• North Carolina’s unfunded liabilities for the state employee pension plan and state health plan pose a fiscal crisis to the state
  • Over the last decade, the value of unfunded liabilities for the state employee pension plan has skyrocketed
  • If policy changes are not made soon then the state health plan will be on the verge of insolvency

Cultivated by decreases in personal and corporate income tax rates, North Carolina demonstrated economic resilience in response to COVID-19. Post-pandemic North Carolina’s economic growth rate outpaced the national average, facilitating a rapid recovery. However, this good fortune does not mean that the Old North State is not facing fiscal challenges now that will only worsen if left unaddressed.

As of fiscal year (FY) 2022-23, North Carolina’s unfunded liabilities for the state employee pension plan and retiree health benefits exceeded $43.3 billion.

Stated simply, unfunded liabilities are promised future benefits for which the state has not set money aside. Unfunded liabilities threaten the state’s fiscal solvency and state employees who rely on state-provided benefits.

Teacher and State Employees’ Retirement System (TSERS)

As depicted in Figure 1 below, in FY 2022-23, the TSERS’s unfunded pension liabilities exceeded $16.6 billion. This represents a 1,322 percent increase in unfunded liabilities since FY 2013-14. For perspective, during the same period, North Carolina’s economic growth rate was 23 percent and the state’s general fund budget increased 36 percent.

A state’s funded ratio measures its program’s net financial position as a percentage of its unfunded liabilities. The higher the percentage, the more solvent the plan. In FY 2022-23, the TSERS’s funded ratio was 82.97 percent, down from 98.24 percent in FY 2013-14.

Policy Recommendations for the TSERS

The table below illustrates that since FY 2013-14, the assumed rate of return (ARR) for the TSERS’s investment portfolio gradually decreased from 7.25 percent to 6.5 percent. The ARR is the expected long-term annual growth rate for the pension plan’s investments.

The decision to implement reductions in the ARR benefits the system because a higher ARR has the following negative effects:

  • Underestimating the value of unfunded liabilities. When expectations for investment returns are lofty, the state believes it can easily grow its financial position. This causes the state to increase the discount rate it uses to calculate the present value of future pension liabilities.  A larger discount rate results in lower levels of unfunded liabilities. For example, in FY 2022-23, if we assumed a 7.5 percent discount rate instead of 6.5 percent, the TSERS’s unfunded liabilities would decrease from $16.67 billion to $6.18 billion.
  • Incentivizing the pursuit of risky investment strategies. When growth targets are ambitious, pension managers are motivated to chase after higher rates of return. To do this, they must seek out riskier investment options that expose taxpayer money to market downturns.
  • Reducing annual contributions to the system. Optimistic assumptions about investment performance cause underpriced contribution rates, which result in an underfunded pension plan.

The next state treasurer should follow Treasurer Dale Folwell’s approach to overseeing TSERS by further reducing the ARR to 6 percent.

It is also worth considering altering the pension system from a defined-benefit (DB) plan to a defined contribution (DC) plan. This is a feasible option with a proven track record in other states. DB plans are typically more costly and risky for taxpayers because they guarantee a certain amount of benefits to retirees; DC plans do not make such guarantees, but provide much more discretion to employees.

North Carolina could implement a mandatory switch to DC plans with a grandfather clause like Alaska, Michigan, and Oklahoma or offer DC plans as an option to employees like Colorado, Florida, Indiana, Montana, North Dakota, Ohio, and South Carolina.

State Health Plan (SHP)

As depicted in Figure 2 below, in FY 2022-23, the SHP’s unfunded liabilities for retiree health benefits exceeded $26.6 billion. Despite these liabilities remaining relatively constant over the last decade, the SHP is more fiscally strained than the TSERS.

In response to solvency concerns, the following reforms have been implemented:

  • The General Assembly voted to permit the SHP to begin charging premiums to employees and retirees. For monthly coverage, employees can choose between the Base PPO Plan (70/30) for $25 or the Enhanced PPO Plan (80/20) for $50. Depending on their service start date, retirees pay either $0, $224.37, or $448.74 per month for coverage in the Base Plan PPO (70/30).
  • Policymakers approved a reduction in plan eligibility, which prevented further growth in the SHP’s unfunded liabilities. The policy change prohibited state employees who began service post-2020 from participating in the plan during retirement.

While these adjustments improved the plan’s long-term outlook, they did little to address short-term solvency issues.

In early August 2024, when asked about the possibility of the SHP’s “imminent insolvency,” the State Treasurer, Dale Folwell, referred to the plan’s reserves and stated, “We will go below our statutory minimums in 2025… we are one pandemic away from not being able to pay our bills.” 

In 2022-23, the SHP’s funded ratio was only 10.73 percent, up from an extremely low 3.40 percent in FY 2013-14.

Policy Recommendations for the SHP

The General Assembly needs to increase appropriations to the SHP. According to Treasurer Folwell, in recent years, health care and prescription drug prices have increased twice as fast as appropriations to the SHP. Policymakers should fully fund the SHP and allocate a minimum of $100 million per fiscal year to the Unfunded Liability Solvency Reserve to improve the SHP’s future viability. This short-term dedication of funds would help stave off more dire fiscal consequences in the future.

The General Assembly should approve reference-based pricing for the SHP. Currently, hospitals have the discretion to set prices, resulting in widely different prices in close geographic proximity for the same medical treatment. Reference-based pricing would allow the SHP to negotiate prices with hospitals based on what is reasonable and customary for each specific geographic market. Treasurer Folwell believes that a change to reference-based pricing would save the SHP $300 million per year.

Policymakers should repeal the Certificate of Need (CON) law in the state. This law requires health care providers to request permission from a state board to acquire, replace, or expand their facilities. The CON increases the cost of health care because it creates wasteful administrative costs and allows the state board the subjective discretion to approve or deny requests, which limits the supply of health care.

Policymakers need to require nonprofit hospitals to operate as nonprofits. Hospitals must match the amount of charity care they provide with the value of tax benefits they receive. Furthermore, compensation packages provided to hospital executives must be transparent to ensure that leadership is incentivized to put patients’ health above the pursuit of personal profit.

Another option would be to ask state retirees to contribute more toward their health coverage, specifically by transitioning the zero-cost option to one in which retirees contribute a small monthly fee. The state could also consider offering the option of a high-deductible plan combined with a Health Savings Account (HSA). In a high-deductible plan with a HSA, premiums are lower and the state deposits a certain amount of money into employee-controlled accounts each year. This typically reduces costs because the savings from the lower premiums exceed the expenses associated with the HSA deposits.