The COVID-19 Economic Collapse Is Absolutely Wrecking State Pension Systems

With some investment returns likely falling as far as 15 percent, states are going to face a cumulative pension debt of between $1.5 trillion and $2 trillion by the end of the year.

Even after an impressive bull run on the stock market, state pension funds across the country were facing more than $1 trillion in unfunded debts even before the COVID-19 pandemic struck.

Now, the gap between what pension funds have promised to current workers and retirees and the funds available to make those payments is expected to grow—perhaps quite dramatically.

With some investment returns likely declining by as much as 15 percent this year, thanks to the COVID-19 pandemic, states are going to face a cumulative pension debt of between $1.5 trillion and $2 trillion by the end of the year. That's according to separate estimates released this week, first by Reason Foundation (which publishes this Reason) and shortly after by the Pew Charitable Trusts.

But the aggregate numbers are only so useful. Some state pension systems were nearly fully funded before the current crisis, and therefore figure to be in better shape to survive it without major problems. States like Kentucky, Illinois, and New Jersey were already in terrible shape are now facing a serious crisis.

"Worse, this is coming after a decadelong bull run in the markets where pensions failed to gain much, if any, ground in terms of funding after the last downturn," says Len Gilroy, managing director of the Reason Foundation's Pension Integrity Project. "It's becoming apparent that we've just experienced a Lost Decade for public pension solvency and that policy makers will need to abandon the failed myth that they can invest their way out of this problem."

We won't know for sure how badly state pension systems got whacked by the coronavirus-induced economic crash until later in the year, but a new tool released by the Reason Foundation's pension integrity project offers a glimpse into the potential damage. Using current data from state pension plans and forecasted investment losses, the tool estimates how much more debt states could be facing by the end of the year.

If its investments lose 15 percent this year, for example, New Jersey's teachers' pension system would find itself with a mere 30 percent of the assets necessary to cover its long-term costs, and with an unfunded liability of more than $40 billion. Illinois' teachers pension plan would be more than $75 billion in the red if it sees similar losses this year.

The economic downturn creates a one-two punch for state pensions. Because of the way most public pension funds are structured, lower-than-anticipated investment returns must be made up with tax dollars. But, now, states are also expecting steep drops in tax revenue.

Already, those prospects are causing some state officials to seek a federal bailout. New Jersey State Senate President Stephen Sweeney has called for the feds to offer low-interest loans to states facing severe pension problems.

But federal taxpayers shouldn't be on the hook to pay for states' mistakes. There have been plenty of warning signs that public pension systems were in trouble.

"Public pension systems may be more vulnerable to an economic downturn than they have ever been," Greg Mennis, Susan Banta, and David Draine, three researchers at the Harvard Kennedy School, concluded in a 2018 analysis that "stress tested" each state's pension system.

Even if annual returns averaged 5 percent, they found, some deeply indebted pension plans in places such as Kentucky and New Jersey would face insolvency. A major economic downturn would be enough to force middle-of-the-road states like Colorado, Ohio, and Pennsylvania to require taxpayer-funded contributions that "may be unaffordable" to avoid insolvency, they wrote.

For years, states have been warned to stop making unrealistic promises about investment returns—a trick used to make shortfalls look smaller than they really are—and to fully fund their retirement systems instead of deferring payments to later years. Both strategies are widespread in state pension systems, and both have contributed to the mess that states now face. Policy makers have clung to the belief that reforms were unnecessary because future investment growth would close the funding gaps.

That idea should now be dispelled. Even a decade of growth wasn't enough for many pensions to fully recover from the last recession—and that should have been a warning right there, if policy makers were paying attention. Now, the deluge.