Rhode Island Governor Lincoln Chafee, who left the Republican Party last year to run as an independent, is joining New Jersey Governor Chris Christie in seeking to roll back benefits promised to government retirees.

Chafee, 58, elected in November after he lost a U.S. Senate seat in 2006, wants to overhaul the state's $7.4 billion pension because it has only about half the assets needed over the coming decades, according to state data. He and Treasurer Gina Raimondo, a Democrat, proposed changes including suspending cost-of-living raises to cut the unfunded liability by $3 billion in a special legislative session today.

"The main thing is getting the economy going, getting people back to work, getting down our unemployment levels," Chafee said in an Oct. 12 interview in his Providence office. "And any time there's a shadow over our efforts to accomplish that lowering of our unemployment, and getting our economy going, they need to be addressed. One of those shadows is the unfunded liability of our pensions."

Rhode Island aligned with states from New Jersey to South Dakota that, since the financial crisis undercut public pension funding, are trying to lower expenses by suspending or rolling back annual cost-of-living increases promised to retirees. The number grew to at least seven since courts in Colorado and Minnesota rejected union claims that such changes illegally break contracts, according to Stephen Fehr, a researcher at the Pew Center on the States, a nonprofit group in Washington.

'Essential' Changes

Christie, New Jersey's Republican governor, suspended automatic cost-of-living increases earlier this year.

Adjustments meant to cover inflation would be suspended until state and local public pensions return to fiscal health, Raimondo said in prepared remarks to the Legislature. The changes also begin a combined system of traditional defined- benefit pensions and defined-contribution, or 401(k)-style, plans, she said. The proposal also raises the retirement age.

Chafee described changes in cost-of-living allowances as "essential" to restoring the state system's stability, in a Sept. 30 letter he and Raimondo sent to state workers. The present system is unaffordable and doesn't provide retirement security, they said.

Underfunded Pensions

Thirty-three states have assets of less than 80 percent of what is needed to pay promised benefits, a common threshold for sustainability, according to an annual study of pensions by Bloomberg Rankings. Median funding fell to 73.7 percent from 76.2 percent in 2009, the data show, even as the U.S. economy rebounded from the longest contraction since the Depression.

"One of the few ways to get immediate savings is the cost- of-living adjustment," said Fehr. "You're going to see more states take this up."

The proposal marks a reversal for Chafee, who was endorsed last year by the National Education Association of Rhode Island over his Democratic rival, former state Treasurer Frank Caprio, after he told the teachers' union that he would seek to protect their pension benefits. The group, which represents 11,800 educators, has since joined with other labor organizations to fight the overhaul effort.

"I want to make sure there's retirement security for teachers," said Chafee when asked about the accusation he's breaking a campaign promise to teachers. "That's what I said in the campaign and that's what I hope to deliver."

Magnitude Forces Action

The Legislature, controlled by Democrats, began considering the plan today because of "the magnitude of the unfunded liability" in the state system, Senate President Teresa Paiva- Weed said yesterday in an e-mailed statement. Larry Berman, a spokesman for Speaker Gordon Fox, who leads the House of Representatives, didn't respond to a telephone call seeking comment on the plan.

"You cannot go into the benefits of people who are already retired," said Paul Valetta, a firefighters' union representative from Cranston, who spoke on a panel about pensions in Providence Oct. 3. "It's illegal and immoral."

Rhode Island already had one of the least-funded state retirement plans in April, when the board overseeing the system voted to lower the assumed rate of return on assets to 7.5 percent a year from 8.25 percent. The board also revised its assumptions for retiree life expectancy.

Increased the Gap

The moves boosted the plan's unfunded liability 27 percent to $6.83 billion from about $5.4 billion and cut the funding ratio, or assets as a proportion of projected obligations, to about 48 percent from 54 percent, according to Gabriel Roeder Smith & Co., a consulting firm hired by the board.

Unless the Legislature adopts changes, the annual cost to taxpayers in required contributions will be about $622 million, up 33 percent from previous estimates because of the lower rate of return. Raimondo said the proposals made today will cut the state's costs by at least $3 billion over the next 10 years.

The state's fiscal 2012 general-revenue budget of $3.14 billion increased 5.7 percent from 2011, while the total spending including federal funds will drop by 5.6 percent this year, to $7.7 billion, budget documents show. The year began July 1.

The proposals would save local governments $1 billion over 10 years, Raimondo said. That includes $100 million in savings in the next fiscal year, she said.

Central Falls, Rhode Island's smallest and poorest city, declared bankruptcy in August because it couldn't afford to pay its bills, including covering annual costs for retiree benefits.

Local Plans

Pension funding at the local level in the Ocean State is in worse shape than at the state level, with an unfunded liability of $2.1 billion, according to a state auditor's report last month. The 36 municipally administered plans hold just 40 percent of the assets needed to meet projected payments, and that excludes benefits such as health care, the report showed. Cities and towns have paid for such benefits on an as-needed basis, so have set aside only $27.5 million of the estimated $3.5 billion they will need, according to the report.

Changing benefits including future cost-of-living increases strikes retiree Jamie Reilly, 54, as an unfair contract breach.

"I worked all my life and now you're going to do this to me who makes only $36,000 a year," said Reilly, a former secretary at the Eleanor Slater Hospital in Cranston. She accepted an incentive offer to retire early, at 50, in June 2008.

'Changing a Contract'

"You're changing a contract on me," the North Providence resident said in an interview. "The whole thing is wrong."

Eight public-employee unions have sued to block earlier attempts to curb pension costs by the Legislature, basing their claims on contract law. The changes included raising the retirement age, capping benefits and altering cost-of-living increases. A Superior Court judge disagreed with the state's contention that the unions lacked standing in the matter last month, permitting the challenge to proceed.

The U.S. Securities and Exchange Commission is probing Rhode Island bond offerings, possibly over disclosure of the state's pension liabilities, Raimondo said in February, when the investigation was made public. The state included information about pensions in statements connected with securities sales.

Rhode Island general-obligation debt is rated third-highest by Moody's, at Aa2, and Standard & Poor's, at AA. S&P has a negative outlook on the credit, citing unfunded retirement-plan obligations among its reasons.

"We can fix this pension system or see taxes triple or double in the coming years," Raimondo, elected treasurer last year, said Oct. 3 on the pension panel in Providence. "The system is not working for anyone. It's broken."

To contact the reporters on this story: Michael McDonald in Boston at mmcdonald10@bloomberg.net.

To contact the editor responsible for this story: Mark Tannenbaum at mtannen@bloomberg.net