Steep losses pose crisis for pensions

The financial crisis has blown a hole in the rosy forecasts of pension funds that cover teachers, police officers and other government employees, casting into doubt as never before whether these public systems will be able to keep their promises to future generations of retirees.

The upheaval on Wall Street has deluged public pension systems with losses that government officials and consultants increasingly say are insurmountable unless pension managers fundamentally rethink how they pay out benefits or make money or both.

Within 15 years, public systems on average will have less than half the money they need to pay pension benefits, according to an analysis by Pricewaterhouse Coopers. Other analysts say funding levels could hit that low within a decade.

After losing about $1 trillion in the markets, state and local governments are facing a devil's choice: Either slash retirement benefits or pursue high-return investments that come with high risk.

The urgent need for outsize returns by these vast public pension funds, which must hit high investment targets year after year to keep pace with rising retirement costs, is in turn fueling a renewed appetite for risk on Wall Street.

Before the crisis, many public pension funds had experimented with risky trading techniques or committed more of their money to hedge funds and other nontraditional firms, which in turn invested some of it in complex mortgage securities. When these melted down, pension funds got burned.

Now, facing an even bigger funding gap, some systems are investing in the same securities, betting that a rebound in their value will generate huge returns.

"The amount that needs to be made up is enormous," said Peter Austin, executive director of BNY Mellon Pension Services. "Frankly, they are forced to continue their allocation in these high-return asset classes because that's their only hope."

Some pension experts say the funding gap has become so great that no investment strategy can close it and that taxpayers will have to cover the massive bill.

The problem isn't limited to public pension funds; many corporate pension funds have lost so much ground that they are also pursuing riskier investments. And they, too, could end up a taxpayer burden if they cannot meet their obligations and are taken over by the federal Pension Benefit Guarantee Corp.

Public systems still have enough to meet their current obligations. If governments take no action, retirees could keep drawing full benefits for the foreseeable future even under the most pessimistic projections.

Government struggling
But already, some funds are seeking to trim benefits to conserve money. Some governments have also proposed increasing the amount of public money paid each year into the funds. In practice, however, some political leaders have begun doing the opposite -- cutting annual contributions to pension funds -- as a way of balancing state and local budgets buffeted in the recession by falling tax revenue and rising costs.

Around the country, governments are struggling with the pact they've made with employees.

In New Mexico, lawmakers passed legislation this year requiring public employees to contribute about 1.5 percent of their salary to cover retirement benefits. Labor unions representing 57,000 of the workers sued the state in response.

In Philadelphia, officials delivered an ultimatum to state lawmakers: Allow the city to take a two-year break from contributing to its pension system or Philadelphia would lay off 3,000 workers and cut sanitation and public safety services. Last month, the lawmakers not only granted the request, but extended the funding holiday to thousands of cities and counties, despite severe pension deficits in many of these places.

In Montgomery County, officials last year committed to setting up an investment fund to finance about $3 billion in retiree health-care benefits promised to employees. But when it came time to put the first round of seed money into the fund this year, county officials balked, citing budget constraints.

"We know we've got a huge health-care liability," chief administrative officer Timothy L. Firestine said. "Our plan was to work gradually to fund that. And this year we abandoned that plan."

Swift change of fortunes
Just a few years ago, it seemed far-fetched that Virginia's pension system would hit hard times. In 2003, the state's primary pension funds either had more money than they needed or, at a minimum, were nearly fully funded. And like their counterparts across the country, state officials assumed they would earn around 8 percent a year from investing in financial markets for years to come given the outstanding performance of stocks in the 1980s and 1990s.

But officials in Virginia and elsewhere soon began to wonder whether those two decades were a fluke. As pension deficits began to rise, officials questioned whether the investment assumptions were too optimistic. In 2006, Virginia's pension officials suggested scaling back benefits or requiring current employees to begin paying into the pension fund. The state's lawmakers took no action.

Then the crisis hit. Virginia lost 21 percent of the value of its portfolio, or about $11.5 billion. Maryland and the District, meantime, suffered drops of 20 percent.

The losses were typical of what pension funds suffered around the country. State and local government officials had predicted before the crisis they would have $3.6 trillion in their accounts by now, according to the Center for Retirement Research at Boston College. Today, they are $1.2 trillion short of that mark.

By David Cho