Courts Worsen the Pension Mess

Courts Worsen the Pension Mess

Court cases are creating a perilous standard for addressing the public-pension mess.

In May, Illinois's highest court said the state's constitution forbids even modest changes to the pension system. The next month, New Jersey's supreme court gave Governor Chris Christie carte blanche to refuse to pay into the state's pension funds.

These are two different courts, interpreting the laws of two different states. But if this signifies the approach courts will take elsewhere, it's the worst of all possible worlds. Eliminating options for reform while letting politicians underfund benefits puts workers and taxpayers between the proverbial rock and hard place. Workers may be forced to watch their retirement security go from squeezed to crushed, and taxpayers could be stuck with rising taxes, fewer services, and a weakened local economy.

Two things have to happen. First, leaders need to immediately adopt responsible, workable plans to adequately fund benefit promises, and second, everyone needs to work together to identify the changes necessary to create fair, sustainable pension systems for the future. Unfortunately, courts are encouraging leaders to do the exact opposite.

And the results of inaction are all too predictable.

Chicago illustrates the impact that pension mismanagement can have. In May, Moody's dropped the city's credit rating by two notches to junk status. The ratings agency also left the city on notice for future downgrades if it did not take concrete steps to deal with its looming fiscal crisis.

While Mayor Rahm Emanuel protested the downgrade, there is little disagreement between Moody's and the mayor regarding the city's significant financial challenges. The mayor acknowledged that “Chicago's financial crisis is very real and at our doorsteps.” The primary point of disagreement seems to be the magnitude of the impact Chicago's underfunded pensions will have on the city's finances.

The city's four pension funds currently have less than half the money they need to make good on the retirement benefits public workers have already earned.

The city must contribute a lot more money to keep the funds from running out of cash in the relatively near-term, a circumstance that would result in retirees' relying on direct budgetary payments from the city.

But there are only four levers the city might use to ameliorate the dire situation: tax increases, reductions to public services, changes to future retirement benefits, and restructuring of other debt. And the Illinois supreme court — interpreting a provision of the state constitution that says membership in a public pension program "shall be an enforceable contractual relationship, the benefits of which shall not be diminished or impaired" — recently took one option off the negotiating table, striking down a law that modestly reduced benefits for current workers and retirees. (For example, the law ended automatic cost-of-living increases for retirees and raised retirement ages for current workers.) This severely restricts the city's ability to find a solution without significant impacts on the other three, which of course should worry Chicago's creditors — Moody's primary concern.

So why does the mayor take issue with Moody's? The city may believe it is not on the hook for making pension payments above and beyond what is currently specified in statute. But the legally required contributions for some of the city's funds are so low that, with minimum payments, they will run out of money in relatively short order. Thus, with immediate benefit cuts off the table, the status quo is very likely to persist until the funds simply run out of money.

This could mark the beginning of a worrisome trend for workers. Given that retirement-plan sponsors in many jurisdictions appear to have very little flexibility to negotiate concessions from workers, what happens if sponsors simply force the issue and allow the funds to run out of money? Will the courts force governments to make benefit payments directly from annual budgets?

The tentative answer, at least in New Jersey, appears to be no. The New Jersey supreme court recently ruled that the state's 2011 commitment to adequately fund retirement benefits did not create an enforceable contract with workers, even though a number of members of the legislature have said that was their intent. Shortly thereafter, Governor Christie said flat-out that he would let the pension funds run dry unless workers agreed to concessions. This is political blackmail at its worst, and makes an already-underfunded system all the more precarious for workers.

What's more, it is not clear how this strategy protects taxpayers. In 2014, contributions to New Jersey's pension plans totaled $4.5 billion, but pension benefit payments were $9.4 billion — in other words, annual contributions would need to more than double just to make benefit payments. Even if workers agreed to concessions, it is unlikely that the savings would be enough to cover the immediate cash-flow deficit without service cuts or increased revenue. And ignoring the problem only makes the potential impacts worse.

It is unclear whether courts in other states will take a different tack, but the New Jersey ruling certainly does raise questions about the judiciary's willingness to force policymakers to appropriate dollars specifically for pensions.

The recent court rulings highlight a significant flaw in the structure of our current public retirement systems. The benefits workers earn are not directly connected to annual contributions or investment earnings. And since benefit payments are distant, this creates both the incentive and the opportunity for governments to understate the cost of benefits, systematically undermining the sustainability of the retirement system and in turn the security of the benefits workers have rightly earned.

Unfortunately, those who should be working to protect workers' benefits, including the pension plans themselves and the actuaries they hire, have too often aided governments in this endeavor. All of this should lead workers to ask, "What good is a benefit promise if there is not an equally strong funding commitment to back it up?"

It is time to stop engaging in pension brinksmanship and begin a real discussion about comprehensive reform.

Josh B. McGee is a senior fellow at the Manhattan Institute and vice president of public accountability at the Laura and John Arnold Foundation.

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