State Employee Pension Plans: Another Reason You May See Higher Taxes

Last Updated Feb 19, 2010 8:57 AM EST

Many public servants, such as firefighters, policemen and teachers, perform difficult or dangerous work for little pay during their careers, but are rewarded later in life through state and local government retirement and health care plans. The funding and investment choices made by plan overseers, plus the markets' results of the last 10 years have eroded the portfolios of many plans, jeopardizing the benefits public workers have earned.

The Pew Charitable Trust, and The Pew Center for the States monitor these sorts of issues, and on February 18 released a study pointing out a shortfall in public pension plans of $1 trillion or greater. State governments have several ways to deal with the problem -- lowering benefits to future workers, raising the retirement age, increasing taxes, and borrowing to shore up the pensions. None of them is politically appealing, especially in a time of recession.

My father worked for much of his life as a public school teacher, and retired at 62, I think, with pension and health benefits. Not huge - a little less than what he got from Social Security. Public employees are some of the few workers in the U.S. that are still covered by old-style, paternalistic defined benefit plans that pay retirees a proportion of their final years' earnings.

A pension plan is supposed to work like this: an employer makes contributions every year, equal to a few percent of workers' pay. Sometimes the employees contribute as well. The money is invested, in stocks, bonds and whatever, in a way that it grows enough to pay a benefit when the workers retire.

It's a simple concept, but becomes very difficult to carry out over a long period of time, whether due to changing economic conditions change in the city or state, or mismanagement of the pension fund. From the Pew report:

When Pew first delved into the realm of public sector retirement benefits in December 2007, our report, Promises with a Price: Public Sector Retirement Benefits, found that only about a third of the states had consistently contributed at least 90 percent of what their actuaries said was necessary during the previous decade. Since that time, pension liabilities have grown by $323 billion, outpacing asset growth by more than $87 billion. Pew's analysis, both then and now, found that many states shortchanged their pension plans in both good times and bad. Meanwhile, a majority of states have set aside little to no money to pay for the burgeoning costs of retiree health care and other non-pension benefits.
In sum, states and participating localities should have paid about $108 billion in fiscal year 2008 to adequately fund their public sector retirement benefit systems. Instead, they paid only about $72 billion.
U.S. state pension funds, such as the $195 billion CalPERS, are some of the world's largest pools of capital. Along with big corporate pensions, and large university endowments, they are advised by specialist consultants, and invest not only in stocks and bonds, but in sophisticated alternative strategies such as real estate, commodities, hedge funds and private equity. Two of the enormous Pennsylvania public plans lost more than 25 percent of their asset value in 2008 alone - and they end their fiscal years on June 30.

The pension shortfalls began after the market crash of 2000 through 2002, and were made much worse in 2007 and 2008. They come at a time when states are facing crises elsewhere in their budgets due to the ongoing recession. (Remember that states are generally required to balance their budgets every year, and cannot print money like the federal government.)

I write on this topic a lot and could go on a long time, but here is the Pew bottom line:

  • In fiscal year 2008, which for most states ended on June 30, 2008, states' pension plans had $2.8 trillion in long-term liabilities, with more than $2.3 trillion socked away to cover those costs. (Click on the graphic at the end to see the status of individual states.)
  • In 2000, slightly more than half the states had fully funded pension systems. By 2006, that number had shrunk to six states. By 2008, only four-Florida, New York, Washington and Wisconsin-could make that claim.
  • While only 19 states had funding levels below the 80 percent mark in fiscal year 2006, 21 states were funded below that level in 2008. (Experts say 80 percent funding is the minimum that can allow a pension to meets its obligation.)
  • In eight states-Connecticut, Illinois, Kansas, Kentucky, Massachusetts, Oklahoma, Rhode Island and West Virginia-more than one-third of the total liability was unfunded.
  • Two states had less than 60 percent of the necessary assets on hand to meet their long-term pension obligations: Illinois and Kansas.

Click on the graphics for a larger image
Fixing these problems is a challenge, because in most cases states cannot cut the benefits already agreed to for current employees. Pew says that ten states lowered benefits for new employees or set in place higher retirement age, or longer service requirements. Several states, such as Oregon and Wisconsin, have shifted to lower guaranteed benefits, while adding defined contribution plans similar to 401ks. Four states took legislative action to reduce retiree health care and other non-pension benefits for employees in 2008, and seven did so in 2009.

Because so few private-sector workers still have traditional pension plans with lifetime income guarantees, the solutions of tax increases or issues of pension bonds are not politically popular. But for many states - see where yours stands on the graphics above - something will have to give.

Addendum to my original post, reporting from (the authoritative source on benefits news). I added the emphasis:

The National Association of State Retirement Administrators (NASRA) and the National Council on Teacher Retirement (NCTR) commended the Pew Center on the States for examining the nation's state and local government retirement benefit programs.
However, in a statement, the groups said that coupling retiree health care with pension liabilities distracts from the issues states face with the different benefits. "When properly dissected, it is clear that the vast majority of the 'financing gap' is not attributable to pensions, but rather to health care programs that until recently were funded primarily on a pay-as-you-go basis," the groups said.