U.S. Public Pensions Need More than Investment Windfall
Paul Sancya/APProtestors, opposed to Detroit's bankruptcy, rally outside the Theodore Levin U.S. Courthouse last October.
By Tim Reid
and Lisa Lambert

Double-digit annual returns for most U.S. public pension systems during the past two years have done little to shrink the yawning deficits facing many of them after a decade of inadequate funding, according to analysts and recent data.

Thanks to a robust stock market, most systems have enjoyed windfalls recently, with investment returns far exceeding projections. Even so, many are still struggling with shortfalls. In some cases, they have worsened as state contributions fail to keep pace with what is needed to pay beneficiaries.

Roughly half of U.S. state pension plans have worrying gaps between what they have promised retirees and the funds on hand to pay benefits, according to most analyses.

The higher-than-expected returns since 2012 are welcome, but experts say they don't make up for a legacy of insufficient funding, a problem that afflicts many states that allow elected officials to control the process.

"For many public pension funds, the hole is so deep -- in the range of many tens of billions of dollars for some of them -- that they would need decades of double-digit returns to approach full funding,"
said Autumn Carter, executive director of California Common Sense, a non-partisan think-tank founded at Stanford University in Palo Alto, Calif. "Realistically they cannot earn their way out of their shortfalls."

For most states and cities, pension obligations are the biggest single expense, and the costs are increasing. Unless jurisdictions find ways to adequately fund such costs, the strain on budgets will reach a breaking point, Carter said.

That is a view shared by Warren Buffett, the chairman of Berkshire Hathaway (BRK-A) (BRK-B), who last week warned that the crisis in public pensions will intensify. The main reason, he wrote in a letter to shareholders, is public entities have promised pensions they can't afford.

"During the next decade you will read a lot of news -- bad news -- about public pension plans," the legendary investor wrote.

Buffett and others believe the recent bankruptcies of Detroit and other, smaller U.S. cities are just the beginning of a trend that will soon envelop municipalities around the country.

Pension obligations were a big factor in Detroit's bankruptcy. The same is true for the bankruptcies of Stockton and San Bernardino in California.

A major issue in Detroit is whether the city can slash pension benefits promised to current and retired workers. If the city prevails in court, its victory might encourage other municipalities to declare bankruptcy to deal with their pension shortfalls. That's not an option for U.S. states, which are barred from bankruptcy.

Almost all state constitutions protect pension benefits. Some, most notably California's, require paying promised benefits to retired workers before any other debts.

Since the 2008 financial crash, which resulted in huge investment losses for public pension funds and major strains on budgets generally, police and firefighting services have been slashed in many cities, along with other basic services such as libraries, street maintenance and schools.

To be sure, others are less pessimistic than Buffett, saying a more robust investment outlook and other economic factors have improved enough for cities and states to rest easier.

Indeed, there is evidence that the overall health of pension systems is brightening. A report released by the Federal Reserve last week said liquidity of pension funds has improved. Pension assets amounted to $3.88 trillion in the final quarter of 2013, more than a third higher than the $2.83 trillion reached in 2009.

"I think we're doing fabulously well," said Hank Kim, executive director of the National Conference on Public Employee Retirement Systems. "Certainly the stock market and the rise in equities over the five years since the Great Recession helped tremendously."

Robust returns over the past two years may have stabilized shortfalls for many systems, said Rachel Barkley, a municipal credit analyst at Morningstar (MORN), but some pension plans will likely struggle to narrow funding gaps. That's because what is paid into the funds each year has consistently fallen short of what is required.

"In general, one or two years of good returns is not going to solve their problems," Barkley said of state funds that were already in weak shape.

By contrast pension systems that were already well funded have been able to use investment windfalls to bolster their positions even more, Barkley said.

Colorado vs. Oregon

Speaking in general, public pension systems are badly underfunded in states, such as Colorado, that give elected politicians in the legislature the power to set funding levels. Oregon and other states that are mandated by law to meet annual funding requirements are in much better shape.

Over the past five years, only nine states have made the full required contributions to their pension plans, according to the non-partisan Pew Center on the States.

Colorado's public pension funds showed overall investment returns of 12.9 percent in 2012, the most recent figure that's available. It was well above its projected rate of 8 percent.

Yet the funding ratio, the measure of assets against liabilities, has remained relatively static, increasing from 61.2 percent in 2011 to 63.1 percent at the end of 2012.

Most economists view a funding ratio of less than 75 percent as unhealthy. According to Morningstar, two-thirds of U.S. states currently fall into that category.

Although Colorado is still absorbing losses from 2009,
the main reason its funding gap is yawning is the state's failure to make the contributions recommended each year by its own budget experts, Barkley said.

Between 2008 and 2012, Colorado lawmakers short-changed the state pension fund by nearly $1.4 billion, and by $3.5 billion over the past decade.

Likewise, in Illinois, with the biggest funding gaps of any U.S. state, a pension fund for teachers showed healthy returns of 12.8 percent in 2013. Yet its funding gap worsened between 2012 and 2013.

By contrast, Oregon's retirement system, covering about 95 percent of the workforce, is required by law to meet the annual funding recommendation of its own accountants. The mandated recommendation, known as the "ARC," or "annual contribution rate," takes the issue out of the hands of policy-makers wrestling over budget choices and competing constituencies.

The ARC is calculated based on myriad factors, including investment returns the fund can expect in future years.

In 2010, despite big investment losses, Oregon's system was 87 percent funded. Today it is 96 percent funded.

Even if public pensions realize their projected investment returns on average over coming years, the failure by many plans "to pay less than the full ARC ... will produce less than full funding over the next 30 years," according to a recent report by the Center for Retirement Research.

Dire Predictions

Buffett and others have made dire warnings about public pensions before, notably in 2010. Some analysts predicted at the time a domino effect of municipal pension-related bankruptcies, something that has yet to materialize. And the $3.7 trillion municipal bond market has shrugged off the latest warnings.

Chris Mier, managing director of analytical services at Loop Capital, said Buffett may not have taken into account the full impact of reforms instituted by about 40 states.

Mier conceded that the reforms, which have cut benefits and increased contribution rates for workers -- mostly for new hires -- will take several more years to translate into improved funding levels for pensions.

Meanwhile, the cumulative budget shortfall of U.S. state public pensions has surpassed $1 trillion and is still growing, according to Pew.

"Public debt is continuing to grow, and despite reforms, the question is if states can manage another downturn or another recession," said Greg Mennis, director of Pew's public pension project.

Jean-Pierre Aubry, assistant director of state and local research at the CRR, said most funds would likely show improvement in shortfalls beginning in the next fiscal next year, as the end of a five-year "smoothing" accounting period will finally push the deep losses of 2009 off the books.

Even so, many funds "are still going to be grossly underfunded," Aubry said. Improved returns will only give them some short-term relief, he added.

Increase your money and finance knowledge from home

Introduction to Preferred Shares

Learn the difference between preferred and common shares.

View Course »

Intro to different retirement accounts

What does it mean to have a 401(k)? IRA?

View Course »

Add a Comment

*0 / 3000 Character Maximum


Filter by:

Remember the military industrial complex? We now have the government employee-democrat party complex. You will never see a government employee vote against or talk against any tax increases. Private industry pensions are mostly gone now but, just look at cities like Vallejo , Stockton, mammoth and San Bernardino California, who are bankrupted by government employee benefits and abuse of work rules. San Jose ca. Police and firefighters recieve pensions in excess of 100k which has them in lockstep with tax and spend liberals. Government employees rule, taxpayers drool,

March 11 2014 at 8:48 PM Report abuse -1 rate up rate down Reply

It is very simple to see where the problem developed. It was easier on budgets to give pension increases in the future rather than raises in the present. It was easier to not put required payments into the pension fund rather than raise taxes or cut programs. There was all this money In the pension fund and when a crisis came it was easier to borrow from the pension fund where you did to have to worry about paying it back. It has nothing to do with people on welfare, or greedy unions, it has to do with easy answers from government. For every complex question there is an easy and totally wrong answer, and unfortunately it is usually the one that the voters want to hear. "we have met the enemy and they are us"

March 10 2014 at 1:35 PM Report abuse +1 rate up rate down Reply

Are the payouts too rich ? That is an area that never gets discussed.
Are there too many people in the pension system, in NJ, they say there are so many loopholes that a part timer can take more in pension benefits in one year , just because they bump their service in the last 3 years.

March 10 2014 at 1:00 PM Report abuse -1 rate up rate down Reply

For many Cities the unions control the City Council and "staff" who are also in Unions. Then they approve 80-95% pensions at the highest earning compensation. The Unions and Councils are corrupt...bought by the unions trying to say they are the backbone of the middle class while in truth they are the ones driving poverty in their own cities. Look at some of these cities where total compensation for a firemen who works 12 days a month is over $150k (some PS are making over 250k ). That's absurd.

March 10 2014 at 11:52 AM Report abuse +4 rate up rate down Reply
3 replies to ricklexus's comment

The exact people (our Polititians) who are trying to kill the pensions in this country, Have a pension and health care that is not included in this mess because they set it up that way. And we pay for it. Democrats and Republicans alike

March 10 2014 at 11:20 AM Report abuse +6 rate up rate down Reply

I am tired of everyone complaining about the pensions that WE earned . My pension has not being given to me, I EARNED it by giving 25 years of service as s a Police Officer. I completed my obligation and deserve my pension. The anger and frustration by taxpayers should be with all the Entitlement programs the Gov't spends our money on. We should be outraged about our millions of dependants who refuse to work and get a check every month for nothing, but always seem to be dressed very well and can afford the latest gadgets. There are more people in Nyc collecting benefits than there are taxpayers, That is the Problem.

March 10 2014 at 10:28 AM Report abuse +5 rate up rate down Reply
3 replies to macw999's comment

in NJ some governors raided the pension funds, then gave a pass to the towns for their contributions. the pension systems would be ok if these liars and thieves had kept their hands off. don't vilify public servants because of what the evil politicians did to them. and take care of the retirees these are the ones who came when you called, ran towards the danger and did what they said they would do when they raised their right hands. shame on them all who would deny and penalize someone who gave their best years to the state or community they worked for

March 10 2014 at 9:48 AM Report abuse -2 rate up rate down Reply

Grumpy, public employees did save through their retirement systems. Each year we paid into our retirement knowing through State law what our benefits would be. Government changed the rules of the game by not putting their portion of the funds into the system. Plus I might add, states have raided, or in their terms, borrowed money from retirement reservoirs to prop up failing business's. In Connecticut we have a long history of borrowing from retirement funds on losing propositions, then not fund the retirement systems that have been promised.

So no, there is no gravy here, just a lack of backbone by the government. To some degree the unions are also at fault because they let the government pilfer the retirement funds every time there has been a threat of layoffs.

March 10 2014 at 9:47 AM Report abuse +5 rate up rate down Reply

They should save like the rest of us for retirement.. We cannot afford to keep paying tens of thousands of former; city, state and fed retirees..
Enough already !! Time for the gravy train to end.

March 10 2014 at 7:50 AM Report abuse -2 rate up rate down Reply
3 replies to olengrumpy's comment

Both sides have been guilty of giving away the company store for free and both sides blame the other when it comes time to pay the piper. Have the feds print more money and fill the coffers (like that's a good idea.....:)

March 10 2014 at 7:17 AM Report abuse +1 rate up rate down Reply