States have only actually funded $2.35 trillion of the $3.35 trillion in employee retirement benefits they owe, according to a recently released report from Washington-based Pew Center for the States. The shortfall could lead to larger liabilities in the future and cuts in services, even at the local government level.

The report, "The Trillion Dollar Gap: Underfunded state retirement systems and the roads to reform," ranks state pension and retiree health care/non-pension benefit systems based on three criteria: a funding ratio of at least 80 percent; an unfunded liability below covered payroll; and an average payment of at least 90 percent of the actuarially required contribution over the past five years. It designates 16 states as "solid performers" for meeting all three standards for their pensions. Another 15 states are "in need of improvement" and 19 are designated as "meriting serious concerns," meaning they did not meet any of the criteria.

Many of the strong performing states consistently fund their systems in both financially good and bad years, and many have a legal requirement to fund their pension systems. The poorly performing states often failed to contribute enough to their plans in good times and made other mistakes, says Katherine Barrett, a consultant for Pew Center on the States.

If states fail to address their pension gaps, less money could be distributed to local governments, such as in the form of highway funds, and reimbursements from the state for social services could be cut, says Chris Hoene, director of research and innovation for the Washington-based National League of Cities.

It is difficult to predict when the unfunded liabilities will reach that critical level because of vagaries in the investment markets and other factors. "But, you can see that states with larger unfunded liabilities already have to pay a lot more each year," Barrett says. "That becomes more of an expensive problem the longer you put it off."

Jennifer Grzeskowiak is a Laguna Beach, Calif.-based freelance writer.

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Florida, New York, Washington and Wisconsin have funded 100 percent or more of their accrued pension liabilities. Connecticut, Illinois, Kansas, Kentucky, Massachusetts, Oklahoma, Rhode Island and West Virginia have funded less than 65 percent of their liabilities.

Source: "The Trillion Dollar Gap," Pew Center for the States, February, 2010