Already-strapped state and local governments are coming under increasing pressure to reduce pension benefits or increase taxpayer contributions that help pay for them because of new rules that would require them to report those obligations more honestly, advocates say.
The latest rules come on line from the bond-rating firm Moody’s at the end of this month. They are projected to triple the gap between what states and municipalities report they have in their funds and what they have promised to pay out to retirees. That hole would stand at $2.2 trillion.
For the worst-off cities, the new pension debt calculations could mean bond rating downgrades and increased borrowing costs when localities try to raise money for new projects, Moody’s has warned.
The accounting changes themselves will not force policymakers to alter how they fund pensions. But finance experts say that by simply highlighting greater funding gaps, the rules will intensify pressure on state and local governments to allocate more of taxpayers’ dollars to their pension funds. More likely, public workers may have to contribute more to their retirements or see promised benefits curtailed, measures that have already been implemented in more than 40 states.
“It is hard to believe that higher numbers would not put increased pressure on governments to deal with this,” said Scott Pattison, executive director of the National Association of State Budget Officers. “If you only have so many dollars, if you are going to put more into pensions, that means less for other things.”
The new rules come at a difficult time for state and local governments struggling with weakened tax revenue and stronger demand for services in the wake of the recession. In addition, states and localities face the prospect of substantial reductions in aid from the federal government beginning in January unless Congress and the White House come up with an alternative to automatic budget cuts.
The changes add to the growing tensions over the often generous retirement benefits that public employees receive. Union leaders argue the packages compensate for lower pay, but critics, including GOP governors, say the pensions are unfair and have become unaffordable for taxpayers.
“It is what we call pension envy,” said David Urbanek, spokesman for the Teachers’ Retirement System of Illinois. “You have an economy that is not performing the way people are used to. For a lot of people, their standard of living is being held steady or declining. Then they see a group of people getting pensions that they’ve earned and it makes them uncomfortable. They ask, ‘Why not me?’ Or, more to the point, ‘Why them?’ ”
Retired Illinois teachers earn annual pensions of a little more than $46,000 a year on average; they do not participate in Social Security under a state opt-out. Under the old accounting rules, their pension fund has $37 billion in assets and $81 billion in future liabilities — making it among the most poorly funded large public plans in the country.
Under the new accounting rules, the assets would be counted even lower, leaving an unfunded liability that one estimate put at 83 percent.
“The new standards are essentially a public relations problem,” Urbanek said. “It doesn’t change the fact that we owe a total liability of $81 billion over 30 years.”
But the situation could get worse, he added. Illinois faces $9.2 billion in unpaid bills, and lawmakers could be tempted to reduce pension funding.
Pension systems are financed through a combination of annual budget allocations and employee contributions. They also greatly rely on investment earnings. But the stock market’s erratic performance over the past decade or more has contributed to a worrisome gap between the amount of money pension funds are projected to have on hand and what they have pledged to pay retirees.
The problem grows even greater when governments factor in the soaring cost of retiree health benefits, for which many of them have not set money aside.
Under current rules set by the Governmental Accounting Standards Board, public pensions are estimated to be about 75 percent funded. This June, like Moody’s, GASB approved new guidelines that would shrink that estimate to 57 percent. GASB’s rules take full effect by 2015.
“Government entities are trying to move toward full funding; that is the goal,” said Cathie Eitelberg, senior vice president for the Segal Co., an employee-benefits consultancy. “Having different sets of numbers out there is going to be a communications challenge. It could also require public officials to look at these plans and make decisions about how to best finance them over time.”
Among other things, the new accounting rules from Moody’s and GASB limit the rate of return on future investments that pension funds can assume for accounting purposes. Most government pension funds assume a 7 to 8 percent return, which critics say overstates future investment income.
Unions and many pension fund managers dispute that critique, pointing out that investment returns have surpassed that over the past several decades, even if recent history has been more difficult. Still, others say the changes are long overdue and will better reflect the funding situations of public employee pension funds.
“The action by GASB and Moody’s will convince people they can’t continue to wait to rein in these costs,” said Chuck Reed, mayor of San Jose, Calif., where voters in June overwhelmingly ratified a far-reaching pension reform plan. “These costs are enormous and nobody can afford them. To the extent that the real costs are obvious, it provokes people into action.”
In San Jose, retirement costs have more than tripled in the past decade and now consume one-fifth of the city’s general fund budget. Reed said the ballooning cost of pensions and retiree health benefits has forced the city to cut 2,000 jobs.
Under the recently approved plan, new city workers would be forced into a less expensive pension plan. Incumbent workers have the choice of joining the less expensive plan or paying much more for the old one. That plan allows workers to retire when they are as young as 55 or have put in 30 years on the job, and they can receive up to 90 percent of their salaries. In addition, they receive a 3 percent cost-of-living increase every year.
Under the reform plan, the city can suspend those increases if it declares a fiscal emergency.
“The retiree costs were going to affect service delivery or cause insolvency,” Reed said. “So we had to do something to reduce them.”