State retirement benefit promises exceeded pension funds, study finds

By David Cho
Washington Post Staff Writer
Thursday, February 18, 2010

Even before financial markets crashed in fall 2008, state governments nationwide had promised to deliver $1 trillion more in retirement benefits than they had in their pension investment funds, according to a comprehensive study made public Thursday.

The problem got worse as funds dwindled in value during the downturn, according to the report from the Pew Center on the States. Yet many states are still not setting aside enough money to cover the cost of the retirement promises they made to police officers, teachers and millions of other public employees as they struggle to balance budgets buffeted in the recession by falling tax revenues.

The shortfall is already consuming a growing share of government budgets at the cost of other services. Eventually, with the price of these benefits soaring as more baby boomers retire, states will have to choose between continuing to pay out and sink deeper into the red or significantly cut back the packages offered to retirees.

State governments faced a $587 billion shortfall to cover retiree health-care costs before the fall of 2008, the Pew study showed, drawing on the most recent available data. More than half of the states have saved virtually nothing to meet the costs of these benefits, and only Alaska and Arizona have more than half of what they need.

The states also have a $452 billion bill coming due for pension payments. On this front, the record among states is mixed, the study found. Some, such as Florida, New York and North Carolina, entered the recession with fully funded pension systems. Others, such as Illinois and Kansas, had less than 60 percent of what they needed to fund their pension obligations.

Yet despite lower funding levels, many states are "kicking the can down the road" by putting off solutions that could address the shortfalls, said Susan Urahn, managing director of the Pew Center on the States. In New Jersey, for instance, the legislature has been underfunding its pension funds for more than a decade. In 2010, the state was supposed to pay $2.5 billion into its system. Just $150 million was budgeted.

"What we have to remember is we have a significant problem now, but it's a problem that can be solved," Urahn said. "But if states wait, if they don't take steps now, they will have an unmanageable crisis on their hands."

The Pew study also raised questions about the rosy assumptions states make to predict how much money they will earn from their investments. Public pension systems generally derive their funding from three sources: state government contributions, employee contributions, and their investments in stocks, bonds and other markets. A higher forecast for the investment activity allows states to contribute less to their pension systems.

On average, states predict they will see an 8 percent return every year from their investments in the markets. Meanwhile, the S&P 500, the broadest measure of stocks, fell more than 20 percent over the past decade.

Most industry and government experts say that pension systems that have fallen below 80 percent funded are in poor health. As of summer 2008, Maryland was 78 percent funded, while Virginia was at 84 percent. Both states saw large investment losses over the next 12 months, with Maryland's pension funds falling 20 percent and Virginia's dropping 21 percent. Those losses will make it even harder for the states to keep pace with the 8 percent return on investment assumption, the study noted.

Maryland also received poor marks in the report because its government contributions are falling short. In 2002, the state adopted a formula that prompted a sharp drop in pension funding levels. The state's pension board has asked the legislature to amend this approach. Yet in 2006, even as funding levels continued to decline, the state promised even more generous retirement benefits to teachers and other public employees. State officials acknowledged problems with the funding formula, but said they cannot be changed before the recession eases.

In Virginia, the House of Delegates passed legislation that would curtail benefits for employees hired after July 1. The bill, which state officials say would enact one of the most significant changes to the state's pension system in decades, would require new employees to pay 5 percent of their salaries toward their retirement benefits, reduce pension payments to those workers and lift the age and years of service they would need to retire. It is estimated that the measure would save $3 billion over the next 10 years. The state Senate has yet to take up the legislation.

"The Virginia Retirement System has $49 billion currently," said Jeanne Chenault, spokeswoman for the system. "That is enough to sustain the system and provide those benefits to the current members and retirees. . . . It's still a very robust system."

Still, the state since 2005 has been using accounting methods and rosy investment assumptions that allow it to contribute hundreds of millions of dollars less into its pension funds each year than what its own pension board recommends.

The Pew report, titled "The Trillion Dollar Gap," was based on data collected from state pension systems whose fiscal year generally ends on June 30 each year. The data from the 2008-2009 fiscal year had not yet been compiled. The study did not include the District or local government pension systems, many of which are also facing severe shortfalls.

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