June 22, 2020
Updated: September 14, 2020
The outbreak of COVID-19 has drastically affected the way states have and will continue to conduct business and serve their citizens, and much of these changes have and will adversely affect state revenue generation. The consequences of depleted state revenues have and will be immense, especially if the economic recession resulting from the pandemic will protract.
As state policymakers grasp the financial consequences of COVID-19 for schools, one important area to pay attention isCOVID-19’s immediate- and long-term impact on state retirement systems. In 2001, 13 state retirement systems had funding ratios of at least 100 percent, meaning that a state’s pension fund possessed the required assets necessary to fulfill pension promises made to current and future public retirees; in 2016, not one state retirement system had a funding ratio of at least 100 percent. This downward trend, as stated by the Equable Institute, can be explained by a “…confluence of underperforming investments, missed assumptions, and failure by many states to pay their full actuarially required contributions, have transformed these systems from being almost fully funded to being major drags on their state budgets.” Many of these failures occurred during economic recessions, and with state pension systems still recovering from the 2001 and 2007-2009 economic recessions, the current recession will add another hurdle for state and local pensions as unfunded liabilities grow. Moreover, state and local pension funds allocate over two-thirds of their $4.4 trillion in assets to volatile equity markets and alternative investments, making these funds highly sensitive to market shocks. Despite these financial woes, the burden of growing unfunded liabilities is not spread evenly among states. As seen towards the end of this brief, some states have done well in keeping up with their pension-related obligations, but as seen below, other states have not.
For example, Illinois is one of several states that has struggled to fully contribute to its annual pension bill, failing to do so for eighteen consecutive years. This has contributed to the state’s growing debt in its Teacher Retirement System (TRS), which grew from $22.4 billion in 2001 to $75.3 billion in 2018. The state, like South Dakota and others, is not immune to the nationwide trend one sees of pension obligations occupying growing portions of education budgets; the share of Illinois’s education spending going to pension obligations grew from 12.2 percent in 2001 to 33.5 percent in 2018. With growing pension costs and likely decreases in state revenue following the outbreak of COVID-19, Illinois, like other states, is likely to see greater cuts in dollars that would go to the classroom and serve immediate teacher and student needs.
Due to states partially shutting down their economies, budget shortfalls are imminent, as seen in several states including Virginia, which is dealing with a projected $2.7 billion budget shortfall. As policymakers encounter decreases in funding, they should consider how state retirement systems can be kept afloat, as declining state and local revenues could lead to much sharper increases in unfunded liabilities. As this debt increases, states that use K-12 budgets to cover these costs will continue to pull more money away from other K-12 expenses.
As policymakers investigate how their state pension obligations are paid, it is helpful to consider where the state’s current method of payment is optimal. For instance, if a state is using its K-12 budget to cover pension obligations, it may be worth exploring whether drawing dollars from other sources of revenue, such as a general fund, would be a better method of paying down the debt and avoiding the drawing of public dollars that could be used for making other educational investments. Moving pension payments away from district education budgets would create greater transparency at the state level on how pension obligations are being funded; making this transition would also prevent pension obligations from eating into school district budgets.
As state and local education funding levels change, policymakers should work with districts to understand the long-term budgetary implications of those changes, specifically looking at where pension obligations fit into those forecasts. When developing these forecasts, stress tests can help determine how certain contribution rates would affect district budgets, and create a long-term strategy for covering pension obligations and other important costs.
To mitigate the effect COVID-19 and future pandemics and/or calamities have on funding state retirement systems, policymakers should look to states that have been able to maintain adequate funding ratios. A few states have been able to avoid significant increases in pension debt due to having state retirement plans with realistic investment assumptions and steadfast commitments to covering growing pension costs.
For example, South Dakota’s state retirement system is praised for being a modern and adaptable system with realistic investment assumptions and ability to cater to a mobile workforce. In 2001, the South Dakota Retirement System (SDRS) had $236 million in pension debt. In the following 17 years, however, South Dakota committed to funding the state’s retirement system in full, reporting a $2.3 million surplus in 2018. The state has done good work in funding the SDRS because of a state law requiring benefit adjustments when the funded status of a retirement system is threatened. The state, however, is not immune to the nationwide trend one sees of pension obligations occupying growing portions of education budgets; South Dakota devotes more of its education spending to pensions than it did two decades ago.
Like South Dakota, New York has displayed a steadfast commitment to fully funding its retirement system. As recently as 2010, the New York State Teachers’ Retirement System (NYSTRS), which manages the retirement benefits of 400,000 current and retired teachers, was fully funded, but lower investment returns in the following years contributed to the emergence of an unfunded liability. That unfunded liability, however, was small, as the NYSTRS maintained a funding ratio of 99.2% in 2018. The state prevented a growing unfunded liability by requiring the pre-funding of benefits. Pension obligations occupied 5.5 percent of the state’s education spending in 2018, a five-fold increase from 2001; however, that 5.5 percent is part of a downward trend in the portion of state education spending going to pension obligations, which reached a peak of nearly 10 percent in 2015.