In recent months, there has appropriately been substantial and growing attention to underfunding in state and local government pension plans. Best available estimates are that such underfunding equals roughly $3 trillion dollars in present value  creating an unsustainable situation that must compel corrective action by elected officials. At the state and local levels of government, those in office will need to effect measures to bridge the significant gap between these plans’ projected assets and benefits.
Adequate legislative reforms are, however, unlikely to occur at the state and local levels unless federal officials convincingly clarify that no federal taxpayer bailout will be forthcoming. This predicament is the basis for pending federal legislation such as the Public Employee Pension Transparency Act  which requires fuller disclosure of state/local pension-plan obligations and would withhold certain federal tax benefits from states that fail to comply. Closing off the avenue of a federal bailout will not by itself force states and localities to eliminate unfunded pension liabilities. Yet at the same time, the existence of these liabilities is already creating pressure for direct federal support to states. In any event, the current policy focus with respect to these public plans is on ameliorating their underfunding, as well as on limiting momentum for a general taxpayer-financed bailout.
At the same time, there exists a similar (though smaller) set of financing risks in the employer-sponsored pension plans covered by the Pension Benefit Guaranty Corporation (PBGC), the federally chartered corporation established to insure employer-provided pension benefits. Here, too, public-policy corrections are required to address underfunding and to contain the risk of a taxpayer-financed bailout.
While the inadequacy of funding information provided to the PBGC renders impossible a precise estimate of all underfunding in such plans, reasonable estimates are in the hundreds of billions of dollars . PBGC’s latest annual report  shows a net negative financial position for its insurance programs of more than $23 billion, of which roughly $21.6 billion is attributable to the PBGC’s single-employer insurance program. PBGC’s estimate of its exposure to reasonably possible terminations of such plans is approximately $170 billion. While these figures may appear small relative to the large potential losses in state and local plans, percentage underfunding in employer-provided plans is nearly comparable.
This paper begins by reviewing the magnitude of and reasons for the substantial underfunding in our employer-provided defined-benefit pension system. These reasons will include both localized financial factors—such as the recent recession, the opacity of asset/liability measurements, and the inadequacy of insurance premium assessments and funding rules—as well as the broader moral hazard and political economy factors that underlie these phenomena. This paper will further explore the moral hazards that operate within virtually all defined-benefit pension plans in the U.S., from employer sponsored plans, to state/local plans, to Social Security. These moral hazards in all defined-benefit sectors establish substantial incentives for sponsors to obscure a plan’s true funding status and to shift the risks of its underfunding to others.
1 Rauh, Joshua, “Are State Public Pensions Sustainable?”, National Tax Journal, September 2010, 63(3), 585-602. “Official” state measurements produce figures significantly smaller—closer to $500 billion in underfunding—but these calculations account inadequately for risk, as discussed later in this paper.
2 See H.R. 6484, http://www.govtrack.us/congress/bill.xpd?bill=h111-6484.
3 Blahous, “Pension Wise,” Hoover Institution Press, 2010.
4 http://www.pbgc.gov/docs/2010_annual_report.pdf, pp. 19-21.