The state's efforts to fund billions of dollars needed for future retiree benefits was handed a setback yesterday when the Hawai'i Employees Retirement System was told the liability increased by $1 billion in the past year.

An actuary told the ERS trustees that major factors in the jump were retirees who are living longer than expected and worker pay increases that are larger than the assumed 4 percent annual pay increase used to calculate benefits. He recommended funding be increased.

"Your retirees are much healthier than (on) the Mainland, as a whole," said W. Michael Carter of Gabriel, Roeder, Smith and Co., the ERS' actuarial consultant. For example, women teachers are living to age 90 instead of the mid-80s that had been used in determining the ERS' liabilities.

While the ERS has more than $10.2 billion in assets and there is no problem paying retirees' current pensions, the state and counties have a liability for future benefits. During the past year, the unfunded liability for the system jumped 25 percent to $5.13 billion. Only 65 percent of its liability is funded, one of the lower percentages among state pension funds.

Carter recommended trustees propose legislation to increase the employer funding rate and for changes that allow the ERS to use actual worker pay increases in formulations. This fiscal year, the state and counties are contributing about $423 million to the pension fund to help pay for current retiree benefits and pay down the unfunded liability.

If they accept the higher contribution rates, the state and counties could be paying about $500 million annually. If they don't increase the funding and if the pension system's investment returns don't exceed expectations, the problem will worsen, Carter said, explaining the unfunded liability will continue to creep up.

"The longer they wait, the more expensive it will be," he said. At present, the state and counties contribute 13.95 percent of their payroll to the pension fund. Carter recommended this be increased to more than 16 percent.

The funding shortfall developed over a 35-year period when the state and counties diverted more than $1.69 billion owed to the pension fund to other programs during tight budgetary times.

Carter said the pension system would be almost fully or fully funded now if it had received the diverted funds and invested them. Until recently, the state and counties were allowed to divert the funds when the pension plan's investments returned more than 8 percent annually.

That practice has since ended. Gov. Linda Lingle's administration and the Legislature have increased funding in recent years with the intention of paying down the liability in 25 years.

Reach Greg Wiles at gwiles@honoluluadvertiser.com.