In fiscal year 2009, states overpromised at least $1.26 trillion in retirement and retiree health care benefits to public employees, according to a study released Tuesday by the Pew Center on the States, a 26% increase in one year.
Pew's report, "The Widening Gap," found pension plans make up more than half of the shortfall. With liabilities of nearly $3 trillion, and just $2.28 trillion in state coffers, there's a gap of $660 billion in state pension funded status. States have saved less than 5% of the funds needed to cover non-pension liabilities.
The shortfall is a result of "precipitous revenue declines" in fiscal year 2009, according to the report. State actuaries recommended states contribute nearly $115 billion to fund long-term obligations, but states only met 64% of that commitment.
"There are no quick fixes to the pension funding challenge," Steve Fehr, project director and senior staff writer for Pew Center on the States told AdvisorOne, "but we are seeing policy makers in a number of states deal with the problem head on."
For example, in 2010, Fehr said, 19 states were able to reduce their long-term bill by cutting benefits levels for new employees and requiring workers to contribute more of their paychecks to pension and health care funds.
"The immediate savings from these reforms are relatively small compared to the size of current budget shortfalls," according to Fehr, "but in the long run the savings are significant. Missouri’s policy changes, for example, are projected to save $660 million over the next decade. One Missouri change was to raise the retirement age from 65 to 67."
The $1.26 trillion figure, high as it is, could be a conservative estimate, according to Pew. Most states use an 8% discount rate to calculate pension liabilities, but "there is significant debate among policy makers and experts" about whether that figure is appropriate. Pew found that between 1990 and 2009, states' median investment return was 8.1%, but for 2000 to 2009, if fell dramatically to 3.9%.
"Given recent economic events," Fehr said, "some states are considering discount rate changes, and at least four have recently lowered their rates. Those states are Alaska, Illinois, New York, Rhode Island and Pennsylvania."
Depending on how states liabilities are calculated, the shortfall could be between $1.8 trillion, assuming the 5.22% discount rate used on corporate pensions, and $2.4 trillion, using the Treasury bond's 4.38% discount rate, Pew found.
Fehr added that Pew does not recommend a discount rate, affirming that each state needs to answer that question for itself. However, he said, "we do want policymakers and taxpayers to understand several potential consequences of lowering the discount rate. Most immediately, a state would see the amount of its annual required contribution increase to compensate for the reduced expectations for investment gains."
As an example, Fehr pointed to objections from California state agencies to a recent proposed cut in the discount rate. "It would have meant that each agency needed to spend more now on retirement contributions, leaving fewer dollars for public services."