Sue Urahn, Managing Director
September 29, 2011 — Rising pension and retiree health care costs for public employees are a continuing challenge for the states, whose budget woes continue.
Pew’s latest research, reported in The Widening Gap, shows that, at the end of fiscal year 2009, the 50 states were at least $1.26 trillion short of the amount needed to cover their retirement costs over the next 30 years.
Sue Urahn, managing director for the Pew Center on the States, discusses what progress has been made, suggests actions states must take and offers solutions states should consider.
Q: What prompted Pew's interest in public pensions and retiree health care benefits and is the situation improving or getting worse?
We started tracking pensions in 2007 because it was an issue that very few people were paying attention to. If you looked at the costs and cost projections, you could see that the liabilities states were beginning to incur were going to be a problem over time. From our perspective, it was a really good opportunity to get ahead of the game, to give states an early warning.
The situation now is challenging. Our last report showed a $1.26 trillion gap between what states had saved to pay for their pensions and the promises they had made to public sector employees. This is a conservative estimate, reflecting the states’ own assumptions about the average investment returns they will see. The situation was exacerbated by the recession, but our research shows that it was not caused by the recession. In many states, the challenges they faced were created by decisions they made about benefit levels, sometimes over a decade ago.
Q: So, going forward, does the situation depend more on the economy or on how states manage their pensions and other retirement benefits?
A: It's both. The economy always affects the return on investment that states get from their pensions funds. That return is a key source of the revenue they need to pay the annual bills and to support the cost of retirement over the long term.
But, that's not the only thing driving this. States really do need to make sure that the bill for promised benefits will be one they can manage over the long term.
On the other side of the equation, they also need to have a compensation structure in place that will get them the workforce they need. Retirement benefits are, in part, how you attract and retain a high quality workforce. This is also part of what states have to assess.
Q: You have argued that talking about retiree health benefits, as well as pensions, gives a more complete picture of states’ long-term costs. Why?
A: Well, about half of the $1.26 trillion gap I mentioned was because of health care. The overall bill is much smaller for health care than it is for pensions, so you could certainly argue that health care is less of a problem. But states have set aside very, very little of what they need for retiree health care costs -- on average, about 5 percent of what they owe over the long term.
That pay-as-you-go approach might be absolutely fine for a state that has made reasonably modest promises and isn’t on the hook for a significant long-term liability. But for states that have a substantial liability – states such as California, Illinois, New York or New Jersey – setting nothing aside leaves them with a very big annual bill to pay. States are facing a big demographic bubble as baby boomers are beginning to retire, and future costs are going to be significant burden for states.
Q: States have reduced their long-term retirement liabilities by cutting benefit levels and requiring employees to contribute more from their pay checks. Is this a direction most states will likely continue?
A: It is a direction that is likely to continue. But one of the best things states can do to manage their long term liabilities effectively is to make the full annual payments that are required into their pension funds, and to set aside some funding to deal with long-term health care benefits. When states don’t make those full contributions– and this is something that’s been exacerbated by the recession – it creates a bigger problem for the next year and the year after that. Making the full payment is a critical thing that states can do.
Funding retirement benefits is a partnership. The state pays some, the employee pays some, and you get some back in return on investments. I think states need to make sure they’re holding up their end of the deal. Depending on the size of the liability, the state actuaries will basically say, "This is what you need to pay in every year to make sure that those liabilities are met."
Q: About one in four public employees are not covered by Social Security, and their retirement security may largely depend on state pensions and other benefits. Should that be a factor when states consider solutions to their retiree benefits shortfall?
A: Well, it’s just another factor to include in their calculations. In part, the public is sometimes not aware that some public employees do not have access to Social Security. So when they raise concerns about public sector pensions, they may be assuming that those employees have other means of support in retirement and, you know, some of them don’t. So it’s an important part of the calculation as states look at whether or not they need to be thinking about Social Security as part of the retirement package for these employees.
People look at the public sector and they say, “Why should those people have a pension when we don’t?” Perhaps the better question is, “What do we need to do to ensure that people, when they do retire, can adequately meet their needs?
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