US state pensions becoming federal issue
By Nicole Bullock in New York and Hal Weitzman in Chicago
Published: May 19 2010 20:44 | Last updated: May 19 2010 20:44 - Financial Times
Illinois used to have a plan to pay off the gaping shortfall in the pension
funds that pay retired teachers, university employees, state workers, judges and
politicians, Dan Long recalls.
Mr Long, director of the Commission on Government Forecasting and
Accountability, the non-partisan auditing arm of the Illinois state legislature,
remembers that, back in 1994, the state laid out a proposal that would have paid
off most of what was then a $17bn gap by 2011.
But Illinois could not stick to the plan.
With financial year 2011 less than six weeks away, the pension arrears of the
1990s look quaint. Instead of a balanced system, the state faces unfunded
liabilities of about $78bn, the biggest pension hole in the US, and
contributions of more than $4bn for 2011, the largest single element of its
$13bn budget deficit.
Illinois is the poster child of unfunded pensions in the US. But state retirement systems could become a national concern, new
research shows.
Joshua Rauh, associate professor of finance at the Kellogg School of
Management at Northwestern University said that, without reform, some state
pensions might run out within the decade. By 2030, as many as 31 states may not
have the money to pay pensions. And, if these funds exhaust their assets, the
size of payments for the benefits they have promised will be too large to cover
through taxes, putting pressure on the federal government for a bail-out that
could potentially cost more than $1,000bn, he says.
gIt is more than a local problem,h Mr Rauh said. gThe federal government
could be on the hook.h
Estimates put the unfunded liabilities at between $1,000bn
and $3,000bn after years of states promising benefits but not contributing
enough in both good times and bad to cover them.
Many states base their calculations on an 8 per cent annual return and use an
accounting method called smoothing, which staggers gains and losses over several
years, two factors that some observers warn could mask the size of the
shortfalls. The problem has come to the fore with the financial crisis and
recession. Pension funds, like most money managers, suffered losses. The tax
revenues that fund annual contributions to pensions, along with essential
services such as healthcare and education, have plummeted, leaving little room
to reimburse the losses.
States have begun reforms, with some lowering return expectations and raising
employee contributions and retirement ages.
Mr Rauh said such measures were cosmetic and states needed comprehensive,
federally sponsored reform that would require closing the systems to new
members, shifting state workers to Social Security and individual plans similar
to those that are used by the private sector in order to obtain incentives to
borrow to bridge the gaps.
Mr Rauh said subsidising pension borrowing would cost a net $75bn with new
contributions to the national Social Security programme offsetting some of the
subsidies.
By his calculations, which assume the 8 per cent return, Illinois would run
out by 2018 followed by Connecticut, New Jersey and Indiana in 2019. Some 20
states will have run out by 2025.
Five states would never run out, including New York and Florida, and 17 other
states have a horizon of 2030 or beyond.
Robert Megna, New Yorkfs budget director, said his state had had to make
gtough choicesh to keep funding its pensions despite budget shortfalls over the
past few years. On March 31, the state made a nearly $1bn payment for the last
fiscal year.
gWe had to make cuts: education, healthcare, local government support and
not-for-profit providers,h Mr Megna said of the last yearfs budget process.
New Yorkfs governor has proposed borrowing from the pension system, which is
about 94 per cent funded, as the state did after the September 11 attacks, and
repaying it with interest if low tax collections persist, Mr Megna said.
For fiscal 2010, Illinois sold $3.5bn of bonds to pay for its annual
contribution.
But in an election year, there is no political support in Springfield, the
capital of Illinois, for another bond issue, particularly since it requires a
two-thirds majority in the state legislature.
The most likely outcome is that the state will defer the issue to next year.
gThatfll have an impact in terms of lost investment opportunities, and theyfll
have to sell some of the portfolio to pay the pensions,h said Mr Long.
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