North Carolina’s state pension plan is prepared to weather another recession, a Pew Charitable Trusts stress test says. 

North Carolina has the sixth best-funded state pension plan in the nation. It boasted a 90.7% funded ratio in 2017, leaping over the 73% national average for state and local pensions in 2018, according to Public Plans Data. 

But North Carolina is a rarity. Only two states have almost fully funded their plans, while others have achieved notoriety for the insolvency of their plans. The pension hole for U.S. cities and states rivals the size of Germany’s economy, says Moody’s Investors Service, which estimated underfunding at $4.4 trillion.

“We’re thankful that we’re one of the most secure pension plans in the U.S,” State Treasurer Dale Folwell said Tuesday, Dec. 3, in his monthly “Ask Me Anything.” “For our participants, behind their health and faith and family, the two most important things in their life are the safety and security and stability of the state pension plan and health plan.”

But that rosy percentage often hides a grimmer reality, says Christopher Burnham, Institute for Pension Fund Integrity president.

Most states calculate those funding ratios with a pernicious optimism. If states inflate their assumed rate of returns on investments, they can pretend the pension is far more funded than it actually is.

“It’s a gimmick to balance the budget,” Burnham said. “The higher we put the assumed rate of return, the less money the legislature has to appropriate into the pension fund every year.”

This lets legislators make funding pensions tomorrow’s problem. 

“It kicks the unfunded liability can down the road,” Burnham said. “It threatens the integrity of the funding for our state troopers, our teachers, our hard-working state employees. It also does a disadvantage to the taxpayer, who is going to have to pay an ever-increasing liability down the road.”

North Carolina set its ARR at 7% — a benchmark it hasn’t made for the past 20 years, and stands only half a chance at meeting in the next two decades. 

Folwell has lowered the ARR twice. He deflated it until it dropped well below the 7.3% average ARR for public funds, according to a survey by the National Association of Retirement Administrators. He would like to lower it again, but such a move would have consequences.

Even shaving 0.05% from the ARR would gouge tens of millions of dollars from the General Assembly, as well as from county and city governments. 

“We would love to be able to lower the ARR,” Folwell said. “But that becomes extremely difficult. You’re raising property taxes on some communities as they are losing population. That’s exactly not the trend you want to establish.”

The libertarian Reason Foundation recommends driving the ARR toward 6%, said Zachary Christensen, Reason Foundation senior policy analyst.

“That’s a big ask. It sounds so simple, but you’re saying that whatever you’re paying into the pension plan now, you’re going to be paying more next year,” Christensen said. “That’s a big deal. … But you’re reducing the risk of huge unfunded liabilities and reaching insolvency.”

Christensen credits North Carolina’s top ranking to the state’s foresight in reducing its ARR and its risk.

“It’s one of the better funded plans in the country, and it’s in a much better position,” said Jean-Pierre Aubry, Center for Retirement Research at Boston College associate director of state and local research. “But it faces all of the other challenges facing pension plans today.”

State pensions across the country are grappling with the Federal Reserve’s policy of suppressing interest rates. Since the Great Recession, the Federal Reserve has poured money into squashing interest rates. It hasn’t raised interest rates since 2006 — the same year people first tweeted.

“Low interest rates are really good for families and businesses and everyday living,” Folwell said. “But they are really harming the fundedness of these pension plans. So much of the money is sitting in things that just don’t earn interest.”

All pension plans suffered during the Great Recession, and many were forced to invest in more risky assets. But North Carolina is an example of a plan that emerged from the recession without collapsing into a pension crisis. 

“It’s important to recognize that there’s ways to manage these systems effectively, though the bulk of states don’t follow these approaches,” said David Draine, Pew Charitable Trusts senior officer.