Pension reform: Litigate, negotiate or go bankrupt
Underfunded public pensions are an enormous problem that states, cities, school districts and other municipal entities will continue to wrestle with in 2013. Many public officials have already taken up the issue of reform, as their budgets are pressured by large required payments to public pension plans.
Nationally public pensions are funded at about 80 percent of their liabilities, but that masks the severe under-funding faced by some systems. For example, the Illinois state system only has about 43 percent of the assets needed to fund future pensions. States, cities, school districts and public employee unions have three options to address this problem – litigate, negotiate or go bankrupt. Here are examples of how this choice is playing out:
A private group, the Arnold Foundation, has published a guide to pension litigation across the country. The guide lays out the changes enacted by state legislatures and city governments, and the litigation filed to overturn the changes (see the map above). From the 2013 guide:
Once reforms occur, however, they are often challenged in the courts. Within the past three years, at least 24 jurisdictions have faced lawsuits alleging that pension reform measures are unconstitutional. Such jurisdictions include Colorado, Florida, Massachusetts, Minnesota, New Hampshire, New Jersey, New Mexico, Rhode Island, South Dakota, Chicago, San Diego, and San Jose.
Pensions are adjudicated differently under each state’s constitution, so there is not complete consistency in judicial outcomes (page 5):
Courts have expressed a wide range of views on pension reform issues, at times arriving at diametrically opposite conclusions. For example, reductions of cost-of-living adjustments [COLAs] were upheld in Colorado, Minnesota, New Jersey, and South Dakota state courts, whereas the same adjustments were struck down in Arizona. Many other significant pension reforms, such as those in Rhode Island or the City of San Jose, California, are currently being litigated. To date, there is little to no definitive guidance or uniformity of interpretation on these matters, either at a state or federal level.
Litigating pension reform is costly and it has unpredictable outcomes. No cost-benefit analysis of its value has been performed. Expect to see more litigation, but hopefully we will also see more clarity on its value.
Numerous communities have chosen to negotiate with unions to reduce pension benefits, increase employee contributions and push out vesting and retirement ages. For example, in October, Atwater, California – facing bankruptcy – gained substantial concessions from employees. Reuters reports:
[Nancy Vinson, a business agent for the American Federation of State, County and Municipal Employees (AFSCME)] said the city will cut 8 positions from its 35-employee non-safety payroll and that its remaining members will accept a 5 percent wage cut and pay more toward their pension accounts and health care.
This week in Long Beach, California the editorial staff of the Press-Telegram wrote:
If the [pension] reform deal is formally adopted by the Long Beach City Council, then current city employees would pay 6 percent more of their salary toward pension costs, continue to receive 2.5 percent of their pay as pension for each year worked and be eligible for retirement at age 55. Those hired after Jan. 1 will get 2 percent of salary at retirement for each year worked and would not be eligible to retire until age 62.
- The reforms suspend all guaranteed annual raises for retirees until the pension system is 70 percent funded and caps all future pensions at one-and-a-half times the median state household income.
- The reforms also reduced the disability benefit from 66.6 percent of an employee’s final salary to 50 percent.
- The reforms changed current rules regarding payments into the system and will now require employees to pay into the pension system for as long as they are earning credit toward a pension.
Negotiating takes a lot of nerve and a spirit of cooperation on the part of public officials, but it seems a clearly productive alternative.
Several cities that are saddled with massive pension costs, among other things, have entered Chapter 9 municipal bankruptcy. Central Falls, Rhode Island forced harsh changes on its retirees during bankruptcy. Reuters reports:
The city’s 133 retirees had their pensions cut by up to 55 percent, with pensioners now getting an average of $16,626 a year. The state allocated $2.6 million to soften the blow for the next five years.
Stockton and San Bernardino, California – now in the middle of bankruptcy proceedings – have taken different approaches to their outstanding pension liabilities. Stockton has not ceased the payments it must make to Calpers, the state agency that manages municipal pension plans, while San Bernardino has stopped its payments. These complex cases will set important benchmarks for how pension plans can be treated through bankruptcy.
Going forward, there will be a lot of action on pension reform. For the first time, unfunded pension liabilities will appear at the front of financial documents. This will be a clear signal to bond markets and others about the condition of city and state finances. It will create more pressure on public officials to deal with pension shortfalls. Change is afoot, and there are many paths to pension solvency.
Source: Arnold Foundation report