There was a $1 trillion gap at the end of fiscal year 2008 between the $2.35 trillion states had set aside to pay for employees’ retirement benefits and the $3.35 trillion price tag of those promises, according to a new report released by the Pew Center on the States. The shortfall, which will have to be paid over the next 30 years by state and local governments, amounts to more than $8,800 for every household in the United States.

The figures detailed in Pew’s report, The Trillion Dollar Gap, include pension, health care and other non-pension benefits promised to both current and future retirees in states’ and participating localities’ public sector retirement systems.

Pew’s numbers likely underestimate the bill coming due because the most recent available data do not account for the second half of 2008, when states’ pension fund investments were particularly affected by the financial crisis. Additionally, most states’ accounting methods spread the investment declines over a period of time–meaning states will be dealing with their losses for several years.

“While the economic crisis and drop in investments helped create it, the trillion dollar gap is primarily the result of states’ inability to save for the future and manage the costs of their public sector retirement benefits,” said Susan Urahn, managing director, Pew Center on the States. “The growing bill coming due to states could have significant consequences for taxpayers—higher taxes, less money for public services and lower state bond ratings. States need to start exploring reforms.”

In fiscal year 2008, states’ pension plans had $2.8 trillion in long-term liabilities, with more than $2.3 trillion reserved to cover those costs. Overall, states’ pension systems were 84 percent funded—above the 80 percent funding level recommended by experts. Still, the unfunded portion–$452 billion–is substantial, and states’ performance is down slightly from an 85 percent combined funding level in fiscal year 2006. Pension liabilities have grown by $323 billion since 2006, outpacing asset growth by almost $87 billion.

Retiree health care and other non-pension benefits, such as life insurance, create another huge bill coming due: a $587 billion total liability to pay for current and future benefits, with only $32 billion–or just over 5 percent of the cost–funded as of fiscal year 2008. Half of the states account for 95 percent of the liability. Because of a 2004 Governmental Accounting Standards Board rule, the full range of non-pension liabilities was officially reported in fiscal year 2008 for the first time across all 50 states.

Many state and local governments continue to provide very large pay to state and local government employees and often use very generous retirement packages as a way of disguising the true cost of the pay packages they provide.

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In spite of the large and growing shortfall and the variation among states, momentum for policy reform is building nationwide. Fifteen states passed legislation to reform their state-run retirement systems in 2009 compared to 12 in 2008 and 11 in 2007. Reforms largely fell into five categories: (1) keeping up with funding requirements; (2) reducing benefits or increasing the retirement age; (3) sharing the risk with employees; (4) increasing employee contributions; and (5) improving governance and investment oversight.

With legal restrictions in most states on reducing pensions for current employees, the majority of changes in the past two years affect new employees. Ten states increased the contributions that current and future employees make to their own benefit systems, while ten states lowered benefits for new employees or set in place higher retirement ages or longer service requirements.

Variations in how states are managing their employee retiree benefits:

Pension benefits

• Sixteen states were deemed solid performers, 15 were in need of improvement and 19 states were flagged for serious concerns (states including Florida, Idaho, New York, North Carolina and Wisconsin all entered the current recession with fully funded pensions).
• In 2000, just over half the states had fully funded pension systems. By 2006, that number had shrunk to six states. By 2008, only four – Florida, New York, Washington and Wisconsin – could make that claim.
• In eight states–Connecticut, Illinois, Kansas, Kentucky, Massachusetts, Oklahoma, Rhode Island and West Virginia–more than one-third of the total pension liability was unfunded. Two states–Illinois and Kansas–had less than 60 percent of the necessary assets on hand.

Health care and other non-pension benefits

• Nine states were deemed solid performers, having enough assets to cover at least 7.1 percent–the 50-state average–of their non-pension liabilities. Only two states–Alaska and Arizona– had 50 percent or more of the assets needed.
• Forty states were classified as needing improvement, having set aside less than 7.1 percent of the funds required. Twenty of these have no assets on hand to cover their obligations.
• Only four states contributed their entire actuarially required contribution for non-pension benefits in 2008: Alaska, Arizona, Maine and North Dakota.

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