Public pension crisis
State pension funding levels vary dramatically in the nation. Several states have pension plans with high levels of funding, but the majority of states have pensions that are extremely underfunded. The crisis is due to an aging workforce, delayed and suspended contributions, increased benefits and investment losses.
Demographics are exacerbating the budgetary burden of the public-sector workforce. Current retirees leave work at an earlier age and live longer, thus drawing substantially more retiree health care and pension benefits than their predecessors. Currently, every private sector worker in America would have to pay $12,000 to support the current pension promises to public sector workers. This figure does not include health benefits.
The current pension crisis started in the late 1990s when the stock market was booming. Growing stock prices increased the value of pension funds to such levels that many state and local governments reduced or eliminated the annual benefit payments made by employees.
According to the Pew Center on the States, in 2000, states only needed to pay $27 billion total into their pension funds. That amount more than doubled to a $64 billion deposit required in FY 2008 when an economic recession had reduced states' revenues. In 2008, prior to the economic downturn, 54% of plans had assets totaling at least 80% of their liabilities, and in 2009 that number declined to 43% of plans. The blow to pension system returns was dramatic. For example, the 2008 stock market crash reduced the Maine pension system's returns in fiscal year 2009 by 18.7% and by 11.1% in FY 2010.
Susan Urahn, managing director of the Pew Center on the States, also noted that the 8% return on investments most states typically expect may need to be lowered.
States’ investment losses exceeded $800 billion in 2008 and worsened the budgetary pressures of pension obligations. Healthcare obligations likewise are sapping state budgets. Unlike the private sector, state and local governments have largely adopted “defined benefit” plans, under which specific types of services are assured. The costs of defined benefit plans escalate annually. In contrast, “defined contribution” plans provide a fixed payment for pensions and thus in fully funding pensions. Public employees contribute far less to their health care coverage compared to workers in the private sector.
In addition, new accounting practices introduced in the early 1990s also revealed the pension funding of previous generations was even worse than previously thought.
The pension crisis is worsened by the large numbers of retirees and the challenging economy, and also by financial institutions. The Ohio Public Employees Retirement System saw a decline in value from $441.4 million in December 2007 to just $73.3 million in December 2008, three months after Lehman Brothers, which managed the system’s investments, filed for bankruptcy protection. In the second quarter of 2010, state and local pension funds lost $58 billion on investments, the worst loss since 2008.
In response to the bad financial performance, many states are also considering lowering their assumptions of pension fund earnings, which will further hurt revenues for future state budgets.
Cost of living adjustments (COLA)
Cost of living increases in pension benefits also exacerbate the fiscal crises facing public pensions. Rhode Island included in its FY2011 budget a limit on the cost-of-living adjustments (COLA) provided future retirees to the pensioner's first $35,000 in benefits and required eligible individuals to wait until age 65 to begin collecting the annual COLAs. Other states that have limited cost of living adjustments include Colorado, Maryland, Michigan, Minnesota and South Dakota.
A Colorado law passed in 2010 reduced the raise that people who are already retired get in their pension checks each year, capping the cost-of-living adjustment at 2% instead of the 3.5 percent raise that many of them were getting. Some retirees and those eligible to retire then filed suit against the state to keep all of the annual cost-of-living increases they anticipated receiving.
Cost of health benefits
Of the unfunded pension and other post-retirement promises made to workers by states, $587 billion is for retiree health care, according to Pew, with less than 6% of that amount funded as of fiscal year 2008. Only two states, Alaska and Arizona, have set aside at least 50% of the needed assets. On average, states have a 7.1% funding rate of their non-pension benefits.
New York City public employees did not contribute to their healthcare plans as of 2010, but did pay co-pays when visiting the doctor. A recent study by the Rockefeller Institute of Government Analysis found that if New York public employees would contribute 10 percent of their earnings, like state workers do, it would save the city nearly a billion dollars annually. Other local governments in New York could save $838 million if their employees would contribute to their healthcare costs.
Delayed and suspended contributions
States have stopped paying into pension funds. The economic downturn isn't the only cause of the current pension funding crisis. "Over the last 10 years, many states have shortchanged pension plans in good times and bad," said Susan Urahn, the managing director of the Pew Center on the States, who called the beginning of the century a "decade of irresponsibility." The levels to which states opt to fund pension benefits seem to depend largely on budgetary convention and the appropriation levels of previous legislatures, experts say.
For example, New Jersey Governor Chris Christie skipped a $3 billion payment into the $66.9 billion fund in his first budget and has said that the state may not be able to make the expected $512 million contribution to the pension system in FY 2012. As of June 30, 2009, the New Jersey pension fund that provides benefits for nearly 800,000 current and retired state employees and teachers had a gap of $46 billion between assets and anticipated payouts.
Impact on individual states
A study by the Pew Center on the States found Illinois to be in the worst shape of all the states, with only 54 percent of its pension obligations funded for FY 2008. Illinois's official unfunded retirement liability easily exceeds $100 billion when health care and other post employment benefits are considered, but that number does not take into account the fact that Illinois pensions assume risk-free returns on investment as high as 8.5 percent every year, which is unrealistic in the current economic climate. In addition, the State Retirement System of Illinois, which oversees three of the state’s five public employee pensions, says that the pension’s funding ratio has shrunk from 43% to 38%, and liabilities have swelled to $29 billion, with assets shrinking to $11.1 billion.
The state was forced to borrow $3.5 billion to meet its pension obligations, thereby incurring tens of millions of dollars in additional debt service costs. Illinois took the unusual step of using debt to fund its pensions to free up funds for operations, according to Illinois' director of capital markets.
At the other end of the spectrum, Alaska and Arizona are the sole states that have more than 50 percent of the assets needed to pay for other post-employment benefits, according to a study by the Pew Center for the States.
Public pension protections
Public pension benefits are protected through various legal means. In some cases, these protections stand as obstacles to public pension reforms that may affect current rather than just future employees.
Several state constitutions explicitly protect the pension benefits of public employees. In these instances, clauses specifically refer to the rights or benefits of public employees without relying on an interpretation of the contracts clause.
|Alaska||Article XIII, Section 7||"Membership in employee retirement systems of the State or its political subdivisions shall constitute a contractual relationship. Accrued benefits of these systems shall not be diminished or impaired."|
|Arizona||Article 29||"“Membership in a public retirement system is a contractual relationship that is subject to article II, section 25, and public retirement system benefits shall not be diminished or impaired.”|
|Hawaii||Article XVI, Section 2||“Membership in any employees' retirement system of the State or any political subdivision thereof shall be a contractual relationship, the accrued benefits of which shall not be diminished or impaired.”|
|Illinois||Article XIII, Section 5||Membership in any State, local, or school district pension plan is an “enforceable contractual relationship, the benefits of which shall not be diminished or impaired.”|
|Louisiana||Article X, Section 29||“Membership in any retirement system of the state or of a political subdivision thereof shall be a contractual relationship between employee and employer, and the state shall guarantee benefits payable to a member of a state retirement system or retiree or to his lawful beneficiary upon his death.”|
|Michigan||Article IX, Section 24||"The accrued financial benefits of each pension plan and retirement system of the state and its political subdivisions shall be a contractual obligation thereof which shall not be diminished or impaired thereby."|
|Texas||Article 16, Section 66||"Benefits granted to a retiree or other annuitant before the effective date of this section and in effect on that date may not be reduced or otherwise impaired." This section does not apply to statewide retirement systems. It is also important to note that before the Amendment went into effect in 2004, municipalities were allowed to, by voter referendum, exempt themselves from the Amendment's requirements.|
Most state constitutions, along with the United States Constitution, contain provisions protecting the right of contract. Under many legal interpretations, these clauses have been held up as guarantors of pension benefits for current and retired state employees. Under this interpretation, an employee enters a contract for pension benefits with his or her employer at some stage of employment (either upon hiring or at a later "vesting" date) that cannot be altered. California has historically held the strongest judicial interpretation of a contracts clause when it comes to protecting public employee pension benefits.
One study highlighted what the author dubbed a "California rule." The legal basis developed in California's court, and the term applies when judicial interpretations have held that "the statutes establishing state retirement systems created contracts between the state and employees that prohibit the state from making any detrimental changes to the benefits provided to current employees within such systems, even on a prospective basis." The study highlighted 12 states with a judicial interpretation of public employee contract rights based on California's model:
|Alaska||Hammond v. Hoffbeck, 627 P.2d 1052, 1057 (Alaska 1981)|
|Colorado||Police Pension & Relief Bd. v. Bills, 366 P.2d 581, 584–85 (Colo. 1961); see also City of Aurora v. Ackman, 738 P.2d 796, 801 (Colo. App. 1987)|
|Idaho||Nash v. Boise City Fire Dep’t, 663 P.2d 1105, 1108–09 (Idaho 1983); Hanson v. City of Idaho Falls, 446 P.2d 634, 636 (Idaho 1968)|
|Kansas||Singer v. City of Topeka, 607 P.2d 467, 475 (Kan. 1980)|
|Massachusetts||Dullea v. Mass. Bay Transp. Auth., 421 N.E.2d 1228, 1235 (Mass. App. Ct. 1981)|
|Nebraska||Calabro v. City of Omaha, 531 N.W.2d 541, 552 (Neb. 1995)|
|Nevada||Pub. Emps.’ Ret. Bd. v. Washoe Cnty., 615 P.2d 972, 974–75 (Nev. 1980)|
|Oklahoma||Taylor v. State & Educ. Emps. Grp. Ins. Program, 897 P.2d 275, 279||Requires that a change not impair the fund's actuarial soundness, or "detrimentally affect vested rights."|
|Oregon||Or. State Police Officers’ Ass’n v. State, 918 P.2d 765, 773 n.14, 775 n.18 (Or. 1996)|
|Pennsylvania||Catania v. Commonwealth, 450 A.2d 1342, 1349–50 (Pa. 1982)|
|Vermont||Burlington Fire Fighters’ Ass’n v. City of Burlington, 543 A.2d 686, 690 (Vt. 1988)|
|Washington||McAllister v. City of Bellevue Firemen’s Pension Bd., 210 P.3d 1002, 1004 (Wash. 2009); Bakenhus v. City of Seattle, 296 P.2d 536, 538–41 (Wash. 1956)|
- “Chamber of Commerce confers on public pensions”
- Government Accountability Office, STATE AND LOCAL GOVERNMENT RETIREE HEALTH BENEFITS, November 2009
- Watchdog, Pension panel: Have we hit bottom?, Sept. 24, 2010
- Watchdog.org "Illinois faces second pension battle"
- National Public Radio "U.S. State Pension Funding Levels" February 18, 2010
- Watchdog, Despite gains, public pensions crashing, July 2010
- San Francisco Chronicle "Public pensions put state, cities in crisis" July 25, 2010
- Reuters "U.S. state pension funds have $1 trillion gap: Pew" Feb. 18, 2010
- The Wall Street Journal "State Pension Funding Declines" April 8, 2010
- The Lewiston Sun-Journal "Pensions to eat up larger share of state budget" Jul 28, 2010
- American Economic Association (AEA), Will public sector retiree health benefit plans survive? Economic and policy implications of unfunded liabilities, January 2009
- ABCNews.com "Ohio Pensions Took $480M Hit After Lehman Collapse" April 19, 2010
- Watchdog, Biggest state, local public pensions lose $58 billion in 2nd quarter, Oct. 13, 2010
- Watchdog, States study pension assumptions, Aug. 20, 2010
- The Providence Journal "R.I. House, Senate put $7.86B budget plan on fast track to governor" June 5, 2010
- National Conference of State Legislators "Pensions and Retirement Plan Enactments in 2010 State Legislatures" July 19, 2010
- The New York Times "Battle Looms Over Huge Costs of Public Pensions" August 6, 2010
- Stateline.org "In graying West Virginia, a mountain of retiree health bills" July 13, 2010
- The Wall Street Journal "States Press Workers on Healthcare " Aug. 27, 2010
- New York Post, City's unhealthy loss, Nov. 9, 2010
- Bloomberg "New Jersey May Not Make Pension Payment in Fiscal 2012, Christie Says" July 31, 2010
- Cal Watchdog “Pension ‘pain train’ coming” July 8, 2010
- Pew Center on the States "The Trillion Dollar Gap" February 2010
- CNNMoney.com "Illinois: Our very own Greece?" July 14, 2010
- The Hawaii Reporter "Hawaii Employees Retirement System $6.2 Billion in the Hole – Will Taxpayers Have to Make Up the Difference?" July 9, 2010
- Article XIII, Section 7, Alaska State Constitution, Ballotpedia
- Article 29, Arizona State Constitution, Ballotpedia
- Article XVI, Hawaii State Constitution, Ballotpedia
- Article XIII, Section 5, Illinois State Constitution
- Article X, Louisiana State Constitution, Ballotpedia
- Article IX, Michigan State Constitution, Ballotpedia
- Article 16, Section 66, Texas State Constitution
- Amy B. Monahan, Statutes as Contracts? The “California Rule” and Its Impact on Public Pension Reform, Iowa Law Review, May 6, 2012