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By Julie Kosterlitz, National Journal
© National Journal Group Inc.
Friday, Jan. 19, 2007

After a parade of major employers palmed off their underfunded pension plans on the federal government, Congress intervened last year. The new law is meant to force laggard corporations to put more money behind their retirement promises and into the federal insurance scheme.

But the legislation doesn't say a word about state and local governments' pension plans, although these are, on average, even worse off than the private ones. States and cities are "systematically making promises they're not paying for, meaning that future generations will pay," says Jeremy Gold, an actuarial consultant in New York City.

Like their private counterparts, many cash-short governments have agreed to boost pensions in lieu of immediate pay increases, to please powerful public employees unions without having to raise taxes. Most public employers also bet heavily on the stock market -- then watched their plan assets shrivel when the market plummeted in late 2000.

Unlike private employers, however, public employers aren't bound by the federal Employee Retirement Income Security Act , which sets minimum funding standards. Some states skipped contributions when the late-1990s' bull markets made them feel flush, and others did so when state revenues fell short. And a few states -- particularly Illinois and New Jersey -- made a habit of skipping payments to fund other projects or tax cuts.

On the surface, state and local pension plans don't appear much worse off than private plans: A 2006 survey by the National Association of State Retirement Administrators said the plans were, on average, 87 percent funded -- with a total unfunded liability of about $337 billion. Private plans are, on average, 90 percent funded.

But many experts say that state accounting measures are too lenient. If state plans used private-sector standards, they would be on average just 64 percent funded, and their cumulative liability would nearly quadruple to about $1.3 trillion, according to Thomas Healey, a lecturer at Harvard University's John F. Kennedy School of Government who is a former Goldman Sachs partner and was a Treasury Department official in the Reagan administration.

State officials and public employees unions say that comparisons with private plans are misleading because states and cities, unlike companies, can't go out of business and aren't a risk to the federal pension insurance scheme. And states don't have to come up with all of the money immediately: Retirement promises come due over time. Only a few plans, they contend, truly face big problems. But the states' accounting standard-setter, the Governmental Accounting Standards Board, has recently proposed tighter accounting rules.

It gets worse. Most states have also promised to cover retirees' medical costs, without putting aside money to do so. But even as health costs have ballooned beyond estimates, states have never had to disclose the size of these unfunded liabilities. Now the GASB has begun asking states to do so by mid-2008. Early estimates from a few states are jaw-dropping: as much as $70 billion for California, $54 billion for New York, $30 billion for Michigan, and $20 billion for New Jersey. Healey puts the total shortfall for pension and health promises at $2 trillion.

Catching up on installment payments for these costs will be tough, says Sujit CanagaRetna, senior fiscal analyst in the Atlanta office of the Council of State Governments, because the states -- still recovering from huge revenue declines -- are about to get a mailboxful of other bills. There are the tabs for deferred repairs to infrastructure, education reform, homeland security, and programs for their aging populations. "Cumulatively, I see a fiscal tsunami," CanagaRetna says.

It's already hit in San Diego, where officials hid a ballooning pension liability from those who bought the city's bonds. The scandal has forced officials from office and left the city racked by fiscal and legal problems -- including sanctions from the Securities and Exchange Commission. "It's legal for politicians and bureaucrats to lie to voters, but it's not legal to lie to potential bond investors," the San Diego Reader wrote.

Facing unpalatable choices, most states, cities, and school districts are merely trying to slow the growth of future costs -- state constitutions often forbid tampering with current workers' benefits. Some are proposing to raise the age at which retirees get full benefits; others are shifting more costs and investment risks to public employees -- a sizable minority of whom don't participate in Social Security.

But some of the bolder attempts have already stalled. In California, Republican Gov. Arnold Schwarzenegger quickly dropped his 2005 bid to push new hires into a 401(k)-style plan after an ad blitz by labor groups said that the measure would cut disablity and survivor benefits for police and firefighters injured or killed on the job. Schwarzenegger punted the issue to a commission that is to report in 2008.

Some states are borrowing by selling bonds and investing the proceeds in the stock market. If stock gains outpace interest costs, the states win. If not, it can cost them dearly, as New Jersey learned when the market tanked in 2000.

Congress has shown glimmers of interest in the issue. A Republican-led House subcommittee held a field hearing in Illinois to look at the state's pension plan -- ranked among the nation's most underfunded -- and the top Republican and Democrat on the Senate Finance Committee jointly asked the Government Accountability Office for a report, which is expected midyear.

But congressional action is unlikely. Proposals to stiffen accounting and management requirements have gone nowhere. Democrats, back in power, are unlikely to support steps that their allies in the public employees unions fear could encourage states to replace traditional pensions with 401(k)-style plans. And states have already served notice on where they stand. States are "diligently managing" their pensions, and will "wholeheartedly resist federal intervention," Steve Rauschenberger, then president of the National Conference of State Legislatures, wrote in a testy letter to the Senate Finance Committee last summer. Rauschenberger is a state senator in Illinois, where the government's pension problems routinely dominate local headlines. [an error occurred while processing this directive]

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