A December issue brief from the National Association of State Retirement Administrators (NASRA) provides encouraging information about the way states have been funding their annual pension contributions in recent years – a major improvement from the past when a number of state contributions failed to engage in good funding practices. 

This improvement is very good news for the world of state and local pensions. As Keith Brainard, longtime research director at NASRA told us, “There’s no factor more important than the employer contribution in terms of the funding condition of public pension plans.”

Of course, it’s easier to keep funding at a strong pace when state funds are flush, as they have been in recent years. Still, state and participating local governments deserve credit for developing responsible pension funding methods, with contributions in fiscal year 2022 and 2023 coming in over Actuarially Determined Contributions (ADC), which are the amounts actuaries determine are necessary to keep pension plans sufficiently funded. 

The chart below illustrates the pattern of funding since 2001 and the narrowing of the gap between what governments needed to put in to reduce pension unfunded liabilities over time and what they actually contributed.

As the brief points out, the $164 billion in contributions from employers and employees in fiscal year 2023 jumped above those made in 2022 by 7.7%. Employers’ contributions provided 76% of the total ADC in 2023, with the split between employers and employees differing depending on the state and plan. 

Investments of annual contributions brought in $10+ trillion of public pension revenue between 1994 and 2023 -- about 61% of the revenue raised in this 30-year-period, according to NASRA. 

Short-changing the contribution carries long-term consequences since the size of the ADC grows as unfunded liabilities rise. “Failing to pay required contributions results in higher future costs due to foregone principle and investment earnings that the contributions would have generated,” the brief explains.

The importance of providing adequate annual contributions was vividly evident in the early years of this century when many pension funds saw unfunded liabilities grow due to underfunded contributions, as well as outdated actuarial assumptions. Investment declines that were out-of-line with actuarial assumptions also added to rising problems.

These additional factors also have a strong impact on pension funding health, but contributions are particularly in the hands of the employer. “One factor that’s just 100% within control of the plan sponsor is their contribution adequacy,” said Alex Brown, NASRA research manager. 

Some states with particularly large unfunded liabilities – for example, Illinois, Kentucky, Connecticut, and New Jersey – have born the consequences of inadequate contributions in the 20th century or past benefit increases that raised pension costs without a parallel increase in funding. “Twenty or thirty years ago, I think that sometimes there was a wink and a nod that everything would be okay,” Brainard said. “But things are not okay if you’re not consistently making your contribution.

In the last fifteen years, significant pension reform changed retirement ages, created new tiers with reduced benefits, otherwise altered defined benefit pension policies and increased the number of dedicated funding sources to guard against short-term decisions that lead to skimpier payments.

In 2017, for example, New Jersey opted to start transferring net profits from the state lottery to the state pension plans. In 2011, Louisiana voters passed a constitutional amendment that assigned 10% of budget surpluses from the prior fiscal year to several large state retirement plans. In 2023, a successful ballot measure raised the percentage to 25%, while also expanding the dedication of past budget surpluses to School Employees’ and Police Retirement Systems.

As NASRA points out, the governance of pension systems carries a lot of weight in terms of how consistently and fully plans are funded. When employers are required to pay the ADC by constitution or statute, the full payments are more likely than when a fixed amount is allocated as a percentage of payroll or when no legal requirement has been established. 

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