Despite the fact that state and local governments have been increasing their contributions to their retirement systems—totaling about $180.7 billion in 2023—U.S. public pension plans are projected to still have $1.34 trillion in unfunded liabilities in 2024, according to new research from the Equable Institute. 

In better news, the average funded ratio for state and local plans is projected to increase to 80.6% in 2024 from 75.8% in 2023, marking the second largest year-over-year increase in the last decade. 

After a decade of insufficient funding, Equable found that state agencies are now consistently paying 100% of their actuarially determined contributions, and state legislatures have used surplus revenue over the past few years to make supplemental contributions to state pension funds. 

In the 12 months through June 2024, the average public pension fund’s 7.4% investment return beat the funds’ average 6.9% assumed rate of return, the main target to hit each year in order to prevent further growth of unfunded liabilities. All asset classes had strong performances over the last year, especially in the period from January through June 2024, which helped investment returns. 

Pension Debt Paralysis 

While this is a welcome improvement, Equable reported that it will require additional years of similar performance to break public plans out of their “pension debt paralysis.” 

Anthony Randazzo, Equable’s executive director, said in a briefing about the research that volatility in investment returns for public plans has “dramatically increased” since the pandemic. 

“In fact, volatility is approaching levels last seen during the [global] financial crisis,” Randazzo said. “So for … public pension [sponsors] who value stability and steady improvement, this is a significant concern.” 

The “record contributions” to pension funds have been insufficient to prevent interest on unfunded liabilities from continuing to accumulate. According to Equable, interest on the pension debt is the fastest-growing contributor to unfunded liabilities over the last two decades. 

As a result, Equable argued in its report that states and cities are not doing enough to eliminate unfunded liabilities, which are driving steadily rising contribution rates that will lead to more costs in the long run. 

“Government complacency is harming taxpayers with lower quality public services and harming public employees who are experiencing reduced benefit values and insufficient inflation protection—problems which are not likely to change even with good investment returns,” the report stated. 

According to Equable, pension debt paralysis has caused average public employer pension contributions to increase to 31.3% of payroll from 17.3% between 2008 and 2024. 

Negative net cash flows from contributions and benefit payments have also steadily increased over the past two decades, reflecting more “mature” pension plans. However, larger negative cash flows put increased pressure on investment return each year to make up for the difference.  

Causes of Unfunded Liabilities 

Jonathon Moody, vice president of research at Equable, explained that some of the main causes of unfunded liabilities are underperforming investments, interest on the unfunded liability growing faster than employer contributions, and changes to liabilities due to adopting new actuarial assumptions. 

According to the report, the largest contributor to the $1.2 trillion in unfunded liabilities in 2022 was necessary improvements to actuarial assumptions.  

The improvements to assumptions include more accurate expectations about investment returns, payroll forecasts, mortality rates and more. While the funding shortfall is a problem, Moody said it is a good thing that public pension funds are improving the accuracy of their accounting.  

“[Pension plans] are improving the accounting for pension liabilities and investment, which suggests that, in the past, pension funds were less accurate in their actuarial assumptions,” Moody said.  

Status Varies By State 

Looking at 2024 estimated funded ratios by state, many states are projected to have improved their average funded status from 2023 to 2024, including Delaware, Maryland and West Virginia, all of which moved up into the 90% funded status range. South Carolina was the only state to move from the less-than-60%-funded category to the 60%-to-70% category. 

Overall, Equable found that funded ratio and unfunded liability levels vary considerably from state to state. For example, a small group of states have historically resilient statewide pension systems, including New York, South Dakota, Tennessee and Wisconsin.  

Meanwhile, more than 13% of all statewide plans and local plans were considered “distressed” in 2023, as these plans face a considerable uphill climb to recovery. The costs of paying down unfunded liabilities for these plans, such as the Teachers’ Retirement System of the State of Illinois and Kentucky Employees Retirement System Nonhazardous, are challenging for state budgets, but Equable argued that costs of insolvency and shifting to “pay-as-you-go” could be even more expensive.