Pension Pains: States Cut Benefits to Skirt Massive Funding Shortfall

Apr. 26, 2010 — -- Dan Montgomery doesn't have many kind words for his elected officials. The high school English teacher from Skokie says Illinois politicians spent years neglecting their obligations to the state's public pension funds and now want workers to foot the bill.

"It's terrible," said Montgomery, who has been teaching for 17 years.

Illinois recently cut benefits and raised retirement ages for public employees in order to cover a $78 billion shortfall in its public pension fund.

"We really fought it, but in the end they did it anyway," Montgomery said.

States around the country are beginning to face the necessity of reforming their public pension systems, after the financial crisis took a bite out of already inadequate savings and put a seemingly insurmountable gap between assets and the benefits that governments had promised their workers.

Illinois is one of the most recent states to tackle its shortfalls, with a reform that the government says is expected to save taxpayers more than $200 billion over 35 years.

Public Pensions Sorely Underfunded

Overall, the nation's public pension funds face a $728 billion shortfall, which means that they only have enough money to cover benefits for 13 years if they continue making payments at the current rate, according to data from the Center for Retirement Research at Boston College. However, some pension funds are in much worse shape. Before the reform for example, the Illinois Employee Retirement Service only had enough money to cover the next six and a half years.

Government representatives emphasize that no current retiree risks losing retirement benefits as a result of the crisis, but they concede that something will have to be done to plug the gap before coffers run dry.

"It's obviously a very serious financial management issue," said Scott Pattison, executive director of the National Association of State Budget Officers. "If this is not dealt with, we will get to the point where states are going to have to put a heck of a lot of general taxpayer money into pension funds."

Workers Say They Will Pull Support in November Elections

Public employee groups, however, are not happy and some have threatened to withdraw their support for elected officials in the November elections.

Ed Geppert, president of the Illinois Teachers Federation, said his group was "deeply disappointed" by the reforms.

"This new law will do grave and long-lasting harm to the state of Illinois' ability to attract and retain highly qualified teachers and public employees," he said in a press release. The law "shifts the burden of the state's past mistakes onto future teachers and public employees."

States Begin Reforms

Seven states, including Arizona, Illinois and New Jersey, have reformed their pension systems so far this year, and three more -- Michigan, Missouri and California -- are pushing for changes, according to Ron Snell, director of state services at the National Conference of State Legislatures (NCSL).

Illinois' reforms, which were enacted at the end of March, have garnered a lot of attention and drawn anger from unions and invidual workers. The state raised the retirement age to 67 from 55, and reduced the maximum allowed pension to $106,800 from $391,000.

The reforms only apply to workers entering the work force in 2011; it will take years before the state's pension gap shrinks noticeably.

In California, Gov. Arnold Schwarzenegger last week put his weight behind proposed reforms.

"The single biggest threat to the fiscal health and California's future, obviously, is our public pension system," Schwarzenegger said at a news conference.

Reforms proposed in California include raising the retirement age for some workers to 65 from 55.

Are Reforms Enough?

Some experts worry that these reforms may not be enough to plug shortfalls quickly enough.

Douglas Elliott, a pensions expert at Brookings Institution, argues that fund deficits are even higher than official numbers indicate, because government accountants use accounting methods that are far too generous.

"Municipalities and states are not acting as if their pension plans are as high of an obligation as they are," he said. "They don't seem to have an urgency to fill the gaps.

He pointed out that the shortfalls will be more difficult to make up in the wake of the financial crisis, because fund managers now have to be more conservative in their investment choices -– which means they are unlikely to earn the 8 percent returns that many are counting on.

"Maintaining such a target level serves to mask the true extent of pension deficits," he said. "Bad as those deficits look now, they would be significantly worse if the expected returns average 7 percent or 6 percent."

Politically Difficult to Get Support From Both Unions and Voters

The problem, however, is that reforms are not easy to enact.

For one thing, pension systems are usually technically complicated, and lawmakers must be very careful that any changes don't destabilize the whole formula, NCSL's Snell said.

On the other hand, it takes a lot of campaigning to get enough support from unions and voters.

"It's not easy politically because there are a lot of interests at stake," Snell said.