POSTED: 01:30 a.m. HST, Feb 25, 2014
When Gov. Chris Christie of New Jersey overhauled the state's pension system in 2011, he celebrated it as a bold, bipartisan step toward paying down the state's costly promises to its retired workers. Some would have to work longer, some would lose inflation adjustments, and both workers and taxpayers would have to pay more into the system.
But it took only three years for Christie to raise urgent new concerns about whether the state could afford the payments it had promised to make to its pension system. Under the schedule agreed upon, the state's annual pension payments were to rise from zero in the first year to $1.7 billion this year, the largest the state has made to the system, yet still only about a third of what it will owe by 2018.
"We need to have the conversation now about further changes to our pension system," the governor said in his State of the State address last month, arguing that education and other needs would be shortchanged by the rising payments. "The time to avoid this conversation and avoid these choices is nearly over, everybody."
Christie will talk more about New Jersey's pension troubles on Tuesday, when he delivers his annual budget address, but the state's underfunded system typifies a problem bedeviling cities and states across the country.
More than 40 states have taken steps in recent years to rein in mounting public employee pension costs that threaten to strangle government services. But pension experts say that while some of those overhauls have whittled state shortfalls, even drawing upgrades from bond-rating agencies, many of them have simply deferred pension costs to the future. And none have come close to closing their pension gaps quickly enough to keep pace with a rapidly aging — and retiring — public workforce.
The most effective solutions, those experts contend, remain the most politically difficult, and thus least often tried: raising taxes substantially, or cutting the future retirement benefits that current public workers will accrue in their remaining years of service, a practice that is routine for companies but illegal for governments in some states and labeled immoral by unions.
"I can't give you a good example of a state" that has solved its pension problem, said Richard C. Dreyfuss, an actuary in Pennsylvania who has studied pension overhauls.
The clearest evidence that pension overhauls have fallen short is that the gap between the projected cost of the benefits and the money set aside to pay for them has continued to grow — to $4 trillion this year from $3.1 trillion in 2009, according to Joshua D. Rauh, a finance professor at Stanford University who has written extensively on public pensions but whose projections have been disputed by unions. Much of that growth stems from factors that states cannot control, like demographics and financial market activity.
The overhauls appear to be faltering for several reasons. They often defer state contributions to pension funds, giving legislators more money in the short term but increasing the long-term debt. They are almost always based on overly optimistic estimates of how much pension fund investments will earn. Some experts also say weak accounting practices obscure the actual costs. And many states have resisted cutting the benefits of current workers, focusing instead on changes for future workers to try to avoid lawsuits by unions.
But much of the problem is political. While labor unions have blocked cuts to benefits in many states, governors and legislatures have also been unwilling to spend the money, or political capital, to adequately finance their ailing pension systems, said Patrick McGuinn, the chairman of the political science department at Drew University, who has studied the politics of pension crises.
"There is a lot of incentive for elected officials operating on limited time spans in office to kick fiscal consequences down the road," McGuinn said.
New Jersey offers a case study. Since 1992, the state diverted money from its pension system to other programs while promising better benefits. By 2010 the system had a large shortfall, or unfunded liability, and New Jersey became the first state accused of securities fraud by federal regulators, for claiming to be properly funding its workers' pensions.
The 2011 changes, passed with the cooperation of Democrats in the Legislature, included bigger mandatory contributions from current workers and a suspension of cost-of-living increases for retirees. For newly hired workers, the retirement age to receive a full pension was raised to 65, with 30 years of service. Previously, many could retire at 55, with 25 years of service.
Christie's office said the system's "funded ratio," a widely recognized indicator of pension health, had leapt to 65.2 percent after the 2011 changes, up from 56.4 percent before them. His office forecast a savings of $122 billion over the next three decades.
But while the pension cuts helped lower the cost of the system, the state also created a new, 38-year funding schedule that began with no payment for one year. That was followed by a seven-year interlude, called "the ramp," during which the state would gradually work its way up to proper funding.
Under the law, New Jersey does not have to start making the annual contributions that its actuaries say are required until 2018; it will have until 2048 to pay down its unfunded liabilities.
But by 2018, the state itself forecasts, its system will have become shakier, with a funded ratio of just 52.3 percent, down from 2010, because its contributions will have trailed far behind the cost of the plan during the seven-year "ramp."
That missing money must be made up, with interest, in subsequent years, meaning the overhaul will have increased the long-term cost of the system.
"No assurances can be given as to the level of the state's pension contributions in future years," the state warned in a recent bond prospectus. In December, Moody's changed its outlook for New Jersey to "negative," citing the renewed growth of its unfunded liabilities.
Union leaders say the New Jersey plan can still work, if the state does not reduce or defer its contributions again.
"The fact of the matter is that if you look at all of these changes taken together, it's worked," said Kevin Kelleher, director of research for the New Jersey Education Association, which represents the state's workers. "And it will continue to work, as long as the state makes its annual required contributions."
Illinois, the most recent state to enact big changes in its pension system, got into trouble much the way New Jersey did: It went for years without making required contributions.
With more and more public workers retiring, Illinois had the biggest unfunded liability in the country last year: $187 billion, from $134 billion in 2012, according to Moody's. That is more than three times Illinois' annual revenue, Moody's says, or $14,510 for every person in the state.
Late last year, after fierce debate, the Illinois Legislature passed a sweeping package of pension changes that supporters, including Gov. Pat Quinn, said would save $160 billion over 30 years. The law reduces cost-of-living increases for many retirees, offers individual accounts to workers willing to leave the traditional pension system and raises the retirement age for younger workers. In exchange, the law reduces workers' pension contributions by one percentage point, and raises the state's annual contributions by at least $60 billion over three decades.
But even if the law survives a legal challenge from unions, Illinois' pension costs would stay high compared with those of other states.
In Rhode Island, legal challenges by workers' unions may reduce the state's savings created under a 2011 law that experts say is among the most comprehensive pension overhauls in the country.
After more than a year of federal mediation, the unions and state officials, including Gov. Lincoln D. Chafee, have proposed to settle the lawsuits by softening some of the law's provisions, especially on state workers nearing retirement. Similar challenges are pending in several California cities and in other states and municipalities.
Under a plan enacted in 2012, California cut benefits for workers hired after Jan. 1, 2013, leaving current workers' benefits unchanged.
But the plan left the state's huge pension system underfunded, and this month Gov. Jerry Brown announced that the funding gap could grow by $9 billion because its mortality table did not reflect the longer life expectancies of retirees. He said the system's trustees should begin filling that gap immediately, rather than waiting two years as they had requested.
"No one likes to pay more for pensions," Brown said in a letter to the system's administrators. "But ignoring their true costs for two more years will only burden the system and cost more in the long run."
Rick Lyman and Mary Williams Walsh, New York Times