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State could face $13.3b retirement benefit gap

Group urges creating trust to trim shortfall, avoid cuts for retirees

Email|Print|Single Page| Text size + By Sacha Pfeiffer
Globe Staff / June 30, 2006

Massachusetts faces a potential $13.3 billion shortfall for the retirement benefits it has promised to pay its state workers, an amount that could further burden an already-strained state budget and result in benefits cuts for future retirees.

The figure, released this week by the state comptroller's office, is the first-ever tally of the total cost of all future healthcare, life insurance, dental, and vision benefits -- known collectively as unfunded liabilities -- for retired state employees. State officials were required to calculate the amount, which previously had not been known, by a new national accounting rule aimed at making cities and states acknowledge the true cost of what they pay their workers, including future benefits.

The new rule does not require government agencies to fund those liabilities. But once the amounts are made public, cities and states will effectively be forced to fund them or risk being downgraded by credit rating agencies. As a result, state and municipal governments may face tough decisions about whether they can continue to afford the same future benefits for their workers, analysts said.

``This is a number that really creates a sobering effect in terms of future collective bargaining agreements and decisions regarding the extent to which the state and cities and towns would continue to provide the same level of health insurance for retirees," said Sam Tyler, the president of the Boston Municipal Research Bureau, a nonpartisan fiscal watchdog group.

Private sector employers have publicly disclosed their unfunded liabilities for some time, and companies including General Motors Corp., United Airlines, and IBM Corp. have reduced or eliminated retiree benefits in an effort to control future costs. But few government entities have tallied their unfunded liabilities, and Massachusetts is one of the first states to do so.

The deadline for disclosure is at least 18 months away. But Massachusetts chose to disclose early because ``we wanted to understand what the ramifications were and start thinking about options," said state comptroller Martin J. Benison. ``The Commonwealth is on the front edge of this, and in the next couple of years we need to have dialogues about what we want to do about it."

To pay for its unfunded liabilities, the state should create an investment trust similar to the reserve fund it formed in the late 1980s to pay for its pension liabilities, and should consolidate management of all unfunded liabilities statewide under a single entity, according to a forthcoming report by the Pioneer Institute, a Boston public policy research group.

If the state creates such a trust, it would earn a higher return on its investments, so the projected shortfall would drop to $7.5 billion. To pay that off the state would have to contribute at least $703 million a year for 30 years to drive the balance to zero. Without the trust, the annual contribution would have to be at least $1 billion, according to Eric S. Berman, a co author of the Pioneer Institute report. Annual contributions would grow each year, he said.

Still, ``even for the state, $7.5 billion is a large number that has to be reckoned with," said Tyler, ``and it's an expense that will have to be borne by the taxpayers of the state and cities and towns, and will require a really careful review of the current programs and what changes may come in the future."

The report also made two politically volatile recommendations: that the state tighten health insurance eligibility for its workers, and require employees to contribute more to the cost of their future benefits. Currently, the state pays 85 percent of healthcare costs and employees pay 15 percent; increasing workers' share to 20 percent could yield millions of dollars of additional funds for future benefits, the report said.

``The challenge now is to think about the tools we need to manage this, and how we begin setting aside money and at least making some progress toward properly funding that amount," said Steven Poftak, the Pioneer Institute's research director. ``Because it's clear to everyone that even if we run a [state budget] surplus this year . . . we're not close to having an adequate funding source for that."

Historically, most cities and states, including Massachusetts, have taken a pay-as-you-go approach to funding retirement benefits. But that approach will become increasingly expensive as healthcare costs rise, and because Proposition 2 1/2 holds local property tax increases to 2.5 percent a year, Poftak said.

As a result, municipal credit rating agencies want cities and states to create ``prudent, practical, reasonable, coherent plans to deal with this issue," although it is unlikely that downgrades are imminent, said Parry Young, an analyst at Standard & Poor's.

``From our standpoint we would like governments to jump on this problem, especially if it's a significant one, and start developing plans for how they're going to deal with it," Young said.

About a dozen other states have reported their unfunded retirement benefit liabilities so far, including California ($40 billion to $70 billion), Michigan ($25 billion to $30 billion), Maryland ($20 billion), and Utah ($500 million), Young said.

Sacha Pfeiffer can be reached at pfeiffer@globe.com.

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