CBO on Pension Plan Losses and Underfunding

Useful new testimony out from Peter Orzag at the CBO on pension plan losses in the U.S. over the last year or so. At $2-trillion the headline number is huge, but you need to keep it in perspective. But that said, the people who are facing the biggest issues are the sponsors of defined benefit plans, who will be forced to make up the difference in plan losses.

Here is a snippet that is worth keeping in mind with respect to the absence of mark-to-market in pension plan accounting:

Funded ratios have been steadily declining in recent years. In 2000, about 90 percent of public pension plans had funded ratios greater than 80 percent. By 2006, that share had decreased to about 40 percent (though, again, a much larger share of large plans have funded ratios above 80 percent). Lower returns caused by a declining market and the economic slowdown, which will translate into lower corporate and personal income tax revenues, will exacerbate the downward trend in funded ratios.

Many public pension plans use actuarial methods that will mute the effects of recent changes in asset values on funded status. One of those methods is “smoothing,” or valuing current assets on the basis of averages over recent years, rather than on current market values. That method generally causes the reported valuations to lag behind the market; in the current environment, it can cause reported valuations to be higher than current market values.

Although the laws governing state and local pension plans vary, significant drops in funded ratios could trigger requirements for higher contributions to the plans from state and local coffers or from public-sector employees at a time when tax collections are also waning.

Originally published at Infectious Greed on Oct 8, 2008 and reproduced here with the author’s permission.