When financial markets cratered in late 2007, state pension officials assured lawmakers and the public that the damage to government retirement funds was only temporary. Pension funds are long-term investors, their story went, and pension systems would recover as soon as the market did. When lawmakers in Montana, for instance, asked the state treasurer whether they should be worried about the government’s ability to meet its retirement obligations, he confidently advised them to “go fishing” instead. They should have ignored him and taken action to bolster the state’s pension system, which has never recovered from the market crash. Montana’s retirement system has only about 75 percent of the money today that it needs to pay retirees, despite a nine-year stock-market rally.

Montana isn’t alone. A recent Wilshire Consulting report estimates that at the end of fiscal 2017, state government pensions nationwide were only 70 percent funded, down from 87 percent in 2007. Since the recovery began in 2009, $100 placed in a broad market-index fund would have yielded an investor about $365 today—an average compound annual gain of some 15 percent. No matter for pensions, though: thanks to a host of problems, most state and local government funds have spent a good part of the nine-year recovery heading in the wrong direction. Many are consequently ill-positioned to withstand the next market downturn, and without further cost-saving reforms, taxpayers in many states will face steep new assessments in coming years.

One problem is that these systems have grown so large, with so many workers earning new pension credits for their approaching retirements, that states’ obligations to these workers are growing relentlessly. Since 2007, state pension-system liabilities have increased to $4.52 trillion from $2.83 trillion, according to the systems’ own accounting. A major underlying driver of that increase is the need for defined-benefit pension systems to raise the amount of money they set aside for each worker as he gets closer to retirement. In 2017, for instance, that factor alone added $307.7 billion in new liabilities to state retirement systems studied by Wilshire.

Pension systems have also missed their projected financial targets. Back in 2007, most of the systems estimated that they’d earn an average yearly investment return of about 8 percent. Instead, according to Wilshire, they registered gains of 6.79 percent over the last decade. Many funds have now lowered their projections to more realistic targets. The average, reports Wilshire, is 7.25 percent. Lower projected market returns add to future debt, to the tune of about $90 billion in 2017 alone.

Pension plans have also miscalculated the impact that volatile swings in the market have on their ability to recover. When the market plunged throughout 2008 and into 2009, the value of government pension assets dipped from nearly $2.7 trillion to just $2.02 trillion. Pension funds then spent the next three years of robust investment returns making back the money they’d lost, even as their liabilities grew. In addition to the sharp market decline, the increasing cost of benefits drained funds. In 2017, for instance, state funds paid out $244 billion in retirement benefits. Governments have struggled to keep up with the drain. Since 2007, they’ve boosted their contributions into pension funds by 90 percent, to $140 billion annually. It’s not been nearly enough to offset the devastating effect of market declines, missed investment goals, and rising benefit payments.

The impact has been wider than many realize. Most coverage of the government pension crisis focuses on those places in the worst condition—school districts in California, Chicago’s fire and police pension funds, municipal pensions throughout Illinois, state pension systems in New Jersey and Connecticut. But the majority of funds are heading in the wrong direction. A Bloomberg report based on 2016 financial data estimated that funding levels for 43 state retirement systems declined. Among the worst was Colorado, which saw its funding ratio drop 14.4 points, to 46 percent, prompting the state to pass cost-cutting reforms.

The underlying message of these distressing numbers is that the financial structure of most state and local defined-benefit pension funds is deeply flawed. In particular, their financial models do not adequately account for the impact that sharp marketplace swings can have on their ability to keep up with the growth in the retirement benefits that workers are earning. That’s especially troubling because if funds cannot make headway reducing their debt in such a robust economy, what happens during the inevitable next bear market? If funding levels remain close to where they are now—and short of some spectacular rise in the marketplace in the next few years, that’s where they will be—then the next market downturn will widen the gap between pension funds’ assets and liabilities even more, increasing their debt. Many pension systems will see their funding slip to 60 percent or less of the money that they need to pay future retirement costs. At that point, states simply won’t have enough money invested in the market to keep up with the growth of their retirement obligations. Only massive infusions of cash from taxpayers could help then, but state and local governments—already having upped their contributions to pensions—will be in no position to bail out funds with taxpayer dollars when the next recession hits.

The only sure answer is to continue reducing pension benefits that workers earn in order to slow the growth of future retirement bills before the gap between what states owe retirees and the money that pension funds have on hand grows so large that there’s no way to close it—and the whole system collapses.

Photo: Thinglass/iStock