Southern Legislative Conference (SLC) States and the Annual Required Contribution (ARC) to Public Pension Plans
Among the myriad fiscal challenges confronting states is adequately funding their public pension plans. The most important way states carry out this function is by making the Annual Required Contribution (ARC) toward the public pension plan, an appropriation designated to cover the benefits accrued that year and to pay down a portion of any liabilities that were not funded in prior years. Since 1994, when the Governmental Accounting Standards Board (GASB) introduced the concept of the ARC, policymakers and those reviewing the performance of public pension plans have often looked to a state’s ARC to determine their commitment in bolstering the funding position of their pension plans.
In determining the ARC for a public pension plan, experts and actuaries calculate expected revenues flowing into the plan from several sources, such as investment earnings and employee contributions, and then alert policymakers about the precise ARC number based on actuarial and other calculations. The legal foundation for states continuing to make their ARCs flow from a variety of sources including statutes, ordinances, bound rules, case law and, in certain instances, state constitutions. For most states, there is an implicit or explicit legal obligation that the ARC will be paid in full. In addition, some state laws require that any increase in either benefits or employee contributions have to be approved by the appropriate authorities, in some instances the state legislative body, in that state. In the past three or so years, the credit rating agencies have started paying a great deal of attention to ARCs and the funding position of public pension plans. In fact, these rating agencies have indicated that the funding ratio of the public pension plan in question remains one of the factors considered when determining the overall credit rating of that particular state or local government.
Public Pension Trends & Developments
The Southern Legislative Conference (SLC) has intensely focused on public pensions and the entire retirement architecture of the United States for more than 15 years. An SLC presentation before the Alabama Legislature a few years ago captures some of the important trends and developments on the topic. Even though the presentation is several years old, the essential elements of the presentation remain valid and provide a good synopsis of the topic. This presentation may be viewed here. Some of the strategies adopted by dozens of states to bolster their public pension plans include: increasing employee contributions; limiting COLA increases (a strategy complicated by recent court decisions); increasing age and vesting limits; trimming benefits; and issuing pension obligation bonds.
In the wake of the 2008-09 market decline and Great Recession, nearly every state and many cities have taken steps to improve the financial condition of their retirement plans and to reduce costs. Although some lawmakers have considered closing existing pension plans to new hires, most determined that this would increase – rather than reduce – costs, particularly in the near-term. Based on the most recent information provided by the U.S. Census Bureau, 3.9 percent of all state and local government spending is used to fund pension benefits for employees of state and local government. Pension costs have remained within a narrow range over a 30-year period, declining from a high point of 5 percent to a low of 2.3 percent in FY02, and reaching 3.9 percent in FY12. State and local governments contributed, in aggregate, an estimated $109 billion to pension funds in FY13, a figure equal to 3.9 percent of projected state and local direct general spending for that year. This February 2015 National Association of State Retirement Administrators Issue Brief, entitled 'State and Local Government Spending on Public Employee Retirement Systems,'provides more details on these trends.
State Retirement Systems: Recent Trends
Public Pensions: Emerging Trends
Public pension systems continue to face significant challenges, a trend that has continued for more than a decade. While public pension difficulties alone would not be a destabilizing force on the economy, the fact that every other element of our nation's retirement architecture also faces complex challenges requires the urgent attention of policymakers at all levels of government. The funding difficulties facing the Social Security and Medicare systems; the rising funding gap at corporate pension plans, record deficits at the Pension Benefit Guaranty Corporation (or PBGC, the federal entity that insures the benefits of private pension plans), low personal savings rate of so many Americans alongside the minimal amounts they have set aside for retirement, the "graying" of America with an increasing number of Americans now reaching retirement age and living longer; and the aforementioned public pension challenges cumulatively amount to a tsunami of red ink.
State Retirement Systems: Recent Trends
State Retirement Systems: Recent Trends
It is a great honor to be here this morning and I thank Representative Josephs and Representative Roebuck for extending this invitation to me and to The Council of State Governments (CSG). While I work for CSG's Southern Region, the Southern Legislative Conference in Atlanta, Pennsylvania is served by CSG's Eastern Region, the Eastern Regional Conference, located in New York City. I bring greetings from Wendell Hannaford, the ERC Director and I know a number of Pennsylvania legislators are active with the Eastern Regional Conference and we do appreciate their support and involvement.
My presentation deals with a topic that has enormous implications for state finances: public pensions. This is a topic that I have been exploring for some years now and I continue to study and highlight this critical issue in presentations and publications before legislative and other audiences. It is important to note that there are two issues here: one, the enormous investment losses public pension plans have experienced in the last six months, and two, the fact that even before these losses, an increasing number of public pension plans faced significant funding challenges.
Broadly, my presentation comprises five interconnected parts. Part I explores the impact of recent market losses on state retirement systems. Part II reviews why it is important for policymakers to focus on the financial position of state retirement systems. Part III looks at where we stand in terms of state pensions and Part IV provides a snapshot of several key developments related to these plans. Finally, Part V describes the various strategies deployed in states across the country to bolster their pension systems.
What is the most recently released data on the asset mix of the nation's state retirement plans?
The turmoil on Wall Street in the last few weeks–with the Dow careening 778 points downwards on a single day in September 2008, the largest point drop ever, when the U.S. House of Representatives rejected a financial bailout plan–continues to befuddle policymakers and citizens alike. As we await the positive developments of the recently enacted Emergency Economic Stabilization Act of 2008, Americans across the country anxiously monitor their own perilous financial positions. The current turbulence on Wall Street comes at a time when state finances were already under a great deal of pressure. Even though state revenues had begun to recover from the recession that swept over the country at the beginning of this decade, several disturbing fiscal signs began to appear by late 2006 and early 2007. The nation's housing market, which had been a major contributor to the surge in economic activity in the aftermath of the 2001 recession, began to crumble as a result of a mortgage meltdown.
How have these developments from impacted state finances? One of the ways involves the adverse impact of the ongoing Wall Street tumult on a state's investment portfolio. In the last 15 years or so, states have moved aggressively away from the more staid but secure U.S. Treasury bills to more exposure to non-governmental equities, such as stock in many of the financial firms that have either disintegrated or been negatively affected by recent trends. Thus, it is a safe assumption that most states have some exposure and that their overall portfolios have eroded.
The October 2008 Question of the Month relates to an inquiry that sought to determine the asset mix of the nation's state retirement plans. Four of the top 10 plans in the nation are under SLC states, while at the other end of the spectrum, three of the bottom ten belong to SLC states.
|Top Ten Plans|
|Bottom Ten Plans|
Funded Ratio Percent (1)
Percent of Cash & Deposits in Total Portfolio (2)
Percent of Governmental Securities in Total Portfolio (3)
Percent of Non-Governmental Securities in Total Portfolio (4)
Percent of Other Investments in Total Portfolio (5)
State Retirement Systems: Recent Trends
My presentation this afternoon deals with a topic that has enormous implications for state finances: under-funded and unfunded state pensions. This is a topic that the SLC has been exploring for some years with reports issued in May 2000 and October 2004. The SLC continues to study and highlight this critical issue in presentations and publications before legislative and other audiences.
Broadly, my presentation comprises four interconnected parts. Part I presents why it is important for policymakers to focus on the financial position of state retirement systems. Part II looks at the finances of state retirement systems and Part III provides a snapshot of several key developments. Finally, Part IV describes the various strategies deployed in states across the country to bolster the finances of their pension systems.
There is growing consensus across the country that more attention needs to be directed toward retirement planning and developing a retirement infrastructure with the capacity to absorb the needs of all Americans. In this context, there are four major reasons why the financial future of state retirement systems requires the urgent attention of policymakers.
America's Retirement Architecture: Strains in the System
My sincere thanks to ACRE for extending this invitation to me and to The Council of State Governments to be a panelist at this session on state pensions. Established in 1933, The Council works primarily with state legislatures in tracking trends, carrying out research and analysis and promoting state interests. While I work for The Council's Southern office, the Southern Legislative Conference in Atlanta, the Council is headquartered in Lexington, Kentucky and has regional offices in New York, California, Illinois and Washington, DC.
My remarks this morning will deal with the challenges confronting state and local government retirement systems in recent years. Primarily, I will draw on my research in preparing a 50-state review of our nation's public retirement systems (published in October 2004) and my ongoing study of this issue. Lawmakers in almost every state grapple with unfunded pension liabilities and the urgent need to devise solutions to ensure the solvency of these retirement systems in an environment where state finances continue to be under stress. After providing a broad overview of the public retirement system landscape, including several emerging trends, I will detail a number of strategies adopted by states across the country to bolster the financial position of their respective pension plans.
Any discussion of the financial position of public retirement systems has to be placed in the context of the overall health of state finances. States are finally seeing improved revenue numbers and for the just concluded fiscal year, 2005, revenues exceeded original budget projections in 42 states while three others met their targets. Revenue in only five states came in below projections. Sales, corporate and personal income tax flows have all performed admirably. This is a marked improvement from the prior four years when states battled a fiscal downturn termed the worst in six decades. Since fiscal year 2001, states closed a cumulative budget gap that surpassed $235 billion by adopting a range of difficult choices.
America's Retirement Architecture: Stresses in the System
Stresses in the System: America's Public Retirement System
America's Public Retirement Systems: Stresses in the System
Full Report (6.2 Mb)
Introduction and Chapter 1: History and Origins of Public Retirements Systems
Chapter 2: Sources of Retirement Income: Social Security, Private Savings and Corporate Pension Plans
Chapter 3: Economic and Fiscal Variables Influencing Public Sector Retirement Systems
Chapter 4: Analysis of Federal Government Data on Public Sector Retirement Systems
Chapter 5: Analysis of Information in The Council of State Government's Southern Office Survey
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