PHILADELPHIA -- Pennsylvania, home to a quarter of all U.S. public pensions, has spent at least $2 billion since 1985 to help pay for managing the retirement plans, including thousands that cover no more than 10 municipal workers each.
The subsidy has prompted towns such as Halfmoon and Elk Lick to set up even smaller plans, with fewer than five members. Some don't monitor or rein in administrative costs, including those paid to firms such as PNC Financial Services Group.
"There's no incentive to reduce your municipal expenses if the state's paying," said James McAneny, executive director of Pennsylvania's Public Employee Retirement Commission. He calls the pensions "snowflakes" because each is different.
With 21 communities operating under state fiscal oversight, Pennsylvania's aid staved off insolvency for "multiple" retirement funds, according to a commission report last year. Yet almost half of covered workers were in plans that lacked at least 50 percent of assets needed to pay promised benefits. Such unfunded costs have helped force cities from Central Falls, R.I., to Stockton, Calif., into bankruptcy court.
Even Pennsylvania's two statewide systems, those for school and state workers, had less than 70 percent of needed assets, contributing to a Moody's Investors Service downgrade of the commonwealth's general-obligation debt last month, to Aa2.
Investors are demanding 0.45 percentage point of extra yield to own 10-year bonds of Pennsylvania issuers rather than AAA tax-exempts, almost double the average for the past decade, data compiled by Bloomberg show. The state's debt has earned 5.3 percent this year, underperforming the $3.7 trillion municipal market's 5.7 percent returns, Standard & Poor's data show.
In Elk Lick, Somerset County, where about 2,200 residents can pick from five churches and three bars, the township supervisors board started a plan to cover four workers -- including two of the board's three members -- in 2006.
"If the pension fund gets to a point that they may raise taxes, I don't know what they'll do," said Ardith Deal, who has served as the town's secretary and treasurer for 17 years. "I know that's not what they had in mind. They don't want to raise taxes to pay the four of us to retire."
As for the costs of running the plan, Ms. Deal said she wasn't familiar with those expenses.
"Honestly, I don't look at this stuff," she said.
Since 1943, Pennsylvania has used a 2 percent tax on out-of-state casualty and fire insurance companies to help pay for pensions, distributing the money among municipalities based on the type and number of covered workers. A change in 1985 expanded the measure to cover administrative costs, with about half the aid since then going to that purpose, Mr. McAneny said.
The state has provided $4.05 billion to its 3,200 municipal-pension plans from 1985 through 2011, according to data from the auditor general and retirement commission.
Pennsylvania's subsidy is unusual. Helping local governments with pension costs occurs in a minority of states and a dedicated tax for the purpose is uncommon, said Tim Blake, a public finance analyst with Moody's Investors Service.
Oklahoma, Colorado, Florida, Idaho, Illinois and Indiana are among states that collect taxes to provide local pension aid, according to Keith Brainard, research director at the National Association of State Retirement Administrators, and the Civic Federation, a research organization in Chicago.
By fueling the proliferation of small funds, Pennsylvania's assistance may be creating additional expenses paid to firms such as PNC and Bank of America Corp.'s Merrill Lynch unit. The costs of administering the plans are higher and their returns on assets are lower than larger retirement systems, Mr. Brainard said.
As a result, small funds pose a greater risk for taxpayers, he said.
"Some plans are in good financial shape; many of them in the older communities in Pennsylvania are not," said Jack Wagner, the state auditor general, who disburses pension aid. Those that lack sound finances place a greater burden on taxpayers, he said.
Amy Vargo, a spokeswoman for Pittsburgh-based PNC, declined to comment. Matthew Card, a spokesman for Charlotte-based Bank of America, didn't comment.
About two-thirds, or 67 percent, of Pennsylvania's local-government plans cover no more than 10 active members. A third have three or fewer.
The management costs for small plans are almost triple the administrative expenses of systems covering more than 500 workers, at $1,440 per beneficiary compared with $404 for the larger funds, according to the retirement commission's report.
Inefficiencies drive up costs for the smaller pensions, Mr. Brainard said. It's "more difficult for them to achieve the investment returns they can likely generate if they were pooling their assets with other funds."
State aid once covered all pension costs for most cities and towns. As of 2010, about a third got enough help to cover their total expense, compared with 75 percent in 1985, meaning taxpayers now pick up most of the tab, according to the commission report. Retirements and failure to make up for returns on assets that were weaker than expected have contributed to growing unfunded liabilities.
North Sewickley Township, population 5,500, may have to raise taxes to cover the cost of a police pension plan set up in 2001.
After two retirements, the Beaver County town's annual contribution to the plan quintupled to $91,221 in 2011 from $16,230 a year earlier. The pension accounted for 7 percent of the 2012 general-fund budget, compared with 1 percent in 2010. With just one active member, it has 51 percent of needed assets.
"If you expect some benefits, you're going to have to pay for them, that's all," said Norman Giancola, chairman of the supervisors board. "Our police officers who go out every day and put their life on the line for this or for that, we got to do them well."state