Market Slide Batters State Pension Funds

The year-long economic downturn and historic financial crisis on Wall Street could threaten the fiscal health of the trillion-dollar state employee pension system.

If the stock market does not rebound soon and the recession stretches into next year, as many analysts predict, state leaders may be faced with difficult choices to shore up pension funds that have lost billions of dollars in value since January.

Among immediate options: postponing retirees’ cost-of-living increases. Other, long-term choices include cutting benefits, increasing employee payroll contributions or relying on more taxpayer dollars to make up for the losses.

“Those are all definitely things to be considered,” said Terry Slattery, president of the National Association of State Retirement Administrators and executive director of the Public Employees Retirement Association of New Mexico .

Any policy choices would be agonizing not only for retirees but all state taxpayers. Employees contribute to state pension funds as do government agencies through tax dollars. About 20 million current state and local government employees and 7 million retirees, ranging from teachers to police officers to office workers, are promised pensions, according to a recent GAO report . Benefit checks total about $150 billion a year.

Paying retired public employees already is one of states’ growing costs, so the market falloff could not come at a worse time. Thousands of aging baby boomers are claiming retirement benefits, and many states are issuing pension checks for longer periods because people are living longer. On top of this, many states are struggling to finance Medicaid, education, transportation and other programs while their tax revenue is shrinking.

Hardly a day goes by without a state announcing a double-digit loss in the value of its pension fund. The latest was Virginia, which reported Oct. 16 that its state worker pension fund declined 20 percent in value since July, or about $11 billion.

North Carolina’s $66 billion public pension fund dropped 12 percent in value over the last year. Tennessee’s $30 billion fund declined 10.7 percent since July 1, or more than $5 billion. Just since Sept. 29, New Mexico’s $9.7 billion public employee pension fund fell 10.2 percent and its $7 billion teacher retirement fund by 12.5 percent. Pension officials also reported losses in Connecticut (11 percent) and Massachusetts (15 percent). Even Maine’s $9.6 billion pension fund, which analysts regard as having one of most conservative investment mixes in the country, has lost 14.5 percent in value since January.

State pension officials had been nervously watching their portfolios decline all year. Then the credit crunch hit in September, causing battered stocks to plunge further despite the federal rescue plan. “It’s painful. It’s hard to watch,” said Slattery of New Mexico.

Pension funds that had investments tied to Lehman Brothers Holdings Inc., which filed for bankruptcy, and insurance giant AIG International Group Inc., which received a federal bailout, lost tens of millions of dollars in value, although only a fraction of their overall holdings.

Florida ‘s pension system , for example, lost nearly $350 million in September in securities of Lehman, AIG and two troubled financial institutions, Washington Mutual and Wachovia Corp. That sounds like a lot of money, but state officials said it was less than two-tenths of 1 percent of the fund’s total holdings.

Pension fund managers have been assuring retirees and employees over the last month that the funds are safe and their assets ample to pay benefits for several years. They say the funds are more diversified than most Americans’ tax-deferred retirement plans, and are designed to withstand the variations of the stock market. History bears this out; pension funds survived the 1987 market crash and most recently the 2001 terrorist attacks.

“Markets go up and down,” said Carroll South, executive director of the Montana Board of Investments , whose teacher and public employee pension funds lost about 5 percent in value since July 1, compared to two years ago when they posted double-digit gains. “You have to take the good along with the bad.”

South’s counterpart in neighboring Wyoming, state treasurer Joe Meyer, was more succinct. Asked by state lawmakers Oct. 9 whether they should be worried about the state’s pension fund loss of about $275 million this year, or about 3 percent, Meyer’s confident advice was, “Go fishing.”

Still, state pension fund managers and other analysts say they are worried that a recession, which many economists say could last as long as two years, could dig a deeper hole for many pension plans that already are underfunded. A study released in December by the Pew Center on the States (of which Stateline.org is a part) said the 50 states have promised to pay $2.7 trillion in pension and health benefits over the next 30 years. But states have only set aside about $2 trillion, the report said.

Pension specialists say that the funding ratio, or the assets of the fund divided by its benefit liabilities, should be at least 80 percent.

New research by Sujit CanagaRetna, a senior fiscal analyst at the Council of State Governments, shows that 30 state pension plans met the 80 percent benchmark at the end of 2007, the most recent year data were available. Five states – Oregon, North Carolina, Florida, Delaware and New York – were 100 percent or more. The bottom five states were Illinois, Oklahoma, Connecticut, Rhode Island and West Virginia.

The fear now is that with the recent plunge in the value of state pension funds, many states will fall below the 80 percent benchmark. The lower the funding ratio, the more it is likely a state would have to make up the difference by reducing benefits, increasing contributions or raising taxes.

“The losses in their pension and other asset funds along with the freezing up of the credit markets has only made the financial position of states even more dire,” said CanagaRetna.

Girard Miller, a benefits and investment analyst , said in a recent column for Governing magazine and in an interview with Stateline.org that he believes the average public pension plan’s funding ratio could fall as low as 65 percent next year, boosting states’ unfunded pension liabilities. That assumes an average decline in a fund’s investment value of as much as 25 percent, he said. Most pension fund actuaries-outside analysts who calculate risk-had assumed that the investment value of most state funds would rise by 8 percent. If a state’s return is below projections, the actuaries could ask them to budget more money.

Miller said pension fund managers soon could be telling state policymakers, “Unless something dramatic happens in the markets, we’re not going to be able to afford what we thought we would.”

The market downswing has drawn attention to the change in investment strategy that has evolved in states. Twenty years ago, most state pension funds invested in safe, government securities such as bonds or U.S. Treasury bills. To produce higher yields in their underfunded plans, states gradually have been putting their money into somewhat riskier nongovernmental securities such as stocks, corporate bonds and foreign investments. Some states also have invested in hedge funds, and venture capital funds, or seed money to start a business.

Federal Reserve Board data show that about 70 percent of state and local pension investments are in equities, compared to 62 percent in 2000 and 38 percent in 1990.

By diversifying their investments, analysts said, states can survive hits such as the bankruptcy of Lehman and collapse of AIG. Pension analysts say that over time, stocks are still the best-performing investment. Fund managers contacted by Stateline.org said they have no immediate plans to make radical changes in their investment mix despite the financial crisis.

South of Montana said he has been put on the defensive recently to explain why the state invests in stocks. “It would be riskier not to invest in stocks,” he says he answers.