Pension Funds Well Below 'Optimal Values'

Thu. May 4, 2000 12:00 AM by Brian Decker

Champaign, IL - Over the next few decades, millions of state and local government workers will find out how well their pension plans are funded. Some may be in for a shock.

There is no uniform funding level of public employee pension systems. "Unlike private pension plans, there are no federal regulations mandating minimum funding requirements for state pension plans. What's more, unlike private plans, there is no insurance coverage in case a public pension fund goes into insolvency," said Stephen P. D'Arcy, a professor of finance at the University of Illinois.

To get a handle on the appropriate funding levels for the state plans, D'Arcy developed current and optimal funding ratios after 10 and 40 years. Enough data were available for the UI professor to examine 48 state pension plans. (Massachusetts and West Virginia were excluded because of missing data.)

The results varied "drastically," with 14 state pension systems found in good shape, 18 states in satisfactory shape and 16 states "at levels well below the optimal values, which creates the potential for serious problems in the future."

The 14 states with strong pension systems included Arizona, Colorado, Delaware, North Dakota, Rhode Island and Tennessee. These states currently funded their pension plans at 100 percent or higher and had enough of a projected tax base to sustain future benefit increases.

In the satisfactory category were clustered many of the largest states, among them, California, Illinois, Florida, Pennsylvania and Virginia. These states had plans that, although not currently funded at the 100 percent level, showed a pattern in which the projected tax base and cost of future pension benefits would cover the cost of the benefits earned.

Examining the Illinois State Universities Retirement System, D'Arcy noted that pension funding legislation enacted in 1995 has led to a current 90 percent funding ratio, which is a significant improvement over the 63 percent level in 1992. Based on the recent relationship between the growth in the state's tax base and pension costs, the optimal funding level, however, appears to be 97 percent.

Connecticut, Michigan, New Jersey and Ohio were prominent among the 16 states D'Arcy found in trouble. The states had not only currently underfunded plans, but the gap between pension expenses and state revenues remained wide over projected 10- and 40-year periods.

Indiana, New York, Texas and Wisconsin were noted as needing to increase pension funding. Even though they fund their public pension plans in excess of 100 percent, pension costs are growing faster than the states' tax bases. So even higher funding levels are needed to avoid a funding crisis. D'Arcy said Texas needed a funding ratio of 129 percent in 10 years to adequately finance its pension program.

"Given these flush economic times, states should consider targeting a higher funding level than at present to protect both future taxpayers and future retirees," he said. The research by D'Arcy and two assistants was published in the Journal of Risk and Insurance.