Arizona’s pension plans were nearly fully funded in 2003, but in 2019 had less than two-thirds of the assets needed to provide promised benefits. The state has always paid actuarially recommended amounts into its pension funds, but analysis by The Pew Charitable Trusts has shown that these payments were not sufficient to prevent the growth of the system’s unfunded liabilities. However, this pattern has changed with the funding and benefits policy reforms carried out in 2016. In addition, the state intends to begin stress testing – i.e. the analysis of the fiscal health of plans under different investment scenarios – from public safety plan to end of 2022 under legislation. approved the previous year.
The combination of a decade of rising pension contributions and the strong market recovery in 2021 has had a stabilizing effect on public pension plans. As a result, The Pew Charitable Trusts estimates that pension plan assets have increased by more than half a trillion dollars since 2011, leading to a 50-state funded ratio (the share of pension liabilities backed by the assets of the plan) by more than 80% and total government pension debt of less than $800 billion at the end of fiscal 2021. This represents the highest funded ratio since before the Great Recession and the greatest progress in reducing the funding gap of state pension schemes – the difference between plan liabilities and plan assets – this century.
However, not all public pension funds approach long-term fiscal sustainability, defined as government revenue matching expenditure without a corresponding increase in government debt. Although pension funds are currently enjoying skyrocketing returns on their investments – which plans rely on to cover 60% of the benefits they pay out – Pew estimates that long-term returns will decline to around 6% per year, which is lower than most state pension plans currently budget.
To help policymakers navigate the uncertainty inherent in managing pensions and assess the resilience of their plans, Pew has developed a 50-state matrix of fiscal sustainability measures. The matrix highlights the practices of successful public pension systems, presenting critical data in a single table to facilitate benchmarking and evaluations of state plans. Specifically, these data points shed light on the historical outcomes of policy choices, cash flow measures that determine long-term solvency, and indicators of risk and uncertainty.
Why are the above measurements important and what do they mean?
- Historical actuarial parameters such as the funded ratio – the value of a plan’s assets relative to the pension plan’s liabilities – and the change in the funded ratio over time highlight the impact of past policies on the a plan’s current financial situation. These measures are the basis of any tax assessment; however, they provide little information to assess future investment or contribution risks.
- Current plan financial measures provide a direct indication of whether existing policy is sufficient to repay unfunded liabilities and help public employees and taxpayers determine whether a plan is following funding policies that target debt reduction or is at risk to experience financial difficulties. The metrics are the operating cash flow ratio – the difference, before investment returns, between payments and contributions, divided by assets – and net amortization, which measures whether total contributions to a system of would have been sufficient to reduce the pension debt if all actuarial assumptions (primarily investment expectations) had been met for the year. Based on historical cash flows and funding patterns, these measures help assess the risk of future underfunding or insolvency.
- Government fiscal risk parameters, such as historical contribution volatility – the range between the lowest and highest employer contribution rate over a given period – and the regular practice of stress testing pensions, are designed to help policy makers when planning for cost uncertainty or volatility in the future. Since state and local budgets often bear much or all of the risks assumed by public pension plans, these metrics are critical for long-term planning and can prompt reforms if needed.