Colorado and South Carolina have pulled back from making additional payments to their underfunded pensions, moves that may play out in other states that are struggling to balance budgets as the coronavirus ravages tax revenue.
Colorado eliminated a $225 million supplemental payment to the state’s Public Employees’ Retirement System, backing away from a 2018 plan to bolster the pension, which is about 60% funded after suffering from years of inadequate government contributions. South Carolina suspended a statutorily scheduled 1% employer contribution increase for the fiscal year beginning July 1.
And New Jersey, which has one of the nation’s worst-funded pensions, has deferred a $950 million pension payment until September and Governor Phil Murphy’s plan to increase contributions 13% to $4.6 billion is in question.
“There’s definitely going to be pressure in some places to not pay annual required contributions because of revenue shortfalls,” said Gene Kalwarski, the chief executive officer of Cheiron, an actuarial consulting firm. “States are going to have to make up the shortfall somehow, some way.”
States are projected to face budget shortfalls of about $555 billion through 2022, according to the Center on Budget and Policy Priorities, and without more aid from Washington they will have to cut spending or raise taxes. Postponing pension payments may ease budget pain in the short-run, but it will defer the costs to later years and allow unfunded liabilities, estimated at as much as $5 trillion by the Federal Reserve, to grow.
Unfunded obligations have kept rising despite steady investment gains
The pension contribution cuts are setbacks for states that enacted reforms in the aftermath of the Great Recession.
In 2018, Colorado passed legislation to raise employee and employer contributions and require an annual lump sum payment of $225 million to the pension. Colorado also capped future cost of living increases at 1.5% and raised the retirement age to 64.
In 2017, South Carolina increased scheduled employer contribution rates by 1% annually starting in fiscal 2019 until they reach slightly more than 21% by fiscal 2023. The pension, which in 54% funded, reduced the amortization period for its $23 billion shortfall to 20 years from 30 -- requiring it to pay off the debt faster -- and reduced the assumed rate of return to 7.25% from 7.5%.
Colorado’s decision to defer the $225 million payment from its budget was a “credit negative,” allowing the pension’s unfunded liability to grow at a compounding rate of 7.25%, the expected rate of return on its investments, Moody’s Investors Service said on July 27.
Although pension assets rebounded in the second quarter after losing almost $1 trillion when the pandemic caused a stock market plunge, pensions almost certainly missed their targeted annual investment returns of about 7% for the fiscal year that ended June 30, meaning the unfunded obligations likely increased. California Public Employees’ Retirement System, the biggest U.S. public pension, gained 4.7%, falling short of its 7% target for the second straight fiscal year.
Record state budget gaps could reignite efforts by officials to reduce pension benefits, raise employee contributions or eliminate traditional pensions altogether, Kalwarski said.
South Carolina’s Republican Governor Harry McMaster wants to close the state’s $32 billion defined benefit pension plan and move all new state workers into a 401(k)-style plan.
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