A financial time bomb is ticking away -- mostly unheard by taxpayers, government workers and retirees.

Years of off-the-mark investment assumptions, inadequate contributions and generous benefits have left government pension funds in a perilous situation: unable to meet long-term commitments to current and future retirees without major changes.

"It's a serious problem," said Sen. Don Betzold, DFL-Fridley, who is working on a plan to shore up the funds.

Minnesota's retirement funds and other investment accounts lost $10 billion over the past two years, leaving about $53 billion under state management at the end of 2009. The pension funds have been slightly above or below minimum balances recommended by the federal government.

Only 76 percent of the pension obligations for 636,000 teachers, state and local government employees and retirees were fully funded at the end of last June, leaving their pensions short $12 billion. One smaller local fund could go broke in as few as five years, meaning pension checks wouldn't be cut, Betzold said.

To deal with the pension problem, legislators are proposing an unusual package of increased government payments, greater contributions from employees and reduced benefits for retirees. Bills in the House and Senate are expected to be acted on this session.

But funding for government pensions also depends heavily on investment returns, which were hammered by the recent stock market decline.

Making matters worse, Minnesota is among five states whose pension funding is based on expected average earnings of 8.5 percent a year, according to the nonprofit Pew Center on the States in a February study. Over the 20 years ending last July, which include the stock boom of the 1990s and the busts of recent years, the state's return averaged 7.8 percent.

Other states have lowered their expectations to 8 percent or 7.77 percent.

"Some experts believe even those reduced rates are still unrealistically high," the Pew Center wrote.

Lower the target?

Minnesota pension funds recently considered lowering the investment target, but that would have required even bigger contributions and bigger benefit cuts to meet commitments -- both politically unpopular choices.

"They're betting that going forward they get at least 8.5 percent," said Edward Burek, deputy director of the Legislative Pension Commission.

Howard Bicker, executive director of the State Board of Investment, which oversees pension earnings, said pension funds in the state earned an average of 9.9 percent a year when taking in the past 30 years.

"History has told us we can do this over long periods of time," Bicker said. "It's the short term that you have got to have the staying power for."

Betzold said the contribution increases and benefit reductions in his bill are needed "even if we get phenomenal returns."

At a Senate hearing Wednesday, he said that without the proposed changes and at least 8.5 percent annual returns, "these funds are in big trouble. Some would go broke before ... 30 years."

The Teachers Retirement Association (TRA) is in the worst shape, with only 59 percent of its obligations covered. "They would run out of money by the year 2032" without the adjustments, Betzold said.

He acknowledged that the proposal to increase school contributions "is going to cause more stress on school budgets."

School districts would eventually be paying $90 million more under the Betzold proposal, said Laurie Fiori Hacking, executive director of TRA.

The organization supports increasing payments from teachers and school districts and a suspension and temporary cut in benefits for retirees.

Legislators have complained that Education Minnesota, the state's largest teachers union, has resisted having its members contribute more to their pension funds.

Education Minnesota President Tom Dooher said the union is willing to have employees pay more as long as school districts also pay more.

But former state Sen. Don Moe, long a critic of Minnesota government pensions, said years of generous benefits have taken their toll on fund balances.

"We're dealing with hundreds of thousands of public employees, all of whom are, it seems, politically astute and active," said Moe, a St. Paul DFLer who specialized in pension issues during his two decades in the Legislature. "It's a very highly politicized system."

In recent years Education Minnesota has even held out hope for benefit increases, "in spite of the crushing economic problems we have," Moe said.

'Insatiable demand'

Even though the pension funds are now calling for curbing benefit increases, Moe sees retirees and employees shifting gears with better investment returns.

"There is an insatiable demand for more benefits," he said. "It's difficult to resist in pension policy because you don't have to pay the bill immediately."

Retirement bonuses pegged to the stock market boom of the 1990s locked in obligations and helped increase debts when the market sagged and investment income declined, said a report by the nonpartisan Minnesota Taxpayers Association.

In addition to boosting school and teacher contributions and curbing teacher benefits, the proposed legislation would increase contributions by local government employees and 2,000 governments covered by the Public Employees Retirement Association. It also would cut their benefits and those for state workers covered under the Minnesota State Retirement System.

The pensions facing the most serious threat are those of the Minneapolis Employee Retirement Fund. It covers city employees who were hired before 1979, so it has about 5,000 people drawing pensions while about 100 are still working.

"It is expected to run out of money between five and seven years," Betzold said.

The proposed legislation to save the pension would merge the Minneapolis fund with the larger Public Employees Retirement Association at an eventual cost to the state of $27 million a year.

Pat Doyle • 651-222-1210