Opinion: Recognizing ‘legacy debt’ is key to better funding public pensions

Legacy debt — the leftover costs of starting retirement programs — is important not only when considering policy changes for Social Security, but also for state and local pension plans.

In the case of Social Security, the payroll tax rate required to fund the promised benefits is high because we have ceded the trust fund to provide benefits to the first generation of retirees. Should today’s workers bear the full burden of this decision or should it be distributed more widely through an injection of general revenue?

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In the case of state and local plans, legacy debt arises because the plans have provided benefits since the early 1900s, but did not adopt modern actuarial practices until the 1970s or 1980s. The Massachusetts State Employees Retirement System (MA SERS) schedule is typical (see Figure 1). The impact of these unfunded liabilities from a bygone era is still being felt today, as the shortfall continues to reverberate.

In addition, the unfunded liability of public plans has increased significantly even after plans moved to modern actuarial funding. The main reasons for this increase were: insufficient contributions; low investment returns relative to expectations; changes in actuarial assumptions, such as expected retiree mortality; the actual experience of plan participants with respect to these expectations; and — to a lesser extent — increased benefits in the 1980s and 1990s.

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As a result, inherited debt represents a significant portion of unfunded liabilities in several states with severely underfunded plans. According a recent study by my colleague J.P. Aubrywho calculated the inherited debt of 13 plans in six states, the inherited debt averaged more than 40% of the unfunded actuarial liability (UAAL) (see Table 1).

Ignoring the unique aspects of debt inherited from the past and managing them within the modern actuarial framework can lead policymakers astray in many ways:

  • This gives the impression that currently promised benefits are more expensive than they are – a misperception that encourages policymakers to focus on cutting benefits as the main solution.

  • This places most of the burden on the current generation – who, at this point, are no more responsible for the inherited debt than any other.

  • This makes unfunded liabilities overwhelming, encouraging long open amortization periods and assumed investment returns to value liabilities.

The legacy costs of moving to funded plans need to be taken off the books and managed separately. They still need to be paid, but not just by today’s public sector workers and today’s taxpayers.

The legacy costs of moving to funded plans need to be taken off the books and managed separately. They still need to be paid, but not just by today’s public sector workers and today’s taxpayers.


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John A. Bogar