VOL. 23, NO. 3 AUTUMN 2010 B ENEFITS L AW JOURNAL From the Editor The Big Lie: Unfunded State Government Pension and Retiree Health Benefits hen Wile E. Coyote walks off a cliff, he doesn’t fall until he W looks down and realizes there’s nothing but air. That cartoon image neatly captures the approach taken by state governments to funding their employee pension and retiree health benefits. Generous accounting standards, a lack of funding requirements, and politicians’ myopic focus on the next election have fueled a combined 50-state unfunded governmental employee retirement obligation conservative- ly estimated at over $1 trillion. Before the money to pay benefits runs out, state governments, unions, employees, and retirees should face up to the problem and learn from the experiences of the corporate world in confronting similar (albeit not as gargantuan) challenges. Further delay will only lead to legal and financial chaos, broken promises, and much suffering. WHY THE PROBLEM? First, government workers vote and second, promises to pay retiree benefits in the future are not booked as a state liability or treated in budgets as a current cost. Offering or increasing state-paid pension and retiree health benefits is a reliable way to get labor peace and the votes of represented and salaried government workers alike. As a result, even as economic pressures drove the private sector to trim coverage and switch to more predictable and lower-cost defined con- tribution programs, the retirement programs for government employ- ees still look like a relic from the Eisenhower era.
From the Editor Indeed, the typical public sector program has a relatively gener- ous final pay pension formula, often including an automatic COLA for retirees, “normal” retirement at age 60 or even 55, and heavily subsidized lifetime health benefits. As an added kicker, some state programs base pension benefits on the employees’ final year’s pay, allowing hourly employees to bump up their pensions with overtime in the 12 months before retirement. Granted, these benefits are offset by the fact that state workers usually must contribute to their pension plans and may not be eligible for Social Security. Nevertheless, most private sector workers would swap benefits with a state employee in a nanosecond. Happily, for the politicians and bureaucrats, there are no feder- ally imposed funding rules on state retirement programs. Instead of ERISA, governmental plans are bound only by a watered-down version of the pre-ERISA Internal Revenue Code rules that imposes very few obligations on state governments other than cutting benefit checks. The Government Accounting Standards Board (GASB) does mandate that each state book its pension and (recently) health and other retiree obligations, but the measurement rules are loose and there has been little real consequence from reporting ever-larger unfunded retiree liabilities. Unlike state bonds and other borrowings, the benefit liability doesn’t affect deficits and isn’t counted as a debt. All this makes it easy for governors and legislators to sweeten benefits while still appearing fiscally prudent—until the day enough workers retire and out-of-pocket costs overwhelm state budgets. CALCULATING THE SHORTFALL There are various estimates of the extent of the shortfall. In an exhaustive study, the Pew Center on the States put the total unfunded liability at the end of fiscal 2008 at $1 trillion: $452 billion in unfunded pension liabilities and $555 billion for health and other benefit obli- gations. State pensions were calculated at roughly 84 percent funded and retiree health was essentially completely unfunded. But the Pew Study observed that its estimate actually understates the size of the problem. Most states have a June fiscal year and use “asset smoothing” to even out market volatility, so that the reported aggregate plan asset levels do not fully reflect the ravages of the 2007–2008 market crash. Moreover, virtually every state assumes its pension investments will earn 8 percent annually in estimating how much money will be on hand to pay benefits; Pew’s numbers are based on this rosy investment forecast. To get a more realistic estimate, other academics have recalculated Pew’s underfunding estimates using various market-based assump- tions ( , yield curve on long-term corporate bonds, risk-free e.g. Treasury yields, or expected interest rates on the state’s own bonds). BENEFITS LAW JOURNAL 2 VOL. 23, NO. 3, AUTUMN 2010
From the Editor For example, Novy-Marx and Rauh of the University of Chicago peg the underfunded liability at an astonishing $3 trillion. And, the Pew and other estimates exclude liabilities for municipal and local govern- ment entities that aren’t part of their state’s system, as well as future accruals for state employees. HOW BIG IS A TRILLION? Even in these days of mega-bank and corporate bailouts, it’s hard for us mortals to get our heads around $1,000,000,000,000. You could think of it this way: if you invested $1 trillion at 6 percent interest, you’d earn almost $7 million . . . an hour. Using a different yardstick, the $1 trillion retiree benefit liability exceeds both total state borrowings ($798 billion) and annual tax rev- enue ($781 billion). States today are contributing an average of about $1 to their pension plans for every $10 in taxes they take in. To reach just full pension funding, those contributions would need to grow by 75 percent for ten years, while pension investments somehow earned 8 percent annually. Right now, unfunded state pension promises in the United States average an extraordinary $166,500 per participant. STATE-BY-STATE However, not all state pension messes are created equal. (Visit for a handy, interactive, state-by-state fund- pewcenteronthestates.org ing map.) Despite the massive political dysfunction that regularly paralyzes my home state, I am pleasantly shocked to report that New York’s pension system is pretty much fully funded (although its retiree health programs are virtually unfunded). In contrast, states such as New Jersey, Illinois, and Connecticut are on a trajectory that could see them blow through their entire pension portfolios before the end of this decade. But even those states that have squirreled away enough to cover their pension costs will have to find a lot of extra cash to pay for health benefits as baby boomers retire in droves over the next ten to 15 years. And, of course, if investment performance doesn’t make the 8 percent bogey, even more cash will be required to satisfy exist- ing obligations. LEGAL PROTECTIONS Absent ERISA protections, eight states’ constitutions protect retire- ment benefits, while 22 others have passed statutes restricting their ability to curtail benefits. Additionally, the Contract Clause of the U.S. Constitution prohibits states from impairing a contractual obligation to provide benefits unless reasonable and necessary to fulfill an impor- tant public purpose. Translation: It’s unconstitutional to reduce vested BENEFITS LAW JOURNAL 3 VOL. 23, NO. 3, AUTUMN 2010
Recommend
More recommend
