States should cut pension costs through measures such as extending the retirement age rather than defaulting on debt, DWS Investments said in a report Thursday.
Pension funds are “unsustainable on their current trajectory,” and “represent a significant and growing threat to the long-term financial health of muni bond issuers,” according to the e-mailed report by the research unit of Deutsche Bank.
Defaulting on debt to free up capital would “handicap their access to the capital markets,” according to the report.
The average state’s pension plans are 76% funded, according to data compiled for the Bloomberg Cities and Debt Briefing in New York last month. Illinois plans are only 50% funded; Kentucky, New Hampshire and Louisiana are funded at 60% or lower. The average five-year return of pension assets is about 3%, below the 7% or 8% benchmarks many states use, according to consulting firm Wilshire Associates.
The severity of budget problems makes unions more willing to work with legislators to change laws and write new ones, the study said. Some states are prohibiting “spiking,” a practice that allows public workers to take overtime and opt out of vacation time to create an inflated benchmark for future benefits.
Other measures include changing from defined benefit programs to defined contribution programs and reducing the public work force, the report said.
“After years of watching the unfunded obligation of municipalities, we are finally seeing an environment where reform is possible,” the report said.