Public Pensions: Is There a Problem?

December 17, 2012

By Neil Bomberg

Running just beneath the political surface, in a way that suggests it is about to leap to the top of the legislative heap, are state and local public pensions. Why? Because the stakes are huge. With estimates as high as $1 trillion dollars in unfunded liabilities, many in Congress are beginning to ask if the federal government will be asked to bail out these pension plans, and others are concerned that some states will be forced into "bankruptcy" as a result of these liabilities. And these perceptions are underscored by the belief that too many pensions are very poorly funded, with significant liabilities that are expected to come due in the next ten years.

States like North Carolina, Washington, New York and Wisconsin will have no difficulty meeting their short or long-term pension obligations. They are funded at 95 percent or better. But states like Missouri and Illinois, Kentucky and Indiana face significant shortfalls, and are underfunded by billions of dollars.

And none of these obligations can be ignored. The pensions that state and local governments must provide to their employees are not only mandated by law, but are part of state constitutions, and are taking up a great deal of state and local resources. While they are about four percent of operating budgets, pension contributions represent a significantly larger chunk of revenues. For example, in Nevada 13 percent of state taxes, and 25 percent of local taxes are going to fund the state's public employees' pension system. Even with these high contribution levels, contributions to pension funds nationally have been $17 billion below what actuaries have said is necessary to adequately fund state and local pensions. In many jurisdictions paying promised compensation for past services is crowding out current services. Twenty percent of the general fund in San Diego, and 27 percent of the general fund in San Jose are going to support the local pension programs.

We do know that a major cause of the public pension funding problem resulted from the 2008 financial markets' collapse and that contribution shortfalls, though significant, are small when compared to investment income shortfalls. Experts estimate that public pension funds overall fell about $1.3 trillion short of their assumptions and that well-managed plans like the California State Teachers Retirement and the California Public Employee Retirement Systems ended up going from being 100 percent to 60 percent funded, simply because of the downturn in the markets and subsequent returns.

But we also know that such a path is not sustainable unless the investment market should substantially change. So what should city and towns think about as they move to shore up their public pension systems and insure their long term viability for current retirees and current and future employees? That question will be the focus of the next articles in this series, as NLC explores how municipalities can continue to meet the promises they have made to their employees, which ensuring a fiscal environment that is sound and reflects the changing economy.