August 2, 2010

NCPA Study: Liabilities of Defined Benefit Plans Are Underestimated

Four states have unfunded liabilities above 35% of their state GDP

Many state and local governments that offer defined benefit pension plans to employees underestimate these plans' liabilities because they use high discount rates in their calculations, according to a new study released by National Center for Policy Analysis (NCPA) on Thursday, July 29.

According to the study, accounting standards allow pension funds to calculate their liabilities using a discount rate comparable to the expected rate of return on the funds' assets. This typically high discount rate tends to reduce the size of a pension plan's accrued liabilities. However, because pensioners have "a durable legal claim to receive their benefits," use of a lower discount rate in calculating the plans' accrued liabilities is more appropriate, the researchers write.

As a result of the use of high discount rates, they said, state and local government pension plans' liabilities are underestimated, and taxpayers' role as de facto insurers for government plans may be much greater than anticipated.

In addition, state and local governments often provide other retirement benefits as well, especially postretirement health care benefits. Unlike pension plans, most of these non-pension benefit plans are completely unfunded, with no assets being set aside to fund the obligations. The Pew Center on the States earlier this year reported that non-pension benefit unfunded liabilities across all states were about $537 billion in 2008.

The NCPA study estimated that the reported unfunded liabilities of state and local governments for pensions and other postemployment benefits totaled $1.03 trillion, but when researchers recalculated these unfunded liabilities using a more appropriate discount rate, the total unfunded accrued liability was much higher.

Researchers analyzed 153 state and local pension plans, repre-senting more than 85% of liabilities for state and local pensions and other benefits, and recalculated their liabilities using a lower discount rate. These calculations show:

? Unfunded pension liabilities are approximately $2.5 trillion, compared with the reported amount of $493 billion.

? Unfunded liabilities for health and other benefits are $558 billion, compared with the reported $537 billion.

? Thus, total unfunded liabilities for all benefit plans are an estimated $3.1 trillion--nearly three times higher than the plans report.

State and local govern-ments' reported unfunded obligations under pension and other benefit plans amounted to 7.1% of U.S. GDP in 2008, according to the study. But when adjusted using a more appropriate discount rate, states' unfunded obligations skyrocketed to 22% of U.S. GDP. All but 10 states and the District of Columbia have total adjusted unfunded liabilities above 15% of their state GDP, and Alaska, Hawaii, New Jersey and Ohio have adjusted unfunded liabilities above 35% of their state GDP.

Michael S. Fischer (msf7@columbia.edu) is a New York-based financial writer and editor and a frequent contributor to WealthManagerWeb.com.

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