(Bloomberg) -- Funding for U.S. state retirement plans fell for a fourth straight year as insufficient contributions and inadequate investment gains overwhelmed cuts that more than 40 legislatures have made to benefits since 2007. As public plans diverge from private in terms of equity vs. fixed-income, participants and taxpayers are caught in the crossfire.

The median public funding ratio was 71.7% for the year through June 2011, down from 74.3% the prior period, data compiled by Bloomberg show. Taxpayers in Illinois, the weakest of the group for the fourth straight year at 43.4%, are paying the price: the relative borrowing cost of the state and its localities is almost double the five-year average.

More than 30 states, including New Jersey and California, had less than 80% of assets needed to meet obligations to workers and retirees, the data show. That left them short of the threshold for sustainability of their plans.

The funding drop shows the challenge states face trying to recover from investment losses suffered during the recession that ended more than three years ago. The Standard & Poor’s 500 Index sank 38.5% in 2008, the most since 1937.

Lawmakers have lifted retirement ages, forced workers to contribute more to plans and suspended cost-of-living increases. Yet more than 30 states still failed to deposit enough into their systems last year as they struggled to balance budgets, according to Christopher Mier, chief municipal strategist at Loop Capital Markets in Chicago.

“If they had been diligently making their contributions, there wouldn’t have been this crisis,” says David Draine, a senior researcher in Washington at the Pew Center on the States. “It’s the states that came into the recession with poorly funded plans and a history of failing to make sufficient contributions that were already in a very vulnerable spot.”

Estimates of states’ combined pension deficit have ranged from $1 trillion to as much as $4 trillion as lawmakers and regulators debate the appropriate rate for discounting liabilities. The Governmental Accounting Standards Board has adopted new rules for next year that could swell the gaps.

Adding stocks

While corporate plans have been cutting equities in favor of fixed-income, public funds have done the opposite. They’ve increased stocks to nearly 70% of portfolios on average over the last decade as they seek higher returns, according to the Center for Retirement Research at Boston College. State systems are also boosting stakes in alternatives such as hedge funds, Cliffwater LLC, an investment advisory firm with offices in New York and Los Angeles, said in a June report.

“They are essentially doubling down to earn their way out of this problem and it’s not working,” says Kimberlee Lisella, vice president of customized strategies at Cutwater Asset Management Corp. in Armonk, N.Y., which oversees $32 billion. “These strategies have had mediocre returns at best and the volatility has been off the charts.”

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