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Maryland’s $73 Billion Pension Liability

Only 34 percent funded

September 18, 2013

Maryland’s state pension system has over $73 billion in unfunded liabilities.

According to a new report from State Budget Solutions, which pegged the total amount of unfunded liabilities for all the states at $4.1 trillion, Maryland’s public employee pension fund is just 34 percent funded.

The report drew on figures from the U.S. Census Bureau’s Annual Survey of Public Pensions and fiscal year 2012 Comprehensive Annual Financial Reports from the states.

According to the report, Maryland’s unfunded liability works out to a cost of $12,416 per taxpayer and represents 23 percent of Maryland’s gross state product—the total amount of the state’s economic output.

Using fiscal 2012 figures the State Budget Solutions report pegged the state pension fund’s actuarial assets at $37.4 billion.  The system reported a 10.6 percent return on its investments for fiscal year 2013, which increased the fund’s assets to $40.2 billion.

In July Moody’s Investor’s Service calculated Maryland’s pension liability at $67.6 billion, but only 33 percent funded.

No matter, which numbers you choose, the massive unfunded liability is a concern as they represent a significant percentage of the state’s economy, and put already overburdened Maryland taxpayers and businesses on the hook to cover the gap.

Maryland has made several changes to its pension system over the last several years, including shifting the cost of teacher pensions to the counties, and moving away from the “corridor method” of funding over a period of 10 years.  The corridor method allowed the state to pay hundreds of millions less than what actuaries required.

In July, the pension board lowered its target rate of return from 7.75 percent to 7.55 percent, and its expected rate of inflation from 3 percent to 2.8 percent.  A move critics say is another way to allow the state to avoid increasing payments into the system.

The report is critical of the flawed funding practices of many of the states, that undervalue the true amount of the liabilities and allows states to contribute less than they should to their pension plans.  State Budget Solutions recommends a market value approach.

This fair-market valuation shows the tremendous impact that the choice of a discount rate has on funding health. It demonstrates the extent to which current funding practices undervalue the retirement promises made to public employees. According to official reporting, the overall funded ratio of state plans included in this report is 73 percent – a far cry from the 39 percent level that a fair-market valuation has revealed.

The size of a pension plan’s liability is based greatly on the discount rate used in a valuation. Public pension plans discount liabilities in order to determine how much must be paid into the fund today to guarantee funding for benefits that will be paid in the future. The process involves starting with the amount of money that is projected will be owed and subtracting interest each year to arrive at a present value.

Current public sector practices involve discounting a liability according to the assumed investment returns of plan assets, typically around 8 percent. Yet with discount rates tied to expected investment performance, plan sponsors can easily take on greater risk in order to make liabilities appear smaller. This reduces the resources required today to pay for the promises of tomorrow.

Accurately accounting for a pension system’s liability requires incorporating the nearly certain nature of benefits. That is, once promised, the chances that benefits will not have to be paid are extremely low.

A fair-market valuation does away with optimistic investment return assumptions and instead uses a rate that reflects the risk of the liability itself. One common approach, taken here, is to discount liabilities according to the yield of a 15-year Treasury bond.

State Budget Solutions used the August 2013 15-year Treasury Bond yield rate of 3.25 percent discount state plan liabilities.

Mark Newgent

Mark Newgent is the editor of Watchdog Wire - Maryland, and a contributing editor to Red Maryland, the premiere blog of conservative politics in the Free State, voted one of the best state political blogs by the Washington Post two years in a row. His writing has appeared in the Baltimore Sun, Washington Examiner, National Review Online, and more. Contact: Maryland@WatchdogWire.com, Twitter: @MarkNewgent

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Categories: Budget and Finance, Must Read, Public Employee Pensions
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