Honor vs. obligation

Every public employee union and pension fund in the nation is on edge.

The question gnawing at them over the past few days? Who might prevail in the Detroit bankruptcy? The bondholders or pensioners?

It’s a question for the courts to now decide, including very possibly the U.S. Supreme Court.

Michigan AFL-CIO President Karla Swift is, as we’d expect, rooting for the 30,000 current and retired workers who contend their pensions are protected by the state constitution.

“Unpaid pensions mean less money circulating in the local economy, making communities less livable. The reasonable expectations of these workers are in tune with the best interests of the larger community. We can hardly afford to drain the city and Metro Detroit of future financial vitality,” she wrote in a Detroit News guest opinion piece.

There’s some logic in that line of reasoning, no doubt.

But these are largely uncharted legal waters; no court has yet had to decide on the questions facing Detroit. As the Los Angeles Times reported last week, San Bernardino is still trying to make its argument that it’s even eligible for bankruptcy. In Stockton, the question of pensions is expected to be a key piece of the proceedings as the city moves forward with its plan in September.

"Truth be told, we know nothing," Karol Denniston, a San Francisco-based attorney who specializes in municipal bankruptcy, told the newspaper. "We know that under bankruptcy code there's an ability to impair creditors, but whether or not that extends to pension obligations — there is no answer."

In Detroit the underfunded pension liability has been estimated at $3.5 billion.

Nationally, the problem is much bigger. In fiscal 2010, the gap between states' assets and their obligations for public-sector retirement benefits was $1.38 trillion, up nearly 9 percent from 2009, according to the most recent figures available from the Pew Charitable Trusts.

Clearly, whatever it might take to close these gaps, there’ll be plenty of pain all around.

It’s hard, when we’re in the middle of a crisis, to try to peer ahead and think about how to avoid the problem from recurring. Detroit’s bankruptcy wasn’t really any surprise, given its decades of decline. But there is a fairly simple way for other cities and states to put their pension obligations in the proper light and perhaps avert a trip to bankruptcy court.

States and cities have historically calculated the value of their pension liabilities based on the returns they expect from investing pension assets. And on average, these governments assume an unrealistically high 8 percent annual return on pension investments while the actual rate should be closer to the yield of 15-year Treasury bonds – say, 3.5 percent.

In contrast, private pension plans are required to use the market value of their investments.

There are plenty of other good ideas on pension reform at the moment, some of which are contained in Orin Hatch's sweeping public and private pension reform bill -- the Secure Annuities for Employee Retirement Act of 2013.

As we reported on this site last week, the legislation would effectively allow states to turn over pension plans from local governments to insurance companies using fixed-annuity contracts.

On its own, that might not be the perfect solution, but it has to be better than what we’re seeing in Detroit.

About the Author
Allen Greenberg

Allen Greenberg

Allen Greenberg is the retirement industry news editor at BenefitsPro.com. Follow him via Twitter @AllenGreenberg. Email him at agreenberg@benefitspro.com or call 720-895-3965.


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