DEEP TROUBLE FOR PENSIONS: ‘Mathematically these problems are solvable,’ one pension expert says. ‘But you can get so deep in the hole that politically they’re unsolvable.’

By Kirsten Adshead | Wisconsin Reporter

MADISON – It appears most state pension plans have recovered the assets they lost during the 2007-09 recession, a Wisconsin Reporter analysis shows.

But that’s not so much a silver lining as a pinpoint of sunshine poking through the towering, black-clouded, fiscal superstorm of pension debt threatening to sweep across the United States.

State and local public legacy costs have become so bloated that every U.S. household would have to contribute nearly $1,400 per year for the next three decades to fully fund the debt-ridden public pension systems.

Lawmakers aren’t blind to the problem.

But, thus far, most have been unable or unwilling to have a serious debate over whether and how to continue public pension programs, many of which are in critical financial condition.

All but a handful of states have pending legislation addressing the issue, according to the National Conference of State Legislatures. But only seven — Alabama, Kansas, Louisiana, New York, South Carolina, Virginia and Wyoming — enacted significant reforms in 2012.

With the dawn of 2013 comes a new round of lawmaking and, in many states, a new round of budgeting.

For governments and the people they are supposed to serve, the problem comes down to a question of priorities, one pension expert asserts.

“From the top down, the public is hearing about these pension liabilities and they’re seeing how the services they’re receiving from state-level governments are being increasingly squeezed by the fact that the tax resources have to go more into pensions and less into other things,” said Andrew Biggs, an economist with the Washington, D.C.-based free-market think tank American Enterprise Institute. “They’re seeing, ‘Well, we’re not able to hire teachers. We’re not able to put computers and books into the classrooms.’”

The risks and the costs of public pensions are no abstraction, or some “accounting thing,” Biggs said.

“They have a real effect on people because we’re spending less on teachers and police and firefighters and more on retired teachers, police and firefighters,” he said.

The long road back

The Great Recession of 2007-09 hit public pension fund investments hard.

The value of Wisconsin’s holdings dropped by nearly a third, 29.5 percent, in 2008 alone, the second-worst decline that year in the country.

Apples-to-apples comparisons of state pension plans are difficult to compile because the plans themselves vary greatly. Some states have one pension scheme for all state employees. Many states have separate pension systems for different employee groups, such as teachers or law-enforcement officials.

But the U.S. Census Bureau produces an annual report of state pension plans.

The analysis of 2012 data won’t be published until this summer.

As of the end of 2011, only nine states had recouped the investment value they had lost in the recession, according to the Census Bureau’s assessment of state pensions holdings.

Those states were New Hampshire, Idaho, North Carolina, Delaware, Nebraska, Tennessee, Arkansas, Nevada and West Virginia.

Other states, however, likely joined that list in 2012 as the financial markets rebounded.

Ten states, including Wisconsin, were close to recovering losses, with the value of their total holdings at the end of 2011 off by less than 5 percent of their 2007 levels.

The State of Wisconsin Investment Board earlier this month announced its Core Fund ended 2012 with a preliminary return of 13.6 percent, ending with a market value of about $79 billion. The Variable Fund, meanwhile, gained about 16.9 percent, with an approximate value of $6 billion.

“These are challenging times but I am delighted with our returns in 2012,” SWIB Executive Director Michael Williamson said in a statement. “We cannot control or influence what happens in the world or U.S. economies nor what happens on the world or U.S. political stages. We continue to remain focused on investing the money of the Wisconsin Retirement System and generating the best returns within acceptable levels of risk to keep the system healthy.  That is what our members expect and what they deserve.”

SWIB spokeswoman Vicki Hearing said the $85-billion fund total is still below the 2007 level of $87.9 billion.

“Investment earnings (are) not the only thing that affect the total amount of money,” she said. “There are two other important factors: Money is coming into the funds because employers and employees are paying contributions and money is being paid out for pensions to retirees.”

While pension funds may be nearing pre-recession levels, that doesn’t mean states — or for that matter, municipalities with pension funds — have “caught up”.

In most cases, they’re far from it.

The liabilities problem

State pension fund managers have spent the past four years digging themselves out of the hole the recession — and pension fund managers — created.

The problem is the pension systems weren’t in great shape pre-recession, and while fund managers have been filling the holes for the past four years, the holes simultaneously have been getting bigger.

“The short story is that pensions are chasing a moving target,” Biggs said. “While public employee pensions struggled to rebuild their assets to pre-recession levels, those plans’ benefit liabilities continued to grow, year after year. As a result, unfunded liabilities today are often higher than they were several years ago.”

Using the market value of the 126 largest public pension plan assets, as reported by governments themselves, Wilshire Consulting estimated that while assets covered about 95 percent of all state pension liabilities in 2001, that percentage was down to 74 percent in 2011.

Liabilities naturally rise, Biggs said. The problem comes when the values of a pension fund’s assets don’t keep up the increased liability.

“In each year they work, employees earn the right to more benefits in retirement,” he said. “While some retirees will die off, the new benefits earned will be far more valuable than the benefits of the retirees who died (because salaries are much higher today than they were, say, 50 years ago).”

In other words, it’s natural that liabilities will continue to rise. You just want to make sure that assets rise along with them.

Possible solutions?

In order to fully fund both state and local public pension plans, every U.S. household in the United States would have to be assessed an additional tax of $1,398 a year for 30 years, according to a June 2011 report from the National Bureau of Economic Research.

That assumes there are no changes in public policy.

Many states have been slow to respond to the crisis of unfunded pension liabilities.

With the state of Illinois facing a projected unfunded pension liability of $96 billion to $130 billion — depending on the method of calculation — lawmakers in December proposed a hybrid “cash balance” pension plan, as a step toward a defined-contribution plan.

Under the proposal, each employee would have an individual account, funded by the employee and the government employer. Retirees then would receive an annuity based on the account balance.

Illinois has the second-largest unfunded pension liability in the country.

And yet, the proposal — or anything of its kind for that matter — went nowhere.

Illinois is back to Square 1.

In Wisconsin, under Gov. Scott Walker collective bargaining reforms, most unionized public employees in the state are required to contribute more to their public pension plans, reducing the burden on taxpayers.

Municipalities are searching for their own solutions. Late last year, the city of Scranton, Penn., proposed a “commuter tax” on the income of individuals who work in the city but live outside its borders, as a means to address mounting employee costs.

But with the nation’s public  pension plans’ total liability possibly stretching to $4.4 trillion — roughly one-third of the country’s GDP and a quarter of the national debt — it’s apparent that, at least in some states, the “fix” must be pretty drastic.

A Harvard study, Underfunded Public Pensions in the United States: The size of the Problem, the Obstacles to Reform and the Path Forward, suggests a number of steps states can take to address their unfunded pension liabilities, including:

• Calculating a retiree’s pension benefit by, for example, using their average salary throughout the course of their career, instead of on their final years of service.
• Raising the eligibility for full retirement benefits.
• Making a number of financing changes that reduce risk, as well as more closely monitoring and controlling the size of a pension plan’s funding ratio.

“We acknowledge that the road to substantive pension reform is a difficult one, fraught with legal, political and financial obstacles,” the researchers note.

But among the benefits, they conclude, is an increased likelihood that public pensions will continue to exist.

Substantively tackling the problem of unfunded public pensions would take the kind of will rarely exhibited by lawmakers, which almost certainly would require the political and financial support of taxpayers.

With Democrats drawing core support from pension-protecting labor unions, and Republicans’ base being spending-hating conservatives, the will to act may continue to be absorbed by politics.

Biggs is blunt.

“Mathematically these problems are solvable,” he said. “But you can get so deep in the hole that politically they’re unsolvable.”

Contact Kirsten Adshead at kadshead@wisconsinreporter.com.

Frank Keegan of State Budget Solutions contributed to this report.