Unfunded Pension Liability Crushing State Budgets

Unfunded liabilities for the states are crushing budgets and forcing legislators to make decisions that are driving unions over the cliff. But the good news is state governments can make this work - look what happened in Wisconsin.

Burning Fast
Source: "Burning Fast," The Economist, June 23, 2012.

That states have underfunded pension liabilities is not news. A combination of generous benefit promises and lower requirements for workers' contributions have landed many states with liabilities that they may not be able to pay. What is news, however, are the enormous difficulties that many states are encountering in attempting to dig themselves out of their current hole, says The Economist.

This difficulty is partially a function of the sheer size of the states' unfunded liability, which can overwhelm tenuous political alliances for progress.

•The Government Accountability Office recommends that states should have a pension-funding level of at least 80 percent.
•According to a recent report from the Pew Centre on the States, only one state was fully funded in 2010, the most recent year examined.
•At the same time, 34 were funded at below 80 percent -- a figure that is up from 22 in 2008.
•Pew found that the total gap among all states in 2010 was approximately $1.38 trillion.

Furthermore, according to Josh Rauh of Kellogg School of Management, these figures from Pew are overly optimistic, as they allow states to use their own biased accounting data. States tend to inflate the rate of return on their investments (most states use the high figure of 8 percent) when this is nowhere close to realistic rates of return in the current economy.

When more realistic rates reflecting the current economy are used, the situation becomes even more severe and the need for immediate government action becomes more paramount. However, recent austerity programs proposed by lawmakers have been met with fierce resistance.

•Many states that try to bring in pension reforms are ending up in court, as unions argue that to take what has been promised to them is unfair and illegal.
•Attempts to change contribution rates and types for current workers, for example, have been ruled against by courts in Florida and New Hampshire.
•Actions to adjust downward the benefits received by current workers and retirees remain on unknown judicial ground.

This leaves states on shaky ground as they attempt to shore up shoddy finances. Though they should seek to address their enormous unfunded liabilities, resistance from negotiating parties may handicap their ability to do so.