State pensions may be $4 billion short

01/23/2007

The state's large public pension funds face more funding challenges than they have reported, a report from the legislative auditor says. It also raised concerns about retiree health coverage.


By Pat Doyle, Star Tribune
Last update: January 22, 2007 – 11:57 PM


The state has painted too rosy a picture of the condition of large government pension funds by not accounting for a $4 billion deficit in a fund used to pay benefits to retirees, the Minnesota legislative auditor said Monday.

The auditor blamed large benefit increases pegged to unusual bull-market investment returns for helping create the deficit and recommended that the Legislature end such increases.

In challenging longstanding assumptions about the health of state and local pensions, the auditor's report raises warning flags about funds that hundreds of thousands of current or former government workers rely on for retirement income.

It also provided a new and critical assessment of the potential effect of retiree health insurance obligations, saying most local governments are not setting aside enough money to cover them.

The findings reinforce earlier warnings in Duluth that health insurance for city employees could lead to higher taxes, reduced services or even bankruptcy.

Population trends lend urgency to taking action to correct the shortfall, an author of the report told the bipartisan Legislative Audit Commission.

"We have a bubble here of people who are nearing retirement age in five to 10 years, and that's when this hits home," said Jody Hauer, project manager for the evaluation.

The report recommended that the Legislature eliminate benefit increases that retirees of some plans get when the investments of their funds rise. The funds do not reduce benefits when investment returns fall.

However, leaders of three major state pension plans and a union representing government workers denied that the funds were in significant trouble. They said Monday that the governments and their employees have increased contributions to the funds and taken other steps to rein in benefit increases.

"I think we have a solution waiting for a problem," said Eliot Seide, executive director of the American Federation of State, County and Municipal Employees.

Obligations underestimated

The review comes amid growing concern nationally about how governments will deal with looming public pension obligations.

The Minneapolis teachers pension fund last year had only about half the money it needed to meet future obligations when it merged with the healthier statewide Teachers Retirement Association fund.

Now the St. Paul teachers pension fund -- which has only about 70 percent of the money it needs -- is most at risk among local government funds, the report said. It urged the Legislature to consider increasing employee or government contributions to it.

The three statewide funds -- the Teachers Retirement Association, the Minnesota State Retirement System and the Public Employees Retirement Association -- have underestimated their funding deficit because they use an accounting system that doesn't fully report future obligations, the report said.

"We believe it has the effect of masking a significant deficit ... possibly to be as much as $4 billion," Legislative Auditor James Nobles said. In particular, the long-term effect of the benefit increases paid out when stock market gains are good wasn't fully considered, Nobles said. Those investment-driven increases will continue for those already retired.

From 1996 to 2001, retiree benefit raises averaged 9.2 percent a year. Those benefit increases remained on the scales after the market slumped and earnings fell, increasing the fund deficits.

When those benefits are considered, the three funds have significantly less money to meet their obligations than they previously reported. The Teachers Retirement Association's funding level drops from 92 percent to 82 percent. The Public Employees Retirement Plan -- which represents local government employees --declines from 75 percent funded to 68 percent. And the Minnesota State Retirement System drops from 96 percent to 90 percent.

The three pension funds noted Monday that the Legislature last year capped future benefit increases for retirees at 5 percent in an effort to deal with the funding gap.

But the audit report said that restriction, which goes into effect in 2010, and increases in contributions from employees and government, will not reduce the $4 billion deficit, though they could reduce the risk of future deficits. The report recommends adjusting future benefits for inflation rather than for investment returns.

Volunteer fire funds

In another report released Monday, the legislative auditor had good and bad news for the state's 700 pension plans for 20,000 volunteer firefighters. On the upside, most of the plans are adequately funded. On the downside, they could make more money on investments if they let the state do it.

While the State Board of Investment, which invests for major pension funds, got an average annual return of 8 percent from 1997 through 2004, firefighter pension funds earned 4.8 percent.

They often didn't turn money over to the board because "they thought they could beat them," said audit project manager Jo Vos.