State Retirement Funds Play Tricks on Retirees, Taxpayers

Published November 14, 2014

Awareness of the problem of underfunded public pensions is increasing among the public, as states seek to balance their budgets without reneging on prior agreements with workers, but a less publicized liability problem is also becoming a concern. In too many cases, states’ retirement health benefits programs are overpromising and underfunded.

State governments, in the aggregate, have set aside only four cents for each dollar of promised health care benefits. In addition to this disturbing trend, some states have started using an accounting trick to hide this debt by keeping it off their balance sheets, effectively sweeping the debt “under the rug” and out of sight.

Papering over the Problem
As a result, some of the reported improvements in healthcare programs’ finances are false. Alaska, Hawaii, and Michigan, for example, employ gimmicks that give the appearance of fiscal improvements in their entitlement programs.

Most states maintain a zero balance in their retirement health fund to cover expenses. As there is no money in the fund, the state can “lowball” its expected rate of return on debt owed, assuming a pessimistic 4 percent rate of investment return.

When money is eventually placed into the health fund, the use of a higher estimated rate of return allows state governments to claim the fund has been “prefunded”—making the fund appear much healthier than it may be in reality.

By triggering overly optimistic funding scenarios through the manipulation of fund balances, states engineer perceptions that their retirement healthcare fund reserves are filling up faster than they are.

Generally speaking, state pension funds assume 8 percent returns on pension investments—a wildly optimistic assumption. Studies by the Pew Charitable Trusts found state entitlement funds’ investments had experienced only a 3.9 percent average annual return over the past decade.

The average state has a total pension and retirement health care debt of more than 22 billion dollars, but over 80 percent of that debt—almost 19 billion dollars—is hidden from citizens and state legislators by means of such accounting gimmicks.

Fixing the Structure
These accounting tricks enable governments to understate their unfunded liabilities by billions of dollars. However, not all states are deceiving their taxpayers in this way.

In Kentucky, the actual value of healthcare and pension claims was lower than earlier estimates made by the fund, allowing the state to revise its expectations and lower its debt load.

Other states have enacted structural reforms to their systems, improving their fiscal outlook. In Ohio, increasing the age of retirement for employees has decreased the estimated amount of money required to fund retirees’ healthcare.

Taxpayers will ultimately be responsible for the real value of the debt, regardless of how accurate the estimated rate of return turns out to be. Unless other states follow the lead of Kentucky or Ohio by making real reforms to pension structures, future taxpayers will be forced to make up the difference if the fund does not have enough money to pay benefits owed to retirees.

Dannie Mahoney ([email protected]) is media relations manager for Truth in Accounting.