Pensions and Promises
A pension war is brewing and it’s likely to pit state and municipal employees against citizens who foot the bill for government pension plans with their state tax dollars. While employees of most companies have watched their 40l(k) plans — and their retirement hopes — shrivel in the bear market, public employees have been smiling.
They’ve been promised lucrative pensions, increased over the years as cities and states negotiated labor contracts. Now those public employees are about to find out that they are not immune from the ravages of the stock market.
The Center for Retirement Research at Boston College estimates that state pension plans have losses greater than $865 billion, a loss of nearly 40 percent in just the past year. Add those current losses to the fact that many municipalities have gotten away with underfunding those pension plans for years and you have trouble brewing. Now the double whammy of stock market decline and lower tax revenues in this recession is causing state and local governments to take a second look at how they will fund those promises.
The options are few. Tax hikes, whether income or property or sales tax increases, will be hard to pass in this economic slowdown, as well as counterproductive. Will voters stand for cutbacks in services? Will cities ask public employees to make up the gap with a combination of benefit cutbacks and/or increased plan contributions? All of those choices are political dynamite.
The National Bureau of Economic Research says the value of pension promises already made by U.S. state governments will grow to approximately $7.9 trillion in just 15 years and forecasts that states are unlikely to be able to keep those promises. “We conservatively predict a 50 percent chance of aggregate underfunding greater than $750 billion and a 25 percent chance of at least $1.75 trillion in underfunding,” it says. That adds up to a huge gap. According to the bureau, “insuring taxpayers against funding deficits and plan participants against benefit reductions would cost almost $2 trillion today.”
The looming issue of state and local pension deficits has been buried by our national financial issues and by state politics. One Web site, www.pensiontsunami.com, is tracking the pileup. It began as a watchdog for California pension issues and now covers state budget and pension deficits nationwide.
The magnitude of the state pension shortfall has been hidden by accounting rules that allow pension liabilities to be discounted based on the “expected rate of return.” Obviously, the higher the expected return is set, the lower the current pension contributions required. Given recent returns, most pension plans will be even more underfunded when they report on assets in the coming months. Pension accounting rules add to the problem. The riskier the assets in the pension plan (stocks are considered riskier than bonds), the higher the anticipated return they can use to make the plans look solvent. That encouraged many plans to become overweight in equities in the past few years.
While the federal government can “print” money to pay its retirement obligations, including Social Security benefits, municipalities can only borrow the money by raising taxes, selling bonds and other IOUs, or by selling assets. It’s not a good market for any of those solutions. When companies go bankrupt, the Pension Benefit Guaranty Corp. steps in to cover most defined-benefit pension promises. But the PBGC does “not” cover municipal or state retirement plans.
The little-known Chapter 9 of the Bankruptcy Code allows cities to reorganize and renegotiate all contracts and promises. Chicago attorney James Spiotto says the law can be murky. “There are varying levels of protection, ranging from strict constitutional rights to general statutory provisions, that might allow for some renegotiation of benefit levels in light of adverse conditions affecting the pension fund,” he says.
In other words, if a government body attempts to renege on pension promise, there will be a huge court battle.