States Mull Borrowing to Bolster Pension Plans

A handful of cash-strapped states plan to borrow to put money into their state employee pension systems, an idea that analysts say is a gamble that might not pay off.

New Jersey first tried the approach in 1997, but California, Illinois, Kansas, Wisconsin and West Virginia might be next.

Here's the current situation:

  • In California, Gov. Gray Davis (D) signed a measure May 5 that authorizes the state to issue nearly $2 billion in bonds to fund the state's retirement contributions for 2003-2004 to the California Public Employees' Retirement System. 
  • Illinois expects to cut its budget deficit by $2 billion under a bill that Gov. Rod R. Blagojevich (D) signed into law April 7. It lets the state issue nearly $10 billion in bonds to cover its pension contributions to five state retirement systems through 2004 and to refinance some of its pension obligation. 
  • Kansas could issue bonds up to $500 million to pay down a portion of its unfunded pension fund liability for the Kansas Public Employee Retirement System/State and School group under a bill (HB 2014) that Kansas Gov. Kathleen Sebelius (D) signed May 22.
  • In West Virginia, a pension financing plan that Gov. Bob Wise (D) proposed and the legislature approved is on hold until the state determines if the plan is legal. The plan was for the state to sell bonds worth $3.9 billion to cover the unfunded liability of the state's pension plans for teachers and state troopers. But West Virginia state auditor Glen B. Gainer II said he believes voters must also approve it. The West Virginia General Assembly is expected to take up the matter during a special session June 8-10. 
  • Wisconsin Gov. Jim Doyle (D) has asked his legislature to give the green light to issue bonds to refinance the state's pension fund liability, lowering the interest rate to 5 percent from the current 8 percent. The plan is expected to save Wisconsin nearly $70 million through '05.

"It's sort of like borrowing to make the mortgage payment as opposed to borrowing to get a house," said Keith Brainard, a spokesman for the National Association of State Retirement Administrators, a trade group of administrators of state retirement systems for all 50 states.

States typically borrow to pay for new roads, buildings, and other capital expenditures. Bonds are essentially IOUs that states agree to pay back over time with interest. But states are now considering floating bonds to pay for their contributions to pension systems for teachers, police officers and other state workers.

"States have always shied away from the act of borrowing money for ongoing expenditures and the annual contributions to the pension system are ongoing expenditures," said Ronald Snell, director of the economic and fiscal division of the National Conference of State Legislatures. "Of course in really tight fiscal crises, [some] tend to take a looser view of good fiscal policy," Snell told Stateline.org.

Issuing bonds to pay the current pension contribution can ease a state's budget squeeze temporarily, but it's not a long-term solution, financial analysts said. "It's basically just pushing a structural budget problem off for a year," said Robin Prunty, director of public finance for Standard & Poor's, an investment and credit rating firm. "You're going to have the same budget gap the following year," she said.

A related, but separate idea, is for the state to borrow money to pay off some of the amount that the state pension system would need to provide pensions to ALL workers in the system, including those who aren't going to retire for another 50 years. The amount that is not funded is called the "unfunded liability" of the pension system. States' pension funds often are not 100 percent, fully funded, Snell said. "If a pension system is funded at 80 or 90 percent, it's in very, very solid condition," Snell said.

The flagging economy is why some states are considering the approach, analysts said. The recent stock market downturn has hit most pension plans, not just state systems, but for some states, the weak market has meant more unfunded pension liability, Raymond Murphy, vice president and senior analyst at Moody's Investors Service, a global credit rating and risk analysis firm, said.

Current low interest rates make the idea of taking out a loan appealing. If a state's pension plan can earn 8 percent by investing money the state borrowed at 6 percent, then the state is ahead of the game. "There is risk," Murphy of Moody's said. The market may not provide returns that cover the interest rate, and once a state issues a bond, it is locked into paying the debt, whereas it has more flexibility in deciding how much to contribute to its pension system.

"It's always a better idea to contribute cash to a pension system than to borrow for it because you'll always have borrowing costs," said Tim Blake, a senior analyst with Moody's Investors Service. He said that's the situation in New Jersey.

New Jersey's experience offers a cautionary tale for states considering the idea. "We borrowed money to make a bet and lost," said Tom Vincz, a spokesman for the N.J.'s Treasurer Office. In 1997, the state issued $2.8 billion in bonds to pay off its unfunded pension liability and to make contributions to the plan. The state banked on getting returns exceeding 7.6 percent, the amount of interest it's paying on the bonds. But New Jersey is seeing returns of only 5.5 percent, and on top of that, the state is "saddled with significant debt service payments," Vincz said.

New Jersey will have to pay $163 million in debt service costs this year for the bonds and those costs are expected to climb as high as $508 million in 2022. The state will also have to kick in $750 million in contributions to the state pension plan over the next five years, Vincz said.

Vincz declined to offer an opinion on whether other states should follow New Jersey's lead. "States are faced with some very, very difficult fiscal times and New Jersey is among them. In our case, the pension bond has compounded our problems," he told Stateline.org.

"A "miraculous" recovery in the economy and stock market could make up for the poor performance in recent years, Vincz said.