By Donald Fry
For people who are not accountants or actuaries, there are few things more challenging than fully comprehending issues relating to employee pensions and other retirement benefits. Grasping the current fiscal impacts of benefits to be paid sometimes far into the future can be a convoluted and daunting exercise.
But that’s precisely the challenge facing elected leaders in state and local governments these days due to recession-related investment losses, the adoption of more stringent financial reporting standards, and past fiscal tendencies of governments.
Baltimore City’s fire and police pension funds’ recession-driven decreases in investment funds of more than 37 percent during the last two fiscal years has prompted city leaders to seek ways to reduce the resulting projected $166 million city contribution to make up for asset losses and to fund the plans for fiscal 2011.
Government retirement plan funding challenges are not unique to Baltimore City, however. State and local governments across the U.S. are facing declining pension fund assets and escalating costs, according to experts.
For example, Maryland’s state government pension assets suffered combined losses of 27 percent in fiscal 2008 and 2009. Maryland’s more than $1 billion contribution in FY 2009 to its pension plans for teachers, state employees, judges, and law enforcement officers constituted almost 7 percent of the state’s General Fund budget.
Even so, Maryland’s unfunded pension liability increased by $7 billion last year and the plans were only 64 percent funded at the end of FY 2009. Eight years ago, the plans were 101 percent funded, according to the Pew Center for the States, which rates Maryland among eight states that should have “serious concern” about pension funding.
Potentially more daunting is the fiscal challenge that governments face in funding retiree health care benefits that are separate from pension plans and to which contributions from most states, including Maryland, are made on a “pay as you go” basis. For example, Maryland’s long-term retiree health plan liability is only 1.1 percent funded.
How did government pension plan funding in our state and elsewhere deteriorate to this point? The recession has certainly played a major role in the last few years. But it is not the sole reason.
Maryland’s ratio of pension fund assets to liabilities had been slipping before the recession. Maryland was among many states and municipal governments that had eased back on contributions to their pension plans when investment returns were booming. Baltimore City did the same.
Elected leaders, who operate in a tactical, year-to year fiscal world, often opt to defer funding future liabilities so money can be directed to more pressing and immediate operational programs and services.
State and local governments are not legally required to maintain high funding ratios for their retirement benefit plans. But new accounting industry standards for fiscal reporting are putting pressure on governments to strengthen their retirement fund balance sheets.
For instance, more stringent accounting standards implemented in 2006 prompted state and municipal governments in the U.S. to measure and report a massive unfunded liability for retiree health benefits totaling more than $550 billion. Collectively, governments in the U.S. have only $32 billion in assets set aside to fund $587 billion in total liabilities for health and other non-pension retiree benefits, Pew reports.
Virtually every municipal and state government is trying to figure out what to do about these retirement fund challenges because bond rating agencies are closely watching this issue. The net effect is that governments are under more pressure to increase the amounts of cash that they – taxpayers – contribute to pension and retirement funds or find other ways to reduce the liability gap.
It’s reasonable to anticipate some post-recession rebound in retiree fund investments, but even a full recovery won’t erase the deficits any time soon. It would take annual investment returns consistently higher than 8 percent over a number of years for states to make up for recession losses, the Pew report notes.
So how will governments close pension liability gaps? Long-term options include increasing employee contributions, and adjusting benefits and benefit increases, along with increasing government contributions, experts say. Other options include restructuring pension funds for efficiency and changing the composition of pension plan boards to engage more fund-management expertise.
Or, governments could emulate the private sector, which has been operating under more stringent accounting rules for 20 years, by replacing traditional defined-benefit plans with defined-contribution plans such as 401-Ks and similar plans to which most private-sector employers have moved.
One thing is certain. Elected leaders must pay closer attention to their government’s past and future retirement benefit promises, to expectations regarding health and retirement benefits among government employees, and to total costs borne by the taxpayers.
The era of kicking the government retirement-funding can down the road is clearly coming to an end.