Public Vs. Private: Where Pensions Are Golden

All pensions and health-care plans are not created equal. At the same time millions of workers in private industry have lost the benefits they once thought they had for life, another group is doing quite nicely, secure in the knowledge that their benefits are protected forever–not by some government agency, but directly by you, the taxpayer.

They are public employees in state and local governments, ranging from teachers to cops. Most collect guaranteed pensions provided through state and local taxes and their own contributions and investment returns. Overall, 90% of public employees enjoy a defined-benefit pension, compared with only 20% (and falling) of the private work force.

Even though the commitment is there, the money isn’t. A study by analysts at Barclays Global Investors in San Francisco estimates that public-employee pension funds in the U.S. are short $700 billion. That’s more than all state and local governments collected last year in property, sales and corporate income taxes combined. As a result, many employees in the private sector will get hit with a double whammy: while their pensions erode, increasingly they will be hit with cuts in government services and forced to pay higher taxes to cover the pensions of public employees, the kind they can only dream about. In three-fourths of the states, public pensions even come with annual cost-of-living increases, a fringe benefit absent from private pensions.

Some public-employee pension plans are well managed and adequately funded. Most are not. A study of 64 state pension systems by Wilshire Associates, an investment advisory company, found that 54 of them were underfunded by a total of $175.4 billion. The situation is even worse at the municipal level. San Diego, which is on the brink of bankruptcy, is in the hole for $1.4 billion in pensions owed but not covered.

How could this happen? Politicians neglected to put money into pension plans, made poor investments, handed out extraordinarily generous retirement packages and gave special treatment to their fellow politicians. As San Diego city attorney Mike Aguirre put it, “What has happened is that the pension plan has somewhat become a personal-benefit slush fund for council members and senior officials.” Not only did high-ranking San Diego officials give themselves preferential treatment for their pensions, they also distributed outsize benefits to city workers. A department director with 39 years of service collects $148,000 a year for life; an assistant port director with 31 years, $132,000. So far, the scandal has cost the mayor his job, six pension-fund trustees have been charged, city services are being slashed and investigations have been launched by the FBI, the SEC and the U.S. Attorney.

San Diego’s excesses have attracted attention, but the city is hardly alone. The California Public Employees’ Retirement System, better known as CalPERS, handed out a pension check last year for $272,200 to a retired university professor. A former water-district general manager collected $206,300. CalPERS, by the way, invests in vulture funds formed by Wilbur Ross, the New York billionaire who specializes in buying bankrupt companies, slashing costs and then selling the firms for an oversize profit. Among the costs pared: pensions. In short, a public-employee pension fund makes money from the killing of private pensions.

Across the U.S., retirement plans in big cities and small ones are underwater. In Philadelphia, the city’s three big pension funds were short $2.6 billion at the end of 2003. The police plan had enough assets to cover only 59% of promised retirement checks. That was after the city had sold $1.2 billion in pension-obligation bonds in 1999, the equivalent of paying your mortgage with a credit card. At the other end of the state, Pittsburgh was in even worse shape. In 2003, the police pension plan had enough assets to cover just 33% of promised retirement pay. That, too, was after Pittsburgh peddled $302 million in pension-obligation bonds between 1996 and 1998. In the end, taxpayers in both cities will have to pick up the tab. The place with the biggest problem is the state of Illinois, whose unfunded liability was estimated last year at $43.1 billion, or nearly double the state’s budget.

And everywhere, the worst is yet to come: health-care obligations. A 2004 study by Workplace Economics Inc. found all 50 state-government employers offered health-care benefits for retirees under age 65. Many who work for state or local governments may retire in their 40s and collect a pension as well as receive subsidized health care. Although future pension costs are well known because contributions and estimates of potential liabilities must be accounted for, such is not the case with health care. Governmental entities pay the bills out of current revenue. As is the case with everyone else’s, those bills are exploding. So, too, are future obligations, as the baby boomers prepare to leave their government jobs. This year New Jersey’s State Health Benefits Program will cost taxpayers $1 billion for active workers and an additional $900 million for retirees, according to Fred Beaver, director of the Division of Pensions and Benefits. By 2010, the state will spend more on health care for retirees ($2.3 billion) than for active workers ($1.8 billion).

Come 2007, state and local taxpayers everywhere will get their first full picture of current and future health-care costs of public employees. That’s when new accounting rules go into effect requiring governments to itemize health-care spending and forecast costs for coming years. The change in bookkeeping will either set off a wave of tax increases, reductions in government services or both. Lest anyone think state and local retirement-plan sponsors may emulate those in corporate America and simply walk away from the promised health-care benefits, think again. More than once, courts have ruled that health benefits promised to government workers (among them judges and legislators)–unlike those promised to workers in private industry–must be honored.