Association for Public Policy Analysis & Management

In the wake of the economic downturn of 2008-2009, researchers and policymakers have focused considerable attention on the extent of unfunded liabilities in U.S. public sector pension plans and the implications for the long term fiscal sustainability of state and local governments. In response to the growth in liabilities, many states have introduced legislation that cuts back on defined benefit plan commitments, in some cases even shifting the pension system from a defined benefit to a defined contribution or hybrid plan.  This paper explores the factors that have led states to engage in pension reform, focusing particular attention on one factor that has been somewhat overlooked in the research literature: contribution risk. While unfunded liabilities have significant long-term solvency implications, in the short-term fluctuations in the amount of required contributions pose substantial difficulties for the ability of plan sponsors to balance budgets and engage in strategic planning. We begin by quantifying the volatility in the required contributions US states were expected to make between 2001-2013 and comparing the volatility of pension spending to other relevant tax and spending measures.  Next, we describe the various types of pension reforms that states have implemented and examine the fiscal pressures facing those states that have engaged in reform. States with greater fluctuations in their required payments have been more likely to reduce benefits and increase employee contributions; they have also been more likely to institute these reforms sooner. Contribution risk appears to be a more important determinant of pension reform than the size of unfunded liabilities.