(BLOOMBERG) -- State and local governments in the U.S. would be permitted to turn their retirement systems over to life insurers under a Senate bill that seeks to diminish public-pension deficits.

Voluntary participation by states and municipalities would reduce the threat of insolvency by removing the possibility of pension-plan underfunding, according to Senator Orrin Hatch of Utah, the top Republican on the Senate Finance Committee and author of the bill introduced today. The measure, which would alter federal tax law, also would permit changes in nongovernmentretirement plans to boost employee savings at small and mid-size companies.

The legislation, S. 1270, comes as more Americans say they want to save yet can’t afford to, and as Illinois tries to fix the nation’s worst-funded state retirement system. The 18-monthrecession that ended in June 2009 eroded pension assets and led some governments to reduce contributions as a way to balance budgets. U.S. state and local funds lack as much as $4.4 trillion to cover promised benefits to retirees, Hatch said.

“The problem is getting more serious every day and cannot be remedied merely by fine-tuning the existing pension structures available,” Hatch said today on the Senate floor. “A new public-pension design is needed -- one that provides cost certainty for state and local taxpayers, retirement-income security for state and local employees, and does not include an explicit or implicit federal government guarantee.”

Competitive Bidding

States that want to transfer their plans to annuity companies, such as life insurers, would be required under the bill to seek competitive bids. The bond ratings of Illinois, Connecticut, Kentucky, New Jersey, Hawaii and Pennsylvania have been cut over the past three years, in part because of how those states have managed growing pension liabilities, according to Moody’s Investors Service Inc.

“The new pension structure for state and local governments will solve the pension underfunding problem prospectively while delivering retirement-income security, in the form of a deferred fixed-income life annuity, to public employees,” according to a summary of the legislation provided by Julia Lawless, a Finance Committee spokeswoman for Hatch.

“The life-insurance industry invests the assets, pays the retirement benefits and bears the risks,” the summary says. “Involvement by the federal government will be limited to certifying the tax-qualified status of the plan.”

The annuities would be re-bid every year and would be portable, following workers from job to job, Hatch said today.

Costly Solution

“Shifting to annuities is just an unnecessarily expensive approach to the issue,” said Steven Kreisberg, collective bargaining director of the American Federation of State, County and Municipal Employees. The Washington-based union has more than 1.6 million members.

“Where we have pension-funding issues in the public sector, it’s not because of exposure to risk,” Kreisberg said today in a telephone interview. “It’s simply because employers have failed to make contributions that they should have made.”

A Bloomberg National Poll published last month found that while 31 percent of Americans say they expect to save more for retirement this year, 42 percent say they need to, yet can’t.

One provision in the bill would let employers that don’t sponsor a 401(k) defined-savings plan for workers to initiate what is known as a Starter 401(k), which would let employees save as much as $8,000 a year in tax-preferred retirement accounts. The new plan wouldn’t be taxed by the federal government, though it would be regulated at the state level.

Bill's Supporters

Hatch’s proposal has the support of MetLife Inc. (MET), the largest U.S. life insurer, as well as the U.S. Chamber of Commerce, the American Council of Life Insurers and Americans for Tax Reform, the Washington-based anti-tax advocacy group led by Grover Norquist.

Jurisdiction over rules prohibiting certain transactions involving individual retirement accounts would be transferred from the Labor Department to the Treasury Department under the bill. The Treasury Department would work with the Securities and Exchange Commission in determining professional standards for brokers and investment advisers for IRA participants.

The Treasury Department, instead of the Labor Department, also would have jurisdiction over rules pertaining to prohibited transactions for employer-sponsored retirement plans.

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