Pension Pinch


First it was a time bomb. Then it was a python. Now, according to Warren Buffett, it’s a gigantic tapeworm. Three scary metaphors for the underfunding of U.S. public pensions. While Corporate America has largely shifted to employee-funded plans — just 10 percent of companies offered defined-benefit arrangements in 2011 — more than three-quarters of state and local government workers have traditional pension coverage. The problem? The financial crisis caused asset prices to shrink and governments to skip scheduled contributions as they grappled with budget shortfalls. Liabilities skyrocketed while plan investments failed to keep pace. States alone face an estimated $780 billion gap between what they promised and what they’ve saved, to say nothing of the thousands of municipalities with their own plans. What seemed like a simple solution to labor negotiations — offer better retirement packages in the future instead of salary increases today — is poised to give lawmakers headaches for years. For the baby-boom generation with its scant retirement savings, it’s one more thing to worry about.

The Situation

Detroit’s 16-month bankruptcy that began in July 2013 pitted taxpayers against pensioners in the city, which ran out of cash to pay for public services. The biggest unions negotiated deals to reduce pension cuts and urged members to vote for them; the plan was to lower the city’s total post-employment benefit costs by 74 percent. A judge will determine the fate of the proposal Nov. 7. Detroit’s approach would differ from a plan to exit bankruptcy in Stockton, California, approved in October, which protected all pension obligations while frustrating other creditors. Lawmakers in Illinois, the U.S. state with the lowest credit rating, passed a pension reform bill to address $100 billion in unfunded obligations. They were met with four lawsuits and a state Supreme Court ruling that shielded retirees’ health-insurance premiums from cuts, imperiling the legislation. In Phoenix, voters rejected a ballot measure that would have made it the largest U.S. city to scrap guaranteed pensions for new public workers, a win for unions that spent $1.2 million against it. Rhode Island Treasurer Gina Raimondo wrote one of the success stories in overhauling public pensions, gaining passage of a measure deemed ambitious and courageous by some, and illegal and infuriating by others. Raimondo was elected governor in 2014, becoming the first Democrat to do so in 22 years.

Source: Wilshire Consulting
Source: Wilshire Consulting

The Background

Thirty years ago, large companies were like states and municipalities, with more than 75 percent of workers participating in defined-benefit pension plans. Then executives realized the arrangement put all the investment risk on them. Defined-benefit plans give workers a pre-determined payout in retirement based on years of service and final salary. It creates a future liability that’s tricky to predict because it relies on assumptions about salary growth and life expectancy. The long-term obligation must be matched with investments that grow at a sufficient pace — a tall order after the recession as stock prices plunged and interest rates reached record lows. Private pensions have problems too; just 5 percent of those at Standard & Poor’s 500 companies are fully funded, though it is deemed a manageable expense. Public plans outside the U.S. also tend to be underfunded, with some better and some worse than American ones. Public pension benefits in countries including Australia, France, Germany and Hong Kong are more generous than those in the private sector, as is the case in the U.S.

Source: Wilshire Consulting
Source: Wilshire Consulting

The Argument

They may be surrounded by ticking snakes and worms, but there are optimists. For 2013, the value of pension assets grew to 75 percent of liabilities, the highest level since 2008. That provides ammunition for those who think the problem is overblown and will resolve itself as the economy improves, stock prices increase, interest rates rise and states and cities become able to put away enough revenue for pensioners. Others say there’s no way to make good on promises without at least scaling back benefits to new workers. Raimondo’s plan in Rhode Island delayed retirement, suspended cost-of-living increases and offered workers employee-financed plans.

The Reference Shelf

  • A Pension Benefit Guaranty Corporation primer on defined-benefit plans.
  • Bloomberg list of most underfunded state pension plans.
  • Report from Brown Center on Education Policy at Brookings, “Are Public Pensions Keeping Up With the Times?”
  • Employee Benefit Research Institute’s frequently asked questions on trends in retirement plans.
  • Morningstar Inc. report, “Determining the Aggregate Per Capita Pension Liability.”
  • The Pew Charitable Trusts report, “A Widening Gap in Cities.”
  • The New York Times reported in August  on how costs and politics are straining New York City’s pension system.

First Published March 10, 2014

To contact the writer of this QuickTake:

Brian Chappatta in New York at

To contact the editor responsible for this QuickTake:

Jonathan I. Landman at