The New Jersey Pension and Health Benefits Commission appointed by Gov. Chris Christie last week will be wrestling with some big numbers, but none larger than the combined $90 billion in unfunded liabilities for future pension and retiree healthcare benefits.
Skepticism over the state’s ability to cover those unfunded liabilities was the main reason why Standard & Poor’s, Moody’s Investors Services and Fitch Ratings, Inc. downgraded New Jersey’s credit rating to single-A status — lower than any state except Illinois, whose unfunded retiree liabilities are even worse.
What is an unfunded liability? An unfunded liability in a retirement system is the shortfall between projected future payment obligations to both current workers and retirees and the amount of funding set aside to pay those obligations. This shortfall takes into account both money currently set aside in a separate retirement fund and projected investment earnings on that money.
Why do unfunded liabilities matter? Unfunded liabilities are costs that need to be covered by future taxpayers.
In New Jersey, an estimated $90 billion in future costs are being pushed onto the backs of future generations to keep taxes low for current taxpayers — a practice that Assembly Budget Committee Chairman Gary Schaer (D-Passaic) decried as “kicking the can down the road.”
Even worse, the cost of dealing with those unfunded liabilities in the future grows exponentially because the failure to make a current payment is compounded by years of lost investment income on that money. For example, $1 billion put into New Jersey’s pension system last July 1 would have been worth $1.15 billion this July 1 because the state earned a 15 percent return on investments. That shortfall due to a lack of return on investment is compounded with every year that passes.
Which unfunded liability is bigger – pensions or retiree health benefits? While the unfunded pension liability gets the most attention, the unfunded liability in retiree healthcare costs for current and former teachers and state government employees is actually larger, at $47 billion.
While the unfunded liability in pension costs is likely to go down in future decades when the state finally approves – and sticks to – a credible pension-funding plan, retiree healthcare costs are covered on a pay-as-you-go basis from annual budget appropriations.
That pay-as-you-go system has actually protected appropriations for retiree health benefits from being cut by past governors and legislatures. When Gov. Chris Christie faced a budget crisis in May, he slashed pension funding by $900 million in Fiscal Year 2014 and $1.5 billion in FY15 –knowing that the cuts would add to future pension problems, but that current retirees would still receive their benefits. He did not cut anything from the $1.5 billion appropriation for retiree health benefits because the medical bills of pensioners would not have been paid.
What is New Jersey’s unfunded pension liability? New Jersey state government, which pays the pensions of both retired teachers and state government employees, is projected to have a $40.4 billion unfunded liability by June 2015, while county and municipal governments face an unfunded liability of $14 billion. While the liability for county and municipal governments is growing slowly, the state government’s unfunded pension liability was expected to jump to $54 billion by FY18 even if the state stayed on the pension payment schedule required in the 2011 pension law pushed through by Christie and Senate President Stephen Sweeney (D-Gloucester).
Wasn’t the 2011 pension bill supposed to put the pension system on a firm fiscal footing? Yes and no. The 2011 law cut the state’s unfunded liability as of that year from $47 billion to $37 billion by eliminating cost-of-living increases for retirees, requiring current employees to pay more toward their pensions, raising the retirement age to 65, and instituting other changes that cut into the benefits of future retirees.
But the biggest cause of the unfunded liability was the failure of past governors and legislatures to make their share of the required pension payment. In the 15 years before Christie took office, Republican Govs. Christine Todd Whitman and Donald DiFrancesco and Democratic Govs. Jim McGreevey, Richard Codey and Jon Corzine contributed just $3.4 billion to the pension system, and $2.17 billion of that was contributed by Corzine before the Great Recession devastated the state budget in 2009.
The 2011 law compounded the pension funding shortfall by giving the state seven years to ramp up to the full funding level that actuaries predict the state will need to cover the annualized cost of the state’s pension system, including an amortization schedule that would enable the state to pay down its unfunded liability to zero by the year 2048.
That payment schedule called for the state to pay $1.6 billion into the system in FY14 and $2.25 billion in FY15 as part of a seven-year ramp-up that would build up to a $4.8 billion payment in FY18, then level off.
Because the state would be paying less than the actuarially required amount for seven years, the unfunded pension liability was expected to continue to grow from $37 billion in FY11 to $54 billion by FY18. However, that was before Christie cut back the state’s FY14 and FY15 pension payments to $694 million and $681 million. Even with the reduced payments, Christie points out that the $2.89 billion he will have paid into the pension system by June 30, 2015, will be more than any other governor.
Nevertheless, because of the Christie cuts, the unfunded liability is now likely to top $60 billion by FY18 — even if the Christie administration is able to meet its target of a $2.5 billion pension contribution in FY16 — and the required state payment for FY18 is likely to jump from $4.8 billion to $5.5 billion.
Can the state afford to make a $5.5 billion pension contribution in FY18 to finally put the pension system on a firm fiscal footing? Not without a a tax increase], fiscal experts agree. State revenues are not going to grow $4.8 billion over the next three budget years – which is the difference between the $681 million Christie put into the FY15 budget for pensions and the $5.5 billion that would be required in FY18.
Can it get any worse? Yes. A state Appellate Division panel ruled in June that cost-of-living increases for those who retired between 1997 and 2011 represented a contractual obligation for the state, which would most likely wipe out at least one third of the projected $74 billion in pension savings Christie expected from the freeze on cost-of-living adjustments contained in the 2011 law.
Furthermore, while Superior Court Judge Mary Jacobson did not order Christie to make the full $1.6 billion pension contribution required for FY14 under the 2011 law, she indicated that the state most likely had a contractual obligation to make the $2.25 billion payment projected for FY15. at
If she rules that Christie and the Legislature violated that contractual obligation by failing to include the $2.25 billion in this year’s budget, she could order the state to do so – similar to the way that the New Jersey Supreme Court ordered the state to come up with an adequate school-funding formula in 1976, which led to the passage of the first state income tax. Undoubtedly, any final order would have to come from the state Supreme Court, because the Christie administration would immediately appeal any such Jacobson directive.
Would that be bad? Yes and no. It would create a major mid-year budget crisis for Christie and the Legislature.
But dealing with the pension-funding issue now would be cheaper than pushing it off again for several years – which is actually the same argument that Christie made when he appointed his new pension commission and asked them to find ways to cut the state’s pension and health benefit costs both to achieve current savings and to reduce unfunded liabilities for the future.
The difference, of course, is that Christie has signaled that he expects his commission to find ways to cut the unfunded liabilities in pension and retiree healthcare obligations by lowering benefit levels, rather than requiring increases in state funding for those purposes.