What Happened?
As unfunded liabilities in public pension systems continue to accumulate, the financial stability of states and municipalities grows weaker. The aftermath of Detroit’s declaration of bankruptcy illustrates the need for reform before taxpayers and public workers suffer the consequences.
What Detroit Taught Us
Detroit has become the poster child for any municipality that can no longer afford annual retirement contributions toward public pensions and must make drastic cuts to public services for taxpayers. When these cuts are not enough:
- Cities face bankruptcy
- More tax dollars are dedicated to pension programs
- Public employee wages and benefits are cut
U.S. Bankruptcy Court Judge Steven Rhodes ruled that public employee pensions could be cut in Chapter 9 bankruptcy cases. This set a new precedent that allows municipalities to file for and then exit bankruptcy at the expense of public employee retirement benefits.
Detroit’s approved plan of adjustment for exiting bankruptcy is a tight two-year budget that significantly reduced retiree benefits. The plan calls for Detroit’s $18 billion in debt and liabilities to be reduced by $7 billion in bankruptcy, 80 percent of which will be the result of reduced retirement benefits. Healthcare cuts alone will lower the city’s debt by $4 million. Reductions in annual cost of living increases will generate more than $1.3 billion in lowered debt, while $190 million will be recouped from alleged interest overpayments into annuity savings accounts, Labor Notes reported.
Because so many other municipalities are not far from bankruptcy, a version of this plan of adjustment may be implemented elsewhere if reforms are not passed.
Other Options
Forbes recently laid out an alternative model for municipal pension systems that provide public employees with a choice when selecting retirement benefits. Workers can either stick with existing government-run pension systems or “cash out.”
The alternative option has public workers and retirees receive their share of the funded portion of their pension obligation. The cash would be transferred into a personal 401(k)-style account and cut ties with the previous pension fund, thus eliminating future obligations. Each employee’s share would be determined by inputting specific data into a formula including:
- Length of service
- Employee class
- Salary history
Based on how much they would receive, employees and retirees could choose to cash out or stay in the pension system. Workers who opt out would be enrolled in an ongoing defined contributions plan similar to those used in the private sector. When a worker would opt out of the pension system, the unfunded liability and municipal contribution obligation would be reduced, Forbes explained.
In fact, an informal poll of public employees in San Diego revealed many workers and union leaders would prefer to have the conversion option available so those interested to could opt out of a government-run pension system. Some union leaders explained the option to opt out would help municipal finances stabilize faster in the long term, which would reduce debt and enable future public employee new hires, Forbes reported.
Pensions On The Brain
Gov1 has reported on a growing number of unions recognizing a need for pension reform which has allowed municipalities to implement necessary changes to avoid bankruptcy.