News: CJ Exclusives

Report: N.C. Pension May Be Underfunded

State has second-highest funded pension but still may be $15 billion in hole

RALEIGH — A recent study concluded that North Carolina’s $87 billion state pension fund is the second-best performing plan in the nation, even though new government-mandated accounting methods show it might be underfunded by more than $15 billion instead of operating in the black, as official state figures claim.

“It is good news” for the state in terms of taxpayer liability and as a recruitment tool to lure business and industry, said Aloysius Hogan, a senior fellow at the Washington, D.C.-based Competitive Enterprise Institute. “Your pension funding is solid.”

Robert Sarvis, a lawyer, software engineer, economist, and Libertarian candidate for Virginia governor in 2013, conducted the meta study, “Understanding Public Pension Debt, a State-by-State Comparison,” for CEI. It amalgamated six separate studies to compile state rankings.

However, Hogan cautioned, $15 billion “is nothing to sneeze at,” and “having to pay these pensions means taxpayers are going to be on the hook. And when you pay it you’re going to have to raise the money either by cutting services or by raising taxes and revenue fees.”

Government officials generally use much rosier financial predictions than the private sector. Public pension plans incorporate a “key fudge factor” in rate of return on investments. By predicting a high rate of return, based on riskier investments, a government does not have to shift as much tax money into near-term funding of the system.

If risky investments tank, higher return projections may not pan out. And because the state officials overseeing the pensions reduced their cash allocations to pursue riskier investments, the pension plans are left underfunded.

The independent, quasi-private Government Accounting Standards Board establishes investment regulations and guidelines for state and local governments. It has a new methodology kicking in this year, “and it does push people to take more conservative estimates” of return on investment, Hogan said.

CEI and others recommend using the 10- to 20-year Treasury bond rate of return, which ranges between 3 percent and 4 percent. That is “the safest way to go, and less risk for your pension obligations means less risk for businesses when they’re interested in selecting a state to locate plants or operations,” Hogan said.

The new accounting procedures are an improvement but do not go “nearly far enough because the stricter standards will apply only if you are less than 80 percent funded,” Hogan said. Therefore, North Carolina would not have to use that methodology.

The six studies looked at pension underfunding as a percentage of a state’s gross domestic product — a measurement of the market value of all goods and services produced.

According to North Carolina’s officially reported figures, the state pension plan has $1.1 billion in assets above its payout liabilities.

But a study by James Naughton of Northwestern University, and Reining Petacchi and Joseph Weber, both of Massachusetts Institute of Technology, arrived at very different results using a 20-year average from 1990-2009.

When re-estimating the plan using fair market value based on Treasury rates, it showed North Carolina’s pension plan was $15 billion in the hole, representing 5.4 percent of the state’s GDP.

CEI did not evaluate the varying methodologies and time periods of the six studies, instead averaging the composite results. The CEI results showed North Carolina’s state pension underfunded at 0.9 percent of state GDP.

That means North Carolina ranked “the second most responsible state in the union in terms of funding their public pension debt,” the same position at which the Census Bureau ranked North Carolina in its study, Hogan said.

“North Carolina has one of the best-funded state pension plans under any reasonable measure because with only one exception in 75 years, the General Assembly has fully funded the retirement system each year,” said Schorr Johnson, a spokesman for state Treasurer Janet Cowell.

“For the purpose of calculating the annual required contribution rate necessary to ensure the current and future financial health of the North Carolina Retirement Systems, the Board of Trustees consistently follows the advice of our actuaries,” Johnson said.

“The North Carolina Retirement Systems assumes a 7.25 percent rate of return on investments, the fourth lowest among state plans,” he said. “This rate is consistent with the median expected return over the next 20 years from a recent asset-liability modeling study.”

“We’re fine with the standards that we have right now,” said Mitch Leonard, a spokesman for the State Employees Association of North Carolina, a major contributor to the state pension plan. He believes that using the new accounting methods would continue to show North Carolina is among the best-funded plans in the country.

“The other [states’] funds are not as well-funded because they don’t meet the standards they need to meet as far as the employer contribution or the employee contribution,” Leonard said.

In the CEI report, Sarvis said one of the problems with state pension funds is that they are defined-benefit, rather than the defined-contribution plans that most private corporations use.

Under a defined-benefit plan, “the amount of benefits to be paid out to future retirees is fixed by a formula and legally guaranteed, so public pension programs that are underfunded may require further infusions of cash, lest they become insolvent,” Sarvis wrote.

A defined-contribution plan allocates a set amount of money to employees to invest as they see fit to best meet their needs.

“There are a lot of legislators who would support a defined-contribution plan,” Leonard said. “We want to stay with the defined-benefit concept because at the end of the road it’s better for the employee.”

Before the long session in 2015 a House committee “will at least get a hard look” at an optional retirement system that would allow employees to choose between defined-contribution or defined-benefit plans, Leonard said.

“If you offered two plans, then that would mean less money would go to the defined-benefit plan. In the long run, that could cause benefit reductions,” Leonard said. “It could hurt the folks who were depending on that who are already retired.”

Dan Way is an associate editor of Carolina Journal.