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.
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.
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.