Today’s pension debt is not primarily caused by increased lifespans, enhanced benefits, or states failing to pay 100% of required contributions. The three primary factors explain unfunded liabilities as of 2022: changes to actuarial assumptions, underperforming investment returns, and interest on the debt.

Managing pension plans requires a wide range of assumptions about future events: investment returns, mortality rates, workforce turnover, salary growth, inflation, government contributions, and more. There are lots of places where actual experience may not line up with actuarial expectations — leading to unfunded liabilities or improved funding.

Pension funds compare actuarial and assumed experience every year, along with other factors that can change the value of liabilities.

We can use the data to look at the internal structure of public pension plans and measure exactly which categories are causing the country’s collective unfunded liabilities.

The red column in the chart below shows the total unfunded liabilities from 2002-2022. Each bar to its right shows much individual factors and assumptions contributed to the accumulation of these unfunded liabilities.

The largest contributor to the $1.2 trillion in unfunded liabilities as of 2022 was necessary improvements to actuarial assumptions (37% of the total accumulated growth). The next largest factors were underperforming investment returns (28%) and interest growing faster than contributions paid (26%).

The below chart looks at how these factors have contributed to the growth of pension debt overtime.

Underperforming investment experience was the largest contributor to unfunded liabilities, until historically strong 2021 investment returns.

Interest on pension debt has been steadily increasing as a cause of unfunded liabilities for nearly two decades.

Benefit experience has gone from causing unfunded liabilities to reducing pension debt.

Unfunded liabilities for state and local pension plans have remained paralyzed above $1 trillon since the 2008 Financial Crisis.

In 2024, The national shortfall in assets for state and local pension plans shrank from $1.63 trillion in 2023 to an estimated $1.29 trillion shortfall in 2024.

This is nearly the same national unfunded liability level as in 2009 ($1.36 trillion).

The improvement in aggregate funded ratio in from 2023 to 2024 was the second best year over year increase in the last decade.

The aggregate funded ratio for statewide and municipal pension plans in 2024 (81.4%) is still below the recent high mark in 2021 (83.9%).

The 10-year average investment return has fallen to meet the assumed rate of return, indicating a tempered outlook for long-term investment gains.   

Preliminary 2024 investment returns are 9.5% on average for state and local plans. All asset classes had strong performance over the last year, in particular for January-September 2024. If the surge to public equities continues, it is likely plans with a fiscal year ending in December will post even stronger returns and move this average return up.

Government employer contributions have surpassed 30% of payroll for the third year in a row.

Combined state and local employer contributions in 2001 were 9.15% of payroll. During the fiscal year ending 2024, employer contributions are 31.27% of payroll.

Employer contributions have steadily increased over the past two decades, mostly because of increased unfunded liability amortization payments.

Normal cost payments, in dollars, are up 139% between 2001 and 2023. However, unfunded liability payments have risen 2,450% during the same period.

State and local employee contributions to their own retirement plans have continued to steadily increase.

In 2024, public sector workers who are enrolled in Social Security paid 120 basis points more than they did during the 2008 fiscal year, a 23.8% increase.

Public workers whose employers do not participate in Social Security paid 16.7% more this year than in 2008, but have paid effectively the same rate since 2022.

Note: Public employees are not uniformly covered by Social Security. Some states never opted into Social Security and, therefore, typically have higher valued benefits and relatively higher contribution rates than for statewide systems where members also have access to Social Security benefits.

Public pension asset allocations have continued to shift away from transparent public equities and relatively safe fixed income investments into riskier categories as trustees search for stronger investment returns.

“Alternatives” are now a third of pension fund investments (33.7%), driven by private capital investments (13.7%).

Negative net cash flows from contributions and benefit payments have steadily increased over the past two decades, reflecting more “mature” pension plans.

Larger negative cash flows put increased pressure on investment return income each year to make up the difference.

Looking forward, there are three primary indicators to watch.

1. Pension debt paralysis has caused average employer contributions to increase from 3% to 31.3% of payroll between 2008 and 2024, all while:

1. • Unfunded liabilities have risen to levels persistently above $1 trillion.
   • Funded ratios have not rebounded to pre-Global Financial Crisis levels.
   • The higher contributions paid are not even enough to prevent interest from continuing to accrue on unfunded liabilities — which is the fastest growing contributor to pension debt for the country as a whole.

2. Meanwhile, there is a less than a 50% chance, on average, that a U.S. public pension plan can earn a 6.9% return over the next 10 years, which is the average rate of return those plans are expecting to earn.

3. In addition, necessary changes to actuarial assumptions and expected demographic turnover patterns are likely to continue to put downward pressure on public pension plan funded ratios.

This collectively suggests that contribution rates will continue growing in the coming years without meaningfully reducing unfunded liabilities—unless state leaders appropriately respond with improved accounting and adequate near-term contribution increases that will gradually decline over time.