Puerto Rico government stumbles on teacher pension reform

April 14, 2014

The Puerto Rico government encountered a stumbling block in its efforts to right a sinking fiscal ship on Friday when its Supreme Court ruled that legislation amending the teacher’s pension system was unconstitutional. Reuters reports:

The Puerto Rico Supreme Court on Friday struck down a recently enacted overhaul of teachers’ pensions, dealing a major blow to efforts to fix the Caribbean island’s crumbling economy and budget.

Five of the court’s nine members determined that significant portions of the reform law were unconstitutional. Three judges dissented and one recused himself.

The ruling stated that the reform plan, known as Law 160, ‘substantially diminishes’ the ‘contractual rights of the petitioners in terms of their retirement plan.’

Government affairs law firm Politank, in a note to clients, wrote in more detail about the basis of the Supreme Court ruling:

On Chief Justice Federico Hernández Denton’s last day in office before the mandatory retirement age of 70, the Supreme Court of Puerto Rico, in a 5-3 decision (Justice Feliberti inhibited) declared that part of Law 160 changing retirement benefits teachers contributing to the system before the law was passed is unconstitutional because, although the US and PR Constitution’s ban on laws that impair contractual obligations is not absolute, this law did not comply with the strict standard of being “reasonable and necessary in furtherance of an important government interest”.

The Court declared that eliminating collateral benefits, such as Christmas, summer and medicine bonuses, and a monthly contribution to retirees’ health policies, to all future retirees is constitutional.

Likewise, it found no constitutional deficiencies in the language reducing pensions to all teachers hired after the law was enacted.

Like most legal decisions related to public pensions on the mainland, the Puerto Rico Supreme Court ruled that benefits peripheral to a core pension (i.e. longevity pay, COLAs and payment for retiree health benefits) can be eliminated.

The core issue in the Puerto Rico ruling is that the structure of the pension changes could trigger a wave of retirements among active teachers and cost the government more than the previous structure of the pension plan. More from Politank:

While usually such a decision would have a significant negative effect on the retirement system’s finances, more than one of the 7 opinions issued by all the justices, The Chief Justice and Justice Feliberti excluded, suggest that, as enacted, Law 160 may have had disastrous effects by triggering huge pension payments to 5-15,000 teachers who would prematurely retire to avoid the law’s cuts. Such premature retirements would consume all retirement system assets by 2016, 2018 or 2022, while not legislating would consume all assets by 2020. Several justices stated that the Legislature did not adequately study the legislation’s probable effects.

The Court’s majority stated that the ban of impairment of contracts is not absolute but that especially when the State wants to violate a contract for its own benefit, as in this case, it has to be held to a higher standard and that in this case the State did not adequately prove that Law 160’s provisions solved the problem it addressed and that it had studied all other possible alternatives.

It’s disastrous if a muniland issuer’s pension fund goes broke in 2 to 8 years. The government would face battles over where to dedicate resources. Bondholders would likely face reduced principal and interest payments. The Puerto Rico teachers union has a long history of strikes and political upheaval and it is hard to imagine what would happen when its pension fund runs out of money.

But it’s not clear when Puerto Rico’s pension funds will be exhausted. Politank again:

The Court’s decision may have the effect of actually improving the teacher’s retirement system finances. Left untouched, the law could have accelerated asset depletion from 2020 to 2018 or 2016. At best, it would have ‘kicked the can’ to 2022.

The dissent by now Acting Chief Justice Fiol-Matta, joined by then-Chief Justice Hernández -Denton questions the majority ruling, saying it relies on questionable actuarial studies and a massive retirement of teachers which is possible but has not yet happened.

The parts of the law the Court left untouched will have a positive financial effect, and the language deemed unconstitutional will surely be revisited by the Governor and the Legislature to devise a scheme that will pass constitutional muster.

Standard & Poor’s is withholding judgment for now. Other raters had not weighed in as of press time. Politank again:

Standard & Poor’s Ratings Services said Friday night that it is not taking rating action at this time pending its review of the court’s opinion and the government’s response.  ‘The administration has said that it believes that if the legislation is struck down, it could be changed so as to pass constitutional muster, based on the court’s recent approval of similar government employee pension reform,’ S&P said Friday. ‘If the commonwealth is unable to implement teacher pension reform we believe there could be negative credit implications, which is encompassed in our current outlook on the commonwealth’s general obligation and tax-supported bonds.’

Daniel Hanson of Height Analytics notes that the governor’s plans for near-term budget balance will not likely be impacted by Friday’s decision. But the government has only been making about 26 percent of the required contribution to the teacher’s pension funds, so it is headed for near-term exhaustion, like the Puerto Rico Supreme Court determined in its ruling.

Here is more analysis from Puerto Rico bankruptcy attorney John Mudd.


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Fitch Ratings-New York-15 April 2014: Fitch Ratings believes that the Puerto Rico Supreme Court
decision finding recent reforms of the teachers retirement system unconstitutional presents the
administration with yet another challenge as it works to stabilize the commonwealth’s fiscal position.
Progress on multiple fronts once again has been offset by a new setback. However, Fitch notes that
the ultimate fate of the pension reform efforts remains to be seen and the court decision does not have
an immediate impact on the commonwealth’s budget.
The Supreme Court decision does not trigger any rating action by Fitch. Fitch continues to see
the economy as the key to future rating direction. Fitch believes that achieving and maintaining
budget balance will remain challenging, and last week’s decision, if unaddressed, would add to
that challenge over time and further weaken the commonwealth’s liability picture. However, at
the same time, there have been some positive recent credit developments. The successful sale of
$3.5 billion in general obligation (GO) bonds last month provided some critical breathing room,
overall general fund revenues through March remain in line with projections three-quarters through
the fiscal year, and some recent economic information suggests nascent stabilization. Also, Fitch
notes that the commonwealth was successful last year in reforming the employees retirement system,
which is a bigger burden on the general fund budget, and the Supreme Court quickly validated the
constitutionality of those reforms.
In the coming weeks the governor is expected to release his budget proposal for the fiscal year
beginning July 1, which he has announced will be balanced. The court decision has no direct negative
impact on the near-term budget, but the commonwealth has stated in the past that without reform the
teachers retirement system would confront an annual cash flow deficit beginning in fiscal 2020.
The commonwealth has three main retirement systems, which cover most public sector workers.
The employees retirement system’s defined benefit plans were closed in 2000; since then, all new
employees have been on a defined contribution plan. The teachers system reform was designed
to convert that plan to a defined contribution system, among numerous other changes; the reform
legislation was passed in late December 2013 but stayed by the Supreme Court in January 2014.
Recent pension reform efforts have focused on achieving a predictable annual funding scheme.
Pension funding is expected to remain exceptionally low, even with pension reform.
Fitch’s ‘BB’ rating and Negative Outlook on the commonwealth’s general obligation debt reflects
demonstrated weakness in the Puerto Rico economy, very high liabilities including outstanding debt
and unfunded pensions, challenged though improving financial operations, and limited financial

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Striking down the teacher pension reform is likely to have an impact on the Puerto Rico government’s plans for a balanced fiscal 2015 budget, which García Padilla is slated to present this month and has pledged will not include deficit spending.

http://www.caribbeanbusinesspr.com/news/ pr-bond-yields-up-on-pension-ruling-9593 4.html

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Moody’s: Puerto Rican Court’s Rejection of Teachers Pension Reforms Is Negative for Commonwealth

On April 11, Puerto Rico’s Supreme Court rejected reforms intended to keep the Teachers Retirement System (TRS) from running out of money. Since 2007, TRS has seen its unfunded liability more than double, exceeding $10 billion, and the plan is projected to become insolvent as soon as 2020. The court ruling is a negative development for Puerto
Rico (Ba2 negative), because it reverses steps to address the commonwealth’s severe pension funding pressures.

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