Study: States' pension shortfall ballooned in 2010

SPRINGFIELD, Ill. -- Recession-plagued states diverted scarce money away from pensions to pay for more immediate concerns, leaving a $757 billion hole in the retirement funds covering millions of public employees, according to a study released Monday.

The Pew Center on the States found 34 states failed to maintain safe levels of money in the pension funds, which most experts agree is about 80 percent of long-term obligations. Four states -- Connecticut, Illinois, Kentucky and Rhode Island -- didn't even have 55 percent of the money they'll need in the long run.

The total gap between the money states had available and what they'll have to pay out in the decades ahead reached $757 billion in 2010, the most recent year for which figures are available. That was up 9 percent from the year before, according to the study titled "The Widening Gap Update."

The Pew Center found most states were trying to address the funding gap, either through cutting benefits for future employees or requiring workers to pay more of their own money into their retirement funds. Some went after benefits for current employees, triggering court battles. States also adopted more conservative estimates for what they'll earn on investments down the road.

Pensions aren't the only retirement problem. States also faced a $627 billion shortfall in health care services for retirees. Essentially, for every $1 they'll eventually have to pay out in health care, states had set aside only 5 cents.

"So why should Americans care about these funding gaps? Because the larger they are the higher the cost to taxpayers today and for many years to come," said David Draine, a senior researcher for the Pew Center on the States.

Nationwide, some 22.5 million public workers fall under a state pension plan. When states fall behind in their retirement contributions, they'll have to come up with even more money later to make up the difference. In addition, pension and retiree health costs are growing, driving up state expenses even more. That leaves states less and less each year to spend on education, public safety and other government services.

Illinois had the worst funding level at just 45 percent. Officials there say fixing the problem is a top priority, but a proposal to cut cost-of-living increases for current employees and retirees has stalled in the legislature.

While the new report looks at figures from 2010, pension expert Robert Rich, said there's no reason to think the situation has improved significantly.

Rich, executive director at the University of Illinois' Institute of Government and Public Affairs, stressed that the recession was not the chief cause of the pension problem, although it contributed by eating away at the value of investments.

For years, states failed to pay their full share of pension costs, he said, so the problem won't be wiped away if the economy improves.

"It took us a long time to get into this hole, and it's going to take a long time to get out of it," Rich said.

The problem may be even larger than the report indicates. Many states calculate their funding levels by assuming an 8 percent return on their investments, a level that many experts believe is no longer realistic.

The Pew Center said that from 2009 to 2011, 43 states cut benefits for future employees, required them to pay more or did both. And six states took similar action in 2012.

Some states also cut benefits for people who have retired already. However, public-employee unions argue that amounts to breaking a contract, and some state constitutions impose tough restrictions on cutting benefits. So going after benefits for current employees and current retirees can result in legal challenges.

Staff at the Pew Center said Rhode Island has been most aggressive in overhauling its pension systems to cut costs. The state, whose systems were only 49 percent funded in 2010, decided to cut retirement benefits for current employees as well as those hired in the future. Officials limited cost-of-living increases, raised the retirement age from 62 to 67 and changed the formula for calculating benefits.

They also put workers in a new hybrid retirement system that combines elements of the traditional system where retirees are guaranteed a certain level of benefits and new 401(k)-style systems were money is invested on behalf of the retiree.

Rich, from the University of Illinois, questioned the emphasis on cutting benefits when much of the pension problem was created by states failing to contribute their share to retirement systems. States also should be promising to put more money into retirement systems over the long run, he said.

"It's neither shared sacrifice nor fairness if it's only employees who are paying for the problem," Rich said.