Six years ago, the funds that pay for employee pensions and retiree health care for Washtenaw County employees were nearly balanced: they held $215 million in assets against what staff estimated to be $225 million in liabilities. The funds’ assets have since edged up, to $261 million–but its estimated liabilities have more than doubled, to $533 million. The county paid more than $20 million into the funds last year, and the contributions required under its union contracts are rising at a rate of 7 to 8 percent a year.

Washtenaw County is far from alone. Between more retirees, fewer contributors, increasing health care costs, and the worst financial crisis since the Great Depression, other local governments, school districts, states, and even nations are facing the same problem. Even among Michigan counties, others have it much worse–Wayne County, home to bankrupt Detroit, has unfunded liabilities of $2.1 billion. Even so, Washtenaw’s add up to $775 for every man, woman, and child in the county.

Like many governments and businesses, the county used to promise its workers a guaranteed level of pension income. Such “defined benefit” plans allow employees to plan securely for retirement–but they are risky for employers, because they have to make those payments even when financial conditions worsen. So in the 1990s, Washtenaw started putting newly hired workers into “defined contribution” plans. They had their own retirement accounts, and the county promised to contribute to those accounts only as long as they worked. How much the employees would have for retirement depended on how much they themselves contributed and on how well their investments did.

The number of employees in the defined-benefit plan, the Washtenaw County Employees Retirement System (WCERS), fell steadily in the years that followed. According to Monica Boote, the county’s human resources operational director, by 2007 just 155 employees were still covered. But in 2008, the county reopened its defined benefits plan, folding newer employees’ individual retirement accounts into WCERS. Five years later, more than 1,000 staff members are “vested”–with enough seniority to claim at least a partial pension–in the system. With an average age of forty-four, they’ll be collecting guaranteed payments for decades to come.

“A lot of people think it wasn’t a good idea now, but our administrator did that with the board’s support,” says county administrator Verna McDaniel, referring to her predecessor, longtime administrator Bob Guenzel. “We all were there.”

“The unions proposed it, AFSCME primarily,” Guenzel remembers. “We were successful in getting the unions to give up a [scheduled] 2 percent [pay] increase. That was a big structural savings, and in return they wanted to go back to defined benefits.

“It was a very difficult decision, but given what we faced and the actuarial projections we had, we felt we were protected,” the retired administrator says. “And by those negotiations we saved about 100 positions and services.”

Boote says that at the time, the change increased the county’s unfunded liabilities by only $15 million. “The reopening of the plan was very insignificant to the funding ratio and unfunded liabilities,” she says. But shortly after the county board voted to make the change, the markets crashed–taking with them the illusion that safe, high-yielding investments would pay off the county’s pension promises.

Boote says the county’s estimates of its WCERS and health care liabilities proved accurate. Where it went wrong was in assuming that the funds would reliably earn high returns–as late as 2008, the “actuarial assumption” was 7.75 percent per year. Instead, as the stock market plunged, returns turned negative. “We lost $60 million in 2008,” Boote recalls–22 percent of the funds’ value.

Though the markets have since recovered, they still lag behind the returns the county banked on. Boote says it was those disappointing investment returns, not the addition of so many more employees, that really hurt the budget.

Still, the county has again reversed course. Starting January 2014, new employees will once again go into a defined-contribution plan. “The public needs to know we closed defined benefits to new hires,” McDaniel says. “We reached long-term agreements with our unions to make that possible. We now have ten-year contracts with most of them.”

But since the Michigan constitution protects pensions, nothing short of bankruptcy can get the county off the hook for its past promises. And beyond legal responsibility, says Ann Arbor county commissioner Andy LaBarre, “we have a moral obligation to meet these liabilities.” Board chair Yousef Rabhi, also from Ann Arbor, says the whole board, from “the most liberal Democrat to the most conservative Republican, agrees we have to meet our unfunded liabilities.”

Because pensions are paid over time, though, the county doesn’t have to meet all its liabilities at once. And as the markets have recovered, so has hope that investment returns could cover much of the burden. Earlier this past year, McDaniel proposed issuing $345 million in bonds and investing the proceeds in funds dedicated to retiree benefits. The theory is that the investments will return more than the interest cost on the bonds–or at the least, McDaniel says, “break even so as to not lose ground over the period of payoff.”

With memories of the market crash still fresh, however, commissioners were wary. “We were asked to make a decision in May,” says Rabhi. “But it’s easy to get carried away, so we pulled it until July.” At that point, the board ruled out a related proposal to borrow money to cover an anticipated shortfall in next year’s operating budget. And by the time McDaniel unveiled her budget in October, bonding for benefits was not included.

The concept of borrowing money to invest is still on the table, however. To Rabhi, the potential benefit is simple: “We won’t have to ask taxpayers for additional money to cover unfunded liabilities.”

“In the best-case scenario, we’d have a surplus of funds in the trust and at end of twenty-five years [would] have money to give back to citizens,” says LaBarre. “I’m not saying it’s likely.”

Neither does Rabhi. “Bonding is inherently risky. If you borrow money to invest, and if the return isn’t what you expect–if there’re a couple years of recession in the beginning–it’d be hard to recover from.” The board chair doesn’t close the door entirely, saying that “bonding is an option we’ll be looking at it in the next months.” LaBarre, though, doubts the votes are there to pass it–and hints that he won’t support it, saying, “I get very nervous when we’re depending on market performance to save our skin.”

If his fellow commissioners agree, that leaves the county facing a dire reality. McDaniel warns that “core services will be impacted” if they continue to divert money from the general fund to retiree benefits. LaBarre agrees, saying that covering the unfunded liabilities from the operating budget would require “massive cuts to discretionary human services and unmandated public safety–though everybody would get cut.”

If bonding is too dangerous, spending general fund money too damaging, and doing nothing no longer an option, the only alternative left is raising taxes. “Some millages are possibilities,” LaBarre says, “like a public safety or human services millage, or a millage to pay into a legacy [cost] relief fund. We could also talk about a Headlee override”–asking voters to restore property taxes cut by the state tax limitation law.

“This is an unprecedented situation,” concludes LaBarre. “If we do the right thing, we can provide long-term stability for this county. If we make the wrong decision–well, I live here, and when I walk down the street, I don’t want to hear ‘That’s the nitwit that cost us so much money!'”