States are staring at a trillion-dollar pension hole

While the Greek and Puerto Rican debt meltdowns command world attention, most American states are grappling with how to cover between $1 trillion to $4 trillion in unfunded pension and health care liabilities, according to experts.

The range of the unfunded liability number can be explained by variables like the assumed rate of return on pension investments and variations in economic forecasts. Yet even at "just" a trillion, that's still a very big number.

This month a report from the Pew Charitable Trust estimated that the nation's state-run pension systems face close to a trillion-dollar shortfall, with at least 27 states confronting at least a $10 billion gap. "If we add in the unfunded health care commitments for public workers, there's another $600 billion out there in unfunded liabilities," said Greg Mennis, with the Pew Charitable Trust.

The increased concern over local and state pension and health care plan shortfalls comes on the heels of new reporting requirements by the Governmental Accounting Standards Board mandating that governments calculate and disclose what their projected liabilities are for things like public employee retiree health care costs.

For 26 states, pension plan funding ratios have fallen below the 70 percent minimum threshold that would deem them "at risk" under the Federal Employment Retirement Income Security Act (ERISA), which regulates private sector pensions.

From fiscal year 2008 until fiscal year 2013 the actual amount of unfunded state pension liabilities has more than doubled from $452 billion to $961 billion, and is now over that trillion-dollar mark. In 2013, 22 states made progress by increasing the percentage of their pension liability that was funded, but 10 were still below the "at risk" ERISA threshold of 70 percent.

Reducing the unfunded liabilities can be done via some or all of the following: increasing what the state sets aside; increasing what workers pay in; and doing things like raising the retirement age, raising taxes and reducing headcount. This pension and health care liability crunch comes as the federal government continues to commit to additional reductions to discretionary domestic spending in the form of cuts to local and state grant programs.

In 2012 the State Budget Crisis Task Force convened by Paul Volcker, former chairman of the Federal Reserve, and Richard Ravitch, former lieutenant governor of New York, issued a report that pegged the states' combined pension and health care liabilities at $4 trillion dollars. The authors billed the report as the first complete analysis of state-level finances done independently of the states themselves.

In remarks during the rollout of the eye-popping findings, Ravitch and Volcker warned that states' reliance on so-called budget "one shots" and borrowing to cover operating costs and payroll had created "balanced budgets" that were "illusory." Ravitch warned that the day of reckoning would require cuts so draconian that there would be "threats to social order."

This week New Jersey Senate President Stephen Sweeney proposed that the federal government provide states like New Jersey with low-interest loans that they could apply toward their unfunded pension liabilities. Sweeney added that the loans would be paid back over time at a profit to the U.S. Treasury. According to Pew New Jersey, as of 2013 the state had a $51 billion unfunded pension liability with just 63 percent of that commitment currently funded.

"We bailed out Wall Street and the auto industry. Why not Main Street?" Sweeney told CBS MoneyWatch. "The biggest winners are the taxpayers because they are the ones who will pay less in the future pension payments and avoid cuts in essential services. This is a win-win for taxpayers across the country because it will avert future tax increases and program cuts, and for the public employees and retirees because it will protect their pensions."

Under Sweeney's proposal, states would have to put the federal borrowing to a referendum by voters committing the state to pay back the loan over a 30-year period. Sweeney believes that just as with the bailout of Detroit, the U.S. government "would make money" on the deal.

Pew's Greg Mennis said Sweeney's proposal should be evaluated through the prism of New Jersey's historically poor performance of making the required contributions to its pension system. He says states like North Carolina, Wisconsin and Tennessee are fully funded, and that it can be done. "In New Jersey, the negligence in not funding the pension goes back at least a decade," Mennis said.

"Just as a starting point in a federal system," added Mennis, "every state has to handle this obligation on its own, and states have been able to it."

Washington hasn't been ignoring this looming crisis entirely. In 2013, Sen. Orin Hatch, R-Utah, introduced legislation that would allow states and local governments to hand over their pension plans to private-sector insurance companies. "America cannot continue sleepwalking in the financial disaster that awaits us if we do not get the public pension crisis under control," Hatch told his fellow senators at the time.