State Pension Funding Gap Has Grown

State eNews Issue #40 | February 18, 2010

n 2000, more than half the states had fully funded state employee pension funds; that dropped to six states by 2006 and four states by 2008, according to a new report from the Pew Center on the States.

That’s partly because some states took holidays from contributing fully to the pension plans, according to Girard Miller, an expert on public pensions and a senior strategist for Public Financial Management Group.
“The pension plans—whether they did it themselves or whether they did it with the political pressure from within the legislature, in some cases—granted benefits increases retroactively in the expectation that financial markets would continue to earn 10 percent on stocks all of the way through 2000 to 2010,” Miller told Capitol Ideas magazine for the March/April issue.
That didn’t happen. The stock market dropped during the recession of late 2008 and 2009.
“There are literally hundreds of billions of investment gains that were expected to occur in the first decade of this century that never actually happened,” Miller said.
And that hit public pension funds hard. But in many states, those pension plans were already hurting.
“The problem was a combination of granting these retroactive benefit increases that happened at the end of the 1990s when the stock market was going up like crazy and then, when the bubble burst, we saw the other side of it,” Miller said.
According to the Pew Report, those actions brought a $1 trillion gap between the $2.35 trillion states have set aside to pay for employees’ retirement benefits and the $3.35 trillion price tag of the promises states have made to employees.
The Pew Center report covers the health of the plans through the 2007-2008 fiscal year. That report, The Trillion Dollar Gap: Underfunded State Retirement Systems and the Road to Reform, agrees with Miller’s assessment of the situation. It found that, to a significant degree, the $1 trillion gap reflects states’ own policy choices and lack of discipline in:
  • Failing to make annual payments for pension systems at the levels recommended by their own actuaries;
  • Expanding benefits and offering cost-of-living increases without fully considering their long-term price tag or determining how to pay for them; and
  • Providing retiree health care without adequately funding it.
The Government Accountability Office believes 80 percent is the funding level preferred by experts to consider pension plans in good standing, according to the Pew report. Just four states achieved that in 2008, according to the report.
In eight states—Connecticut, Illinois, Kansas, Kentucky, Massachusetts, Oklahoma, Rhode Island and West Virginia—more than one-third of the total pension liability was unfunded, according to the report. Illinois and Kansas had less than 60 percent of the necessary assets on hand, the report said.
The problem for states isn’t limited to their pension funds.
“This matters tremendously because how well states manage their retirement costs affects how much money they have to spend on other priorities,” Susan Urahn, the Pew Center’s managing director, told National Public Radio. “And in fact, these costs are already adding significant pressure to already stressed state budgets.”
Several states have taken action to deal with the unfunded liability levels of their state employee pension plans and the other post-employment benefits, primarily retiree health care, the report said. Fifteen states passed laws in 2009 to reform some aspect of their pension plans; one-third of the states have groups to study ways to reform their retirement systems, according to the Pew report.
The Pew report and Miller believe states must take action now, or it will cost them later.
“Every dollar you don’t pay toward your actuarial costs today will cost you $2 or $3 in the future because you don’t earn investment income on the money that should be in the fund,” Miller said. “The funds are all based on actuarial assumption that you’re funding them properly.”
Check out the March/April issue of Capitol Ideas for six steps Miller says will help states better manage their employee retirement and retiree health benefits systems.
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