States Face Huge Pension Funding Gap

An analysis by the Pew Center on the States showed that at the end of FY2008 ended June 30, states and participating localities had set aside $2.4 trillion to pay from employees' retirement benefits, while the cost of those promises clocked in at $3.4 trillion. Worse, that calculation didn't take into account the second half of 2008, when states' pension fund investments suffered significant losses in the market downturn, which were only partly made up in 2009.

The $1 trillion gap, Pew said, owes to states' failure to meet levels of annual payments recommended by their own actuaries; expanding benefits and offering cost-of-living increases without figuring out how to pay for them; and providing healthcare to retirees without adequately funding it.

Failures to fully pay for their retirement obligations and investment losses in the dot-com downturn have pushed up states' annual required contributions. Between 2000 and 2008, Pew found, state and local governments' pension benefits bill increased by 135%, and seemed certain to rise in 2009 and later. In 2008, states and local governments owed $64 billion, and on top of that had a tab for $43 billion for retirees' healthcare benefits.

The results of this mess, according to Pew: "high annual costs that come with significant unfunded liabilities, lower bond ratings, less money available for services, higher taxes and the specter of worsening problems in the future."

Pew said that between the onset of recession in December 2007 and November 2009, states faced a combined budget gap of more than $300 billion, with revenues expected to continue to decline over the next two years. As a result, many states are considering reforms to right their public sector retirement benefit systems. Reforms include keeping up with funding requirements, reducing benefits or increasing retirement age, sharing the risk with employees, increasing workers' contributions and improving governance and investment oversight.

Michael S. Fischer is a New York-based financial writer and editor and a frequent contributor to Wealth Manager.