A growing and largely ignored crisis: Public pension funds are running out of money

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Photo by UGArdener via flickr

WASHINGTON, June 13, 2014 — As of fiscal year 2008, there was a $1 trillion gap between what states had promised to public employees in retiree pensions, health care, and other benefits and the money they currently have  to pay for it — their so-called “unfunded liabilities.” This is according to a study from the Pew Center on the States. Some economists say that Pew is too conservative and that the problem is two or three times as large.

Roger Lowenstein, an outside director of the Sequoia Fund and author of “While America Aged,” points out that, “For years, localities and states have been skimping on what they owe. Public pension funds are now so massively short of money to pay future claims, depending on how their liabilities are valued, the deficit ranges from $1 trillion to $3 trillion. Pension funds subsist on three revenue streams: contributions from the employer; contributions from the employees; and investment earnings. But public employees have often contributed less than the actuarially determined share, in effect borrowing against retirement plans to avoid having to cut budgets or raise taxes.”

Pension funds, Lowenstein notes, also assumed that they could count on high annual returns, typically 8 per cent, on their investments: “In the past, many funds did earn that much, but not lately. Thanks to high assumed returns, governments projected that they could afford to both ratchet up benefits and minimize contributions. Except, of course, returns were not guaranteed. Optimistic benchmarks actually heightened the risk because they forced fund managers to over-reach.”

Consider the case of Massachusetts. The target of its pension board was 8.25 per cent. “That was the starting point for all of our investment decisions,” says Michael Travaglini, until recently the executive director. “There was no way a conservative strategy is going to meet that.”


Lowenstein notes that, “Travaglini put a third of the state’s money into hedge funds, private equity, real estate, and timber. In 2008, assets fell 29 per cent. New York State’s fund, which is run by the comptroller … a former state assemblyman with no previous investment experience, lost $40 billion in 2008.”

A report issued by the Empire Center for New York State Policy, a research organization that studies fiscal policy, reports that the cities, counties and authorities of New York have promised more than $200 billion worth of health benefits to their retirees while setting aside almost nothing to pay for it, putting the public work force on a collision course with the taxpayers who are expected to foot the bill.

The Teacher Retirement System of Illinois lost 22 per cent in the 2009 fiscal year. Alexandra Harris, a graduate journalism student at Northwestern University who investigated the pension fund, reported that it invested in credit-default swaps on A.I.G., the State of California, Germany, Brazil, and “a ton” of subprime mortgage securities.

According to Joshua Rauh of the Kellogg School of Management at Northwestern, assuming states make contributions at recent rates and assuming they do earn 8 per cent, 20 state funds will run out of cash by 2025. Illinois, the first, will run dry by 2018.

In a report issued by Professor Rauh and Robert Novy-Marx, a University of Rochester professor, five major cities, Boston, Chicago, Cincinnati, Jacksonville and St. Paul, are said to have pension assets that can pay for promised benefits only through 2020. Philadelphia, according to the report, has assets on hand that can only pay for promised benefits through 2015.

Professor Rauh declares that, “We need fundamental reform of the ways employees in the  public sector are compensated. It is not feasible to make promises of risk-free pensions when in the private sector (nearly) everyone has to share some of the risk.”

Over the years, politicians of both parties have given in to the demands of public employee unions for higher pensions, rather than wage increases, because they knew that such pensions would be paid many years later, under someone else’s watch. Now those bills are coming due, and many states and cities are in no position to pay them.

In New Jersey, Governor Chris Christie has been seeking to reform his state’s sick-pay policies. Current law allows public workers to accumulate unused sick pay, which they can cash in upon retirement. “They call them ‘boat checks,'” Christie says. “Know the reason they call them boat checks?  It is the check they use to buy their boat when they retire, literally.”

He tells the story of the town of Parsippany, where four police officers retired at one time and were owed a collective $900,000 in unused sick pay. The municipality didn’t have the money and had to float a bond in order to make the payments.

Governor Christie wants to end sick-pay accumulation. “If you’re sick, take your sick day,” he says. “If you don’t take your sick day, know what your reward is? You weren’t sick, that was your reward.”

Estimated at $46.4 billion by Pew Research, New Jersey’s unfunded pension liability is one of the worst in the nation on a per-capita basis. Governor Christie came to office in 2009 vowing to end this dysfunctional system. With bipartisan support from the Democratic legislature, he managed to enact reforms that would have put the state on a path to pension sustainability by 2018. This was to be a cornerstone in his bid for the presidency. On May 20, however, he announced that New Jersey would have to cut a scheduled payment to the state’s pension fund by $900 million this year. He also requested legislative authority to reduce next year’s payment by $1.5 billion.

In California, total pension liabilities, the money the state is legally required to pay its public sector employees, are 30 times its annual budget deficit. Annual pension benefits rose by 2,000 per cent from 1999 to 2009. In Illinois, they are already 15 per cent of general revenue and growing. Ohio’s pension liabilities are now 35 per cent of the state’s GDP.

The accounting at the heart of government pension plans is fraudulent. David Crane, an economic adviser to former California Governor Arnold Schwarzenegger, points out that state pension funds have assumed that the stock market will grow 40 per cent faster in the 21st century than it did in the 20th. While the market has grown 175 times during the past 100 years, state governments are now assuming that it will grow 1,750 times its size over the next 100 years.

Inflated retirement benefits are the reason for dramatic cuts in spending by state and local governments for anything else. In 2011, California spent $32 billion on employee pay and benefits, up 65 per cent over the past ten years. In that same time period, spending on higher education is down 5 per cent. Three-quarters of San Jose’s discretionary spending goes to its public safety workers alone. The city has closed libraries, cut back on park services, laid off many civil servants and asked the rest to take pay cuts. Today, San Jose, the 10th largest city in the country, is serviced by 1,600 public workers, one third the number it had 25 years ago.

In Roger Lowenstein’s view, states need to cut pension benefits. “About half have made modest trims, but only for future workers. Reforming pensions is painfully slow, because pensions of existing workers are legally protected. But public employees benefit from a unique notion that, once they have worked a single day, their pension arrangement going forward can never be altered. No other Americans enjoy such protections. Private companies often negotiate (or force upon their workers) pension adjustments. But in the world of public employment, even discussion of cuts is taboo.”

Recently, some states have begun to test the legal boundary. Minnesota and Colorado cut cost-of-living adjustments for existing workers’ pensions. In Colorado, in what many have called an act of political courage, a bipartisan coalition of state legislators passed a pension overhaul bill. Among other things, the bill reduced the raise that people who are already retired get in their pension checks each year. “We have to take this on, if there is any way of bringing fiscal sanity to our children,” said former Governor Richard Lamm, a Democrat. “The New Deal is demographically obsolete. You can’t fund the dream of the 1960s on the economy of 2010.”

In Colorado, the average public retiree stops working at 58 and receives a check of $2,883 each month. Many also receive a 3.5 per cent annual raise, no matter what inflation was, until the rules changed in 2011.

According to The New York Times, “Private sector employees who want their own monthly $2,883 check for life, complete with inflation adjustments, would need an immediate fixed annuity if they don’t have a pension. A 58-year-old male shopping for one from an A-rated insurance company would have to hand over a minimum of $860,000, according to Craig Hemke of Buyapension.com. A woman would need at least $928,000 because of her longer life expectancy. Who among aspiring retirees has a nest egg that size, let alone people with the same moderate earning history as many state employees? And who wants to pay to top off someone else’s pile of money via increased income taxes or a radical decline in state services?”

“We have to do what unions call givebacks,” said Mr. Lamm, the former Colorado governor. “That’s the only way to sanity. Any other alternative , therein lie dragons.”

Americans were quite properly shocked when it was revealed that the Los Angeles blue-collar suburb of Bell, California was paying its city manager Robert Rizzo $787,637 a year, with 12 per cent annual pay increases. Rizzo along with Police Chief Randy Adams and Assistant City Manager Angela Spaccia resigned. The combined annual salary of these employees was $1,620,925 in a city where one of every six residents lives in poverty. The city’s debt quadrupled between 2004 and 2009.

The Washington Examiner states that, “The likely reason why Rizzo, Adams and Spaccia resigned so readily is that they are eligible for public pensions. Under current formulations, Adams will make $411,000 annually in retirement and Spaccia could make as much as $250,000, when she’s eligible for retirement at age 55 … California is but one of many states on the brink of fiscal ruin largely due to outrageous public employee benefits.”

While the Bell, California example may be extreme, the crisis in public employee pension funds across the country is very real, and must be confronted to avoid massive bankruptcies in the future.

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Allan C. Brownfeld
Received B.A. from the College of William and Mary, J.D. from the Marshall-Wythe School of Law of the College of William and Mary, and M.A. from the University of Maryland. Served as a member of the faculties of St. Stephen's Episcopal School, Alexandria, Virginia and the University College of the University of Maryland. The recipient of a Wall Street Journal Foundation Award, he has written for such newspapers as The Houston Press, The Washington Evening Star, The Richmond Times Dispatch, and The Cincinnati Enquirer. His column appeared for many years in Roll Call, the newspaper of Capitol Hill. His articles have appeared in The Yale Review, The Texas Quarterly, Orbis, Modern Age, The Michigan Quarterly, The Commonweal and The Christian Century. His essays have been reprinted in a number of text books for university courses in Government and Politics. For many years, his column appeared several times a week in papers such as The Washington Times, The Phoenix Gazette and the Orange County Register. He served as a member of the staff of the U.S. Senate Internal Security Subcommittee, as Assistant to the research director of the House Republican Conference and as a consultant to members of the U.S. Congress and to the Vice President. He is the author of five books and currently serves as Contributing Editor of The St. Croix Review, Associate Editor of The Lincoln Review and editor of Issues.
  • Tough Love

    The focus of change (notwithstanding difficult legal impediments) must NOT be how Taxpayers should fully fund these grossly excessive Public Sector pension & benefits promises …… granted via collusion between the public Sector Unions and our elected officials BOUGHT-OFF with Public Sector Union campaign contributions and election support, or threats if you refuse to support their agenda …. but how we can either:

    (A) hard freeze all current Public Sector DB Plans (ZERO future growth) for all CURRENT (not just new) workers, replacing them with a modest DC Plan comparable to what Private Sector workers typically get in the form of 401K contributions from their employers, or
    (B) if (A) above is absolutely impossible to implement (and then only after forcefully pursuing every option to do so), then continue the current DB Plans, but reduce the pensions accrual rate for future service by 50% for non-safety workers, and by 66% for safety workers. The resultant pensions would STILL be greater than 90+% of the pensions granted Private Sector workers in comparable occupations.

    Lastly, almost nobody in the Private Sector receives subsidized employer-sponsored retiree healthcare any longer. As such, there is ZERO reason for Taxpayers to fund it for Public Sector workers. Such subsidies should end immediately, replaced with AT MOST a very modest (e.g., $300) annual contribution to a Health Savings account (HSA).

    • disqus_nBlOXUeC3W

      The good news is that while it’s nearly impossible to reduce pensions, that’s not the case with health care benefits–so many munis are going after those benefits.

      • Tough Love

        Reducing pensions for the FUTURE Service of CURRENT workers has yet been thoroughly Court tested, and even then, the outcome will likely vary by location.

  • eatingdogfood

    CA CHING, CA CHING, CA CHING! YEAH, IT MUST BE THAT TIME OF YEAR AGAIN!
    My Union Boss down at the Town Hall emailed me yesterday and.
    Told me that this article was hitting the Papers today, and He told Me.
    to make it Look like I was Working till this Blows Over in a week. I
    know the routine! In a week, I’ll be back to my usual activity of.
    Collecting A Paycheck for Doing Nothing! Hey, Private Sector.
    Workers; You really gotta Pony Up more Taxes! I need at least a 10 %.
    raise! My Cabin Cruiser at the Dock behind my Vacation House in.
    Florida needs a New Engine. My wife has been after me for a new car.
    She wants a BMW X6 G-Power Typhoon S! I told her I can’t afford that.
    car. So then she says she will accept a Mercedes-Benz CL-Class and.
    Nothing else! I also got Private School Tuition of $ 40,000.00 due.
    in September. I got Credit Card Expenses coming out my AXX! That
    new 3000 sq ft extension on my house raised my property taxes $ 15,000.
    The maid and the housekeeper want raises. The gardener also wants a.
    raise. You see Bunky; It ain’t easy in the Public Sector! So come
    on Private Sector Worker; Pony Up and Pay More Taxes so I can afford to.
    live here! You See; Life Is Not Fair, and the DemoRats will take.
    care of Everything! HAPPY DAYS ARE HERE AGAIN!

    • disqus_nBlOXUeC3W

      Those pensioners in Detroit will have a little less cash to spend on new cars. lol. The deal they are voting on is they get to keep their pensions with a 5% cut, with no COLA’s and no health benefits. That’s awesome.

      • Tough Love

        From a fairness (to Taxpayers) standpoint, the cuts should have been greater. With Private Sector workers RARELY getting any employer-subsidized retiree healthcare, eliminating that for Public Sector workers just put them in the same position as everyone else, and their pensions are MULTIPLES greater than comparable Private Sectors retiring at the SAME age, with the SAME pay, and the SAME years of service. Rightfully, the pensions cuts should have been greater, and if not for the “Grand Bargain” put together to protect Detroit’s Art Collection from sale as part of the bankruptcy, the pensions reductions assuredly WOULD HAVE been far greater.

  • Equal Time

    Eating – I have seen your post before, on other articles about public pensions – same wording! Makes me suspect you are a paid blogger – could that be?

  • disqus_nBlOXUeC3W

    I’m beginning to like the Koch brothers a lot. They got Scott Walker elected governor and they said they would spend $135 million on ads against lawmakers in Michigan who support using state money to bail out Detroit. I think I’ll buy a roll of Brawny paper towels today.

  • So Nee

    In addition to the billions of dollars wasted during Afghanistan reconstruction, $7 billion of US military equipment is being left there.

  • CaptainKevin

    I feel really bad for these pensioners, especially those in and around Detroit who are good people. For the record, I’ve been to a number of cities and Detroit area residents welcome visitors and act as good ambassadors for their city. Regardless of how I feel, the math tells the truth. There is absolutely no way to fix the Federal, State, County and City pension systems without cuts to existing workers and pensioners. We as a people need to quit voting for politicians that kick the can down the road and instead vote for those that are responsible.

    The Federal Government should lead by example. If a 401K is good enough for those fortunate enough to have it in the private sector, the same should apply to the Federal Government. However, at least one Federal Government employee I know also gets a 401k match type of plan in addition to his pension. This needs to stop. The taxpayers should only pay to contribute to one retirement plan per Federal employee. Next, politicians needs to cut out all the paid sick days. My State, County and City employees get 15 paid sick days per year that accumulate and can be “sold back” for a nice lump sum payment upon retirement. This too is bleeding taxpayers dry. In a neighboring County a number of higher up officials retired, collected “buy back” bonuses that totaled just under 3/4 of a million dollars at a time when they were laying people off because the County had no money. And they wonder why the County is broke? Really?

    The bottom line is that we need to make legislators responsible for their actions and inactions. If they can’t work to fix the problem, then they are part of the problem and should be voted out of office or even recalled in some cases.