How poorly funded are the nation’s public pensions at the state and local level?

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The answer depends on whom you ask and is largely dependent onthe discount rates states use to assess the cost of futureliabilities.

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Discount rates, or the assumed rate of return on investments,are set by plan trustees and vary by pension.

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According to new analysis of more than 280 public pension plansby the American Legislative Exchange Council, theaverage assumed discount rate is 7.34 percent.

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ALEC, and other economists and actuaries, claim that presumedrate of return is too optimistic, ultimately leading to thesystemic under-reporting of liabilities, in turn lowering annualminimum contributions states make to pension plans.

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“In effect, these state governments are relying on unlikelylong-term investment gains to remedy decades of underfunding thepension funds,” ALEC’s report says. The non-profit advocacy’smembership is comprised of mostly conservative state lawmakers andcorporations.

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Instead of the average 7.34 discount rate, ALEC maintains arisk-free rate of 2.14 percent, drawn from an average of 10- and20-year U.S. Treasury bond yields between April 2016 to March 2017,provides a more accurate measure of pensions’ funded ratios.

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ALEC is not alone in advocating for a risk-free measurement offuture liabilities. The Society of Actuaries recommends pensionsuse a risk-free rate to assume investment returns.

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When applying the risk-free assumption on investment returns,the average funding ratio of the plans ALEC analyzed is a paltry33.7 percent. All told the plans carry more than $6 trillion inunfunded liabilities, amounting to $18,676 of unfunded liabilitiesfor every resident of the U.S.

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Earlier this year, Pew Charitable Trusts released its study ofstate-sponsored pension plans, and it put the total unfundedpension liabilities at $1.1 trillion, based on the higher assumedrates of returns states use.

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Using a risk-free assumption creates a seismic difference fromreported funding ratios. For instance, California’s public pensionsreport an aggregate funding level of 70 percent. CalPERS, thenation’s largest public pension fund, uses a 7.5 percent assumedrate of return. However, in applying the risk-free rate of return,the funding ratio for California’s plans drops to 33 percent.

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Wisconsin’s pension plan reports a 100-percent funding level,but under a risk-free rate assumption, it drops to 62 percent. TheBadger State is the only state that can claim a funded-ratio above50 percent using the risk-free model.

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Here is a list of the 10 states with the lowest average fundingratios among the plans they sponsor when applying the risk-freemodel.

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10. Pennsylvania

Funded ratio using risk-free model: 28.1 percent

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Reported funding ratio: 58 percent

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Assumed rate of return in 2015, according to Pew Survey: 7.5percent

9. South Carolina

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Funded ratio using risk-free model: 28 percent

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Reported funding ratio: 60 percent

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Assumed rate of return in 2015, according to Pew Survey: 7.5percent

8. Massachusetts

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Funded ratio using risk-free model: 27.2 percent

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Reported funding ratio: 59 percent

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Assumed rate of return in 2015, according to Pew Survey: 8percent

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7. Hawaii

Funded ratio using risk-free model: 27.2 percent

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Reported funding ratio: 55 percent

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Assumed rate of return in 2015, according to Pew Survey: 7.8percent

6. Michigan

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Funded ratio using risk-free model: 26.9 percent

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Reported funding ratio: 62 percent

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Assumed rate of return in 2015, according to Pew Survey: 8percent

5. New Jersey

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Funded ratio using risk-free model: 25.7 percent

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Reported funding ratio: 57 percent

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Assumed rate of return in 2015, according to Pew Survey: 5.2percent

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4. Mississippi

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Funded ratio using risk-free model: 24.2 percent

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Reported funding ratio: 54 percent

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Assumed rate of return in 2015, according to Pew Survey: 8percent

3. Illinois

Funded ratio using risk-free model: 23.3 percent

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Reported funding ratio: 47 percent

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Assumed rate of return in 2015, according to Pew Survey: 7.3percent

2. Kentucky

Funded ratio using risk-free model: 20.9 percent

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Reported funding ratio: 44 percent

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Assumed rate of return in 2015, according to Pew Survey: 6percent

1. Connecticut

Funded ratio using risk-free model: 19.7 percent

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Reported funding ratio: 47 percent

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Assumed rate of return in 2015, according to Pew Survey: 8.2percent

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Nick Thornton

Nick Thornton is a financial writer covering retirement and health care issues for BenefitsPRO and ALM Media. He greatly enjoys learning from the vast minds in the legal, academic, advisory and money management communities when covering the retirement space. He's also written on international marketing trends, financial institution risk management, defense and energy issues, the restaurant industry in New York City, surfing, cigars, rum, travel, and fishing. When not writing, he's pushing into some land or water.