Benefits Still a Major Burden on Municipal Finances

Analysts continue to warn that employee pensions and retirement benefits are a growing problem for municipal government finances.

“Two of the factors that city finance officers report as having the largest negative impact on their ability to meet needs are employee-related costs for health care coverage and pensions,” the National League of Cities said on its website. “Underfunded pension and health care liabilities will persist as a challenge to city budgets for years to come.”

In mid-November, Natalie Cohen, senior analyst with Wells Fargo Securities LLC, highlighted municipal pension finance problems. She noted that Central Falls, R.I., declared bankruptcy after running out of money to pay its retirees. While most municipalities are managing their retiree obligations, there are some like Central Falls that are running out of funds, she said.

In the last year, all three major rating agencies have issued reports on pension pressures on municipal finances. The Center on Budget and Policy Priorities and the Pew Center on the States have also released major reports.

By fiscal 2009, the gap between what states had promised for employee retirement benefits and pensions and the money they had set aside had grown to $1.26 trillion, according to the Pew Center’s report, “The Widening Gap.” About 52% of this gap was for pensions, and the remainder was for retiree health care and other benefits.

States had set aside money for 78% of their pension liabilities. They had set aside money for just 5% of their retiree health and other benefit liabilities.

Even this picture may be too bright, the report argued. While most states use an 8% discount rate — their investment return target — some observers said this is too optimistic. Using lower discount rates would increase the estimated benefit gap to $1.8 trillion or more.

Postponing payments now could result in even bigger problems for governments in the future, Pew noted. “A state’s failure to pay the annual bill for retirement benefits can mean it will have to pay more in the future,” the Pew report said.

Standard & Poor’s also addressed the pension problem in its report, “U.S. States’ Pension Funded Ratios Drift Downward.” As of 2008, the mean funded ratio for the state pension system was 80%, it stated. However, this declined to 75% in 2009.

The Pew report said: “When added to reduced or depleted rainy-day reserves, a winding down of federal stimulus funding, and the increased social service demands that typically accompany a recession, higher pension contributions are either adding to already stressed state budgets or are not being fully funded.”

On a brighter note, the Pew report pointed out that states have weathered weaker pension funding ratios in the past. Before accounting changes made by the Governmental Accounting Standards Board in the 1980s, things were worse. For example, in 1975, the state-funded ratio for pensions was 51%.

States have also taken actions to try to curb long-term retirement costs, Standard & Poor’s reported. However, these reforms may only provide modest relief in the medium term because existing employee benefits may be legally protected.

The Center on Budget and Policy Priorities has taken a more measured view of the employee pension and retirement benefit problem.

With regard to the retiree health benefit problem, “I think [states] have a lot of flexibility to address the problem and the benefits may be scaled back,” said Elizabeth McNichol, co-author of a CBPP report, “Misunderstandings Regarding State Debt, Pensions, and Retiree Health Costs Create Unnecessary Alarm.”

On the other hand, pension promises are legally binding, the report said. Yet, “state and localities have the next 30 years in which to remedy any pension shortfalls.”

Further, either last year or this year, 40 out of 50 states have taken steps to address the pension shortfall, McNichol said.

In keeping with this positive outlook, the Standard & Poor’s report predicted states will continue to meet their debt service obligations in the near future.

To be sure, pension pressures on state budgets continue to be in the news. According to the Pew Center, the state with the worst pension funding deficit in the country — Illinois — had an unpleasant surprise this week. In mid-November an updated actuarial assessment raised by $540 million a previous estimate of what Illinois would need to contribute in fiscal 2013. That brings the total projected contribution to $5.9 billion, or $1 billion more than the 2012 payment.

In New York, Gov. Andrew Cuomo has said that reducing public pension benefits will be his top goal in 2012.

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