State and local pensions plans are on a path to failure.

Saturday, January 2, 2010; A12

THE RECENT history of pension plans for state and local government employees can be summarized as "promise now, pay later." Eager to attract good workers -- or to placate unionized ones -- elected officials often contracted for generous retirement benefits, including health benefits, without increasing taxes to pay for them. The next governor, mayor or city council could worry about that. Meanwhile, governments used rosy investment earnings projections, typically 8 percent a year, to make their promises appear more affordable than they really were.

Never truly a sustainable strategy, given the aging of the population, this approach took on artificial plausibility during the stock market boom of the 1990s. But the current financial crisis has thoroughly exposed the folly of it. The stock market's plunge since the Dow Jones industrial average hit an all-time high of 14,164 on Oct. 9, 2007, has cost state pension funds hundreds of billions of dollars. The hardest-hit states are those, such as California, Illinois and New Jersey, that made the most lavish underfunded promises. Still even relatively responsible states such as Virginia and Maryland have been hit hard. The market's comeback this year has ameliorated the situation to some extent. Many pension funds are tempted to gamble for higher returns to make up for their losses. Even if pension funds do manage to achieve that magical 8 percent average rate of return over the next 15 years, they will only have an average of 45 percent of the money they need to pay benefits, according to an analysis by state pension expert Kim Nicholl of PricewaterhouseCoopers. The picture for health benefits, which states are generally paying out of current revenue, is even worse.

States must not count on the markets to rescue them from this predicament. There are some savings to be achieved through efficiency measures, such as irrevocable trusts that protect pension funds from periodic raids by the rest of government. But the path to solvency, if there is one, runs through the hard business of restructuring -- i.e., trimming -- benefits. This will take political courage, especially in states where public-sector unions are most powerful. Yet the truth is that state and local public employees often enjoy far more generous pensions and medical benefits than the taxpayers who fund them. Nine out of 10 public-sector employees have a defined-benefit plan, with a median pension in 2005 of $17,640 per year. By contrast, only 20 percent of private-sector employees enjoyed defined benefits, and the median level was $7,692. This is a ticking financial time bomb, and the time to disarm it is now.

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