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Sharpening the battle axes

This month governors in two financially troubled states released the details of their pension reform plans. Both would take a swipe at current employees’ future benefits. In New Jersey, Gov. Chris Christie unveiled his new pension reform plan just one day after a state court struck down his attempts to reduce state contributions to public employee pensions. Developed by Christie’s Pension and Health Benefit Study Commission, the proposed reform would freeze the current defined benefit plans and shift active employees to a new cash balance defined benefit plan. (In cash balance plans, employers guarantee a minimum rate of return to the retiree, though the payout is likely to yield lower yearly returns than a traditional pension plan.)

Christie’s plan would also decrease employee health benefits and increase employee contributions to reduce employers’ current and post-retirement costs. It would also shift the cost of teachers’ health benefits and new pension benefits to local school districts. Such costs are currently met by the state. That shift will be a key hurdle to gaining support for the proposal, notes a Feb. 26 analysis by Moody’s Investors Service, because the state is asking local governments to take on more debt. Additionally, of all the pension funds managed by the state, the only one that’s remotely healthy is the local government fund. That's because localities have actually been paying their required contributions. The state employee fund and the state teachers fund are both less than 50 percent funded.

Meanwhile, Illinois Gov. Bruce Rauner is also seeking to slash current employees’ retirement benefits in an effort to close his state’s continual budget gaps. A previous pension reform, which cuts benefits already accrued by employees, is tied up in a legal battle. Rauner’s proposal would allow current employees to keep the pensions they've already earned but future benefits would be less generous. The move would save an estimated $2.2 billion in 2016 alone. His plan to overhaul the employee health program would also pare down the 2016 general fund expenses by about $700 million. But Moody’s said “the ability to realize these savings is doubtful, however, given the hurdles to enactment and legal challenges to the new reforms that would almost certainly delay their implementation.”

The new governor’s proposal also includes a voter referendum clarifying that the state’s constitutional public pension benefit protection clause applies neither to future accruals nor to health insurance. Currently, Illinois has what many consider the strongest constitutional protections for public employee benefits, which is why it’s been so hard for prior administrations to make major financial change the retirement system.

Food for thought

If all these glitzy pension ideas fail, struggling governors could take a glance at a Center for State and Local Government Excellence (SLGE) report released this week that detailed common strategies employed by well-funded pension plans. Not shockingly, the plans all shared a commitment to fund the actuarially determined contribution in both good and bad financial times; conservative, realistic assumptions that are adjusted based on experience; and changes to benefit levels and contribution rates as needed. SLGE looked at four plans: the Delaware Public Employees’ Retirement System, the Illinois Municipal Retirement Fund (this one is under different management than the state’s troubled systems), the Iowa Public Employees’ Retirement System and the North Carolina Retirement Systems.

Trouble in Chicago

Chicago Mayor Rahm Emanuel will have to work a little harder than expected this spring to keep his job. He failed to get more than 50 percent of the vote in this week’s election, and must face a runoff against second-place finisher Jesus "Chuy" Garcia in April.

The result was a surprise but what does it have to do with public finance? (Other than possibly another guy running the show?) Standard & Poor's Ratings Services said the election could delay a crucial $600 million pension contribution plan for the police and fire departments in the city's upcoming 2016 budget. This "puts into question a plan the city has been working on for the past four years and will mean the next administration will need to determine how to fit this cost into its budget in less than a year,” the ratings agency warned.

S&P said it will be keeping a close watch on how the city handles this short-term pension obligation plus “how the next administration will address long-term pension issues that have been weighing on the city's credit standing.” The uncertainty of how this issue will be addressed prevents the city's credit outlook from being stable at this point.

Under Emanuel, the city has tried to address its longer-term pension liabilities by restructuring two of its four existing pension plans for non-police and fire employees. Some of the affected employee unions are (no surprise) challenging the reforms in court. It’s hard to overstate how much of a burden Chicago’s retirement obligations have become. Currently, the city currently only contributes 26 percent of its annual required pension contribution (ARC) for its four plans. Underpayment, as we know, contributes to increases in the unfunded liability. Still, that current payment represents 7 percent of Chicago’s total governmental funds expenditures. If the city were paying down these liabilities with the full ARC payment today, the contributions would represent a whopping 27 percent of total governmental funds expenditures. The national average for big cities is around 12 percent.