. Consequently, Milwaukee residents will pay a combined sales tax rate of 7.875% under the new tax structure. Furthermore, under AB 245, Milwaukee will receive an additional $21.75 million from state taxpayers, adding to the existing $217.49 million the city already receives in state aid.

According to the Wisconsin Policy Forum report, the city of Milwaukee’s structural budget deficit arises from three primary issues: increasing public pension costs, limited shared revenue payments, and a state restriction on implementing new revenue sources. 

Since 2000, Milwaukee estimates that its annual shared revenue proceeds, adjusted for inflation, have decreased by $155 million. Additionally, Milwaukee is the only large city among 39 peers in Wisconsin that does not have some form of direct sales tax revenue. On the pension front, the city must contribute $132 million to fund its public pension system next year, up from $71 million in 2023. Although the pension system was 83.4% funded before the 2023 budget adoption cycle, a funding level that exceeds that of many other public pension systems, it still falls short of the mandatory full funding requirement. It is likely to require more funding or major tax hikes to pay for the benefits promised to workers and retirees.

As a result of these challenges, the city of Milwaukee had to resort to budgetary tactics—unleashing property tax dollars and amplifying the ability to allocate additional resources towards pension contributions—to allocate $30 million from the federal ARPA grant to a pension reserve fund. This will only act as a temporary band-aid for the costs because the grant will be exhausted by the end of 2024, and the city will need to nearly double its annual pension contribution from the current amount to continue to make progress on fully funding the pension system.

While AB 245 temporarily relieves the city and county’s fiscal pressures, it does not address the fundamental causes of the budget deficits and unfunded pension liabilities. Specifically, Milwaukee’s rising pension costs have increased unfunded liabilities since the system’s investment losses around the 2007-2009 Great Recession. To ensure the stability of public pension systems and local budgets, Milwaukee must rethink the funding policies and retirement benefits it offers for both current workers and future hires. Luckily, policymakers can emulate the reforms enacted by the Wisconsin Retirement System, widely recognized as one of the most forward-looking and effectively reformed public pension plans of the past few decades.

The cornerstone of the Wisconsin Retirement System’s success with managing runaway costs lies in the flexibility of benefits given to WRS retirees, known as annuity adjustments. All WRS retirees are guaranteed a minimum benefit level that remains inviolable, but the WRS board performs an annual assessment of the five-year averaged investment return and determines the extent to which pension payments can be adjusted. WRS pays a dividend in the form of a benefit increase only if the pension fund’s investment return target is met. This means that state employers and retirement system members share surprise costs caused by investment returns coming in below expectations—an issue that has plagued nearly all public pensions for over a decade.

The retirement benefits offered to Milwaukee employees include an automatic cost-of-living adjustment (COLA) to retirees, irrespective of investment performance. This approach starkly contrasts the policies used by WRS and has generated significant negative impacts for local taxpayers. 

Two critical challenges need to be addressed to implement the proposed pension reforms. First, per the June 2021 report of the “Mayor’s Task Force on the City of Milwaukee’s Pension System,” Milwaukee needs to adopt a more rapid amortization of unfunded pension liabilities, reducing the current practice of funding benefits over 25 years down to 10 years. As a result, the city would require an additional $226 million in accelerated payments per actuarial standards. This move would reduce the interest taxpayers must pay on the pension debt, which is prohibitively expensive in the long term.

Second, state law prohibits the city from making unilateral changes to the pension benefits for city employees hired before Nov. 3, 2011, or for those with the right to collectively bargain. Any pension benefit adjustments for those Milwaukee employees would require arduous negotiations and potential modifications to state law or the city charter.

Furthermore, the city should consider directing future hires to the risk-reduced state plan rather than bringing more members into a public pension plan that continues to generate unexpected costs. This approach would help spare city budgets from so many runaway pension costs in the future.

The newly passed state bill provides temporary relief to city governments via a tax increase. However, Milwaukee needs to urgently tackle the mounting pension expenses burdening the city’s budget. To accomplish this, WRS presents a viable blueprint for overhauling Milwaukee’s retirement system. 

The Wisconsin Retirement System properly aligns a retirement plan’s financial risks and costs to strike a more appropriate and modern balance between taxpayers and public employees, which should be the template for Milwaukee policymakers.

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Cost-of-living adjustments (COLA) are designed to counteract the effects of inflation on retirement income and are generally seen as an optional add-on to a core pension benefit. Between 2010 and 2013, 17 states reduced, suspended, or eliminated cost-of-living adjustments for current public workers and retirees in an effort to address the growing solvency issues of their pension plans. According to an analysis by the Center for Retirement Research at Boston College, eliminating a 2% compounded COLA reduces pension liabilities by 15-17%, making this an attractive option for policymakers facing billions in unexpected pension costs.

Today, with the impact of inflation at the forefront of retirees’ minds, there are growing calls for state and local lawmakers to introduce or restore cost-of-living adjustments for many of these public employee pensions. 

In Washington state, there are frequent proposals to address the loss of purchasing power for the oldest retirees. These proposals aim to institute a COLA for retirees of Plan 1 of the Public Employee Retirement System and the Teacher Retirement System, two plans that have never had a COLA. Washington did have a provision called “gain sharing” in place until 2011, which granted retirees an increase to their annual retirement benefits, but the state was forced to shut that program down after the massive losses of 2009. As the state has only granted one-time increases to benefits over the past few years, Plan 1 retirees are calling for a recurring COLA. Responding to this pressure, lawmakers passed legislation that mandates the State Select Committee on Pension Policy recommend a course of action for implementing a permanent COLA for these retirees.

Similarly, in 2011, the Rhode Island General Assembly enacted the Rhode Island Retirement Security Act of 2011 (RIRSA). The law suspended COLAs for all state employees until the public pension plans’ funding level for all groups, calculated in the aggregate, would exceed 80 percent. Now, 12 years later, despite not reaching the 80 percent funding goal, state legislators are considering a bill that would re-establish a 2.5% compounded annual COLA for retired state and municipal workers and public school teachers.

A decade ago, New Jersey, facing severe pension underfunding, also eliminated its COLA for retired public workers. However, the recent legislative session saw similar pressure from retirees and beneficiaries to reconsider the cost-saving measures of the past. Legislation proposed in the current session, Bill S260, would reinstate an automatic COLA for members of the state’s retirement systems. An automatic COLA is different from an ad hoc COLA, which requires a governing body to actively approve a post-retirement benefit increase. An automatic COLA occurs without additional actions and is usually predetermined by a set of rates or formulas.

There are both advantages and disadvantages to restoring COLAs for retirees and beneficiaries. On the one hand, they can protect against inflation, which is eroding the purchasing power of retirees’ pension benefits due to rising prices. Over the past year, the Consumer Price Index for all urban consumers increased by 6 percent, which can create real budget challenges for some retirees on fixed incomes. 

On the other hand, implementing cost-of-living adjustments can pose a significant and unpredictable financial burden for state and local governments and taxpayers, only adding to the ongoing funding challenges of many public pension plans.

In New Jersey, for instance, public pension funds currently have a funded ratio of just 33.2%, meaning the state only has about one-third of the assets needed to pay for the retirement commitments already made to public workers. If the automatic COLA for plan members were to be reinstated, the state’s contribution would need to rise from $7 billion to an estimated $9 billion annually, and New Jersey’s local governments would need to contribute an additional $1.6 billion per year.

The pressure from retired workers to implement or restore cost-of-living adjustments will continue to be a thorny issue for policymakers, and this pressure becomes all more prevalent if inflation remains high. Nevertheless, policymakers must also carefully consider the long-term costs of COLAs—or any benefit increases—before committing current and future taxpayers to that arrangement. Realistically, most states must first address the underfunding of their retirement plans before adding costly inflation-protection benefits.

The post The costs of proposals to add or restore cost-of-living adjustments for public retirees appeared first on Reason Foundation.

Government pension plans depend on annual investment results to help generate the funding needed to pay for the retirement benefits that have been promised to teachers, public safety, and other public workers. Since investment returns contribute to long-term public pension solvency trends, interested parties keep a close eye on the annual return results of these pension funds to see how they are performing compared to their own assumed rates of return. 

Reason Foundation’s list of public pension investment return results includes all major state pension plans that have reported their 2022 fiscal year results as of this writing.

The distribution of 2022 investment returns shows a significant range of results across all of the state pension plans reporting results at this time.

The Oklahoma Public Employees Retirement System reported a -14.5% return for its 2022 fiscal year, which is the lowest return rate among the public pension plans reporting results.

The New York State and Local Retirement System (NYSLRS) and the New York Police and Fire Retirement System (PFRS) reported 9.5% returns—the highest return rate in the nation for fiscal 2022, although their results are mostly attributed to plans’ 2022 fiscal year ending in March 2022, before the largest market losses in the 2022 calendar year.

Overall, the median investment return result for state pension systems in 2022 is -5.2%, which is far below the median long-term assumed rate of return for 2022 of 7% for the plans included in this list. With return results for the 2022 fiscal year so far below pension plans’ return assumptions, most state pension plans will see growth in their unfunded liabilities and a worsening of their reported funding levels.

With each public pension plan achieving different investment returns, the funding impact will also be different for each pension system.

Methodology

'Estimated Investment Gain/(Loss)' is calculated by taking the plan's FY 2020-21 Market Value of Assets and multiplying it by the difference between '2022 Return' and 'Assumed Rate of Return.' Estimated values are meant to approximate total amounts of investment loss that plans would fully & directly recognize this year due to FY 2021-22 return deviating from the assumption (i.e., not accounting for the smoothing mechanism). Investment returns shown are Net of Fees, if not stated otherwise. ‘Deviation from Assumed Rate of Return’ shows the difference between ‘2022 Return’ and ‘Assumed Rate of Return.' Positive returns are highlighted in light blue, and negative in orange. The distribution of the 2022 investment returns chart is based on the `normalized` probability density function, with all probabilities (i.e., all points on a line graph) summing up to 100%. 

The post The 2022 fiscal year investment results for state pension plans  appeared first on Reason Foundation.

Responding to across-the-board investment underperformance relative to their lofty return expectations, some public pension plans have greatly expanded their investments in high-risk, high-reward assets. More and more public pension fund managers have raised their target investment allocations to alternative assets, such as private equity, private credit, and real estate, over the past two decades in search of the greater returns needed to make up for large unfunded liabilities. Developments from the past few years suggest that many public pension plans do not intend to slow or stop this financially risky practice.

In May 2022, the New York state legislature passed a bill that increased its pension funds’ alternative investment ownership limit from 25 percent to 35 percent. Signed into law by New York Gov. Kathy Hochul just last month, the bill allows riskier investment strategies by the state’s three largest pension funds, with a total value of assets under management of approximately $700 billion.

Before that, other major pension plans took similar actions. In 2021, the nation’s largest public pension plan, the California Public Employees’ Retirement System (CalPERS),  announced a new asset allocation mix that increased the upper bounds put on its alternative assets from 22 percent to 33 percent. The new asset allocation boundary took effect on July 1, 2022.

Furthermore, the board of the Texas Employees Retirement System approved a new target asset allocation to be applied this year which lowers the fund’s public equity ownership to 35 percent from 37 percent and simultaneously increases the allocation to private equity from 13 percent to 16 percent. Similar movements have also been recorded in the Ohio Public Employees Retirement System, the Iowa Public Employees’ Retirement System, and the New Mexico Public Employees Retirement Association.

Public Pension Asset Allocation

The drive behind those reallocation decisions comes from tough economic perspectives and the downtrend of investment assets on public markets. The latest world economic outlook published by the International Monetary Fund (IMF) shows that global economic growth is projected to slow to 2.7 percent in 2023, down from 3.2 percent last year, as more than a third of the global economy likely enters contraction in the next 12 months.

In addition, the IMF says global inflation is expected to remain at a high level of 6.5 percent in 2023, after doubling from 4.7% in 2021 to 8.8 percent in 2022. These conditions indicate a macroeconomic transition to an economy struggling with high inflation and slow growth.

On the stock market, the returns of the two most popular investment assets—public equities and long-term bonds—experienced historically painful drawdowns together. For example, the Wisconsin Retirement System returned a net -7.3 percent for the plan’s fiscal year that ended June 30, 2022, as its two largest asset classes, fixed-income bonds and public equities, posted a net return of -12.7 percent and -16 percent, respectively.

Based on poor annual investment returns from the latest fiscal year that had been reported as of July 2022, the Pension Integrity Project projected that the aggregated funded ratio—the ratio of its liabilities to assets—of state government pension funds in the U.S. would fall from 85 percent funded in 2021 to 75 percent funded in 2022. For instance, CalPERS recently reported a major loss of -7.5 percent for its 2022 fiscal year, compared with its annual assumed rate of return of 6.8 percent. The failure to meet its investment expectations dragged down CALPERS’ funded ratio from 81 percent in 2021 to 71 percent in 2022, meaning it has just 71 cents of every dollar needed to pay for pension benefits already promised to workers and retirees.

Due to those ongoing challenges, many public pension plans are hoping that raising exposure in alternative assets will help deliver decent returns to improve their funded status, protect employees’ benefits against structural inflation, and preserve capital to meet legislative requirements.

On the other side of the coin, both policymakers and pension fund managers should be aware of the consequences of further expanding allocation into risky and volatile investments. The decision directly results in a substantial increase in a portfolio’s liquidity risk, which is usually underestimated by long-term investors. Even more pressing, engaging in riskier investments further exposes governments and taxpayers to the potential of even more unexpected costs driven by unfunded pension liabilities, which is already a major challenge at its current magnitude.

With over $1 trillion in public pension debt already and taxpayers ultimately on the hook to pay for these costs, public pension plans should not be taking on more financial risk. Instead, they should reduce their overly optimistic investment assumptions to reflect the consensus investment return forecasts for the next 20 years. Adopting lower investment return assumptions would improve the chances of meeting expectations and reduce the pressures to take on unnecessary risks.

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