The looming public pension crisis

There are many issues that we, as a society, are tending to ignore even as they become more severe. One of these is the under-funding of pensions. Around the U.S., the remaining public pension plans have far less in assets than they need. Cook County Illinois, where Chicago is located, is the home of quite a number of pensions that have massive shortfalls. The four largest pensions in Cook County have about 1/4th of the assets that they need in order to meet the benefits that they have promised. Illinois also has a massive funding gap, not including Cook County. This situation has been caused by a number of factors, not least being that the number of active workers per retiree is falling–and will continue to fall–as Boomers retire. This is a problem faced by every country, not just the U.S. Even for Americans, who don’t have traditional pensions, the under funding of pensions should be of great concern. State employees such as teachers, police, and firefighters all rely on these pension plans.

The simple fact is that pension plans have made promises that they cannot afford to keep, given current funding levels. The promised benefits, and the estimates of how much workers needed to contribute, were based on life expectancy that was too low and assumptions about investment returns that were too high. The primary problem in Cook County is that the government entities that promise the pension benefits have also frequently skimped on their contributions, promising to catch up in the future.

Calculating whether a pension is on-track or not requires a lot of assumptions, such as expected rates of return on the plan’s investments, inflation (which is often used to determine cost-of-living adjustments) and how long plan members will live. The consensus opinion, however, is that many of the remaining traditional pension plans are facing a substantial shortfall.

So what are the possible solutions? Going forward, pension plans can increase the contribution levels required of current workers and reduce promised benefits to these younger employees. In effect, younger workers will have less generous pension benefits and contribute enough to cover these benefits and subsidize the current retirees. This solution has younger employees bearing the burden of under funding. This is not generally equitable, however. Another option is providing less than the promised pension benefits to current retirees, a strategy that has been used to keep some private pensions afloat. Illinois’ public pension benefits are protected under the state constitution, so cuts aren’t an option there. Increased taxes are the third solution. If decisions are simply delayed, more cities will end up in the situation of Harvey, Illinois, which laid off active police and firefighters in order to cover pension payments. Yikes.

Some of these issues are severe enough that there are places that I would not want to live because of the potential impacts of coping with under-funded pensions. Who wants to live in a city which is laying off police or firemen or teacher to make up for under-funding their pensions? In addition, if the solution is to raise taxes, this means that residents may see big jumps in tax bills. Finally, places that shift the burden onto younger employees are going to have a harder time attracting young people.