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Can State and Local Pension Promises Be Altered?

The perception is that public employees have much greater protections with respect to their defined-benefit plans than their private-sector counterparts. While the Employee Retirement Income Security Act of 1974 — the governing law in the private sector — protects benefits earned to date, state laws or constitutions prevent public-plan sponsors from reducing future benefits for current employees. Thus, if the employer wants to reduce the future accrual of benefits, such a change can apply only to new hires.

But in a recent blog post, I described how actions taken by plan sponsors have shown that public-sector benefit promises are less secure than one would have thought before the financial crisis.

Plan sponsors have reduced the pension wealth of current employees by increasing required employee contributions so that while the employee continues to accrue the expected benefit, the net contribution from the employer has been reduced. In the case of retirees, sponsors have reduced or suspended cost-of-living adjustments. And these changes have been upheld in a number of courts.

Thus, to the extent that protections exist, they must apply only to “core” benefits. Most states protect core benefits under the U.S. Constitution’s Contract Clause or similar provisions in state constitutions. To determine whether a state action is unconstitutional under the Contract Clause, the courts apply a three-part test. First, they determine whether a contract exists. This process determines when the contract was formed and what it protects. Second, the courts determine whether the state action constitutes a substantial impairment to the contract. If the impairment is deemed substantial, then the court must determine whether the action is justified by an important public pur­pose and if the action taken in the public interest is reasonable and necessary.

The strength of the protections depends on where the protections are located. Constitutional provisions are harder to overcome than statutes or case law. Only three states — Alaska, Illinois and New York — have explicit constitutional provisions that protect future as well as past benefits for current employees. In these states, changing benefits for existing employees is virtually impossible without amending the state constitution. Other states where benefits are protected have statutes that expressly adopt the contract clause theory or judicial decisions that have ruled the relationship to be contractual. Interestingly, for 13 states, the protections apply only once benefits are vested, and eight states protect benefits only once the employee is eligible for retirement.

Two states that protect benefits under the contract clause — New Jersey and Rhode Island — have passed legislation that explicitly reduces core benefits for current employees. These cuts have been challenged, and the cases are currently in the courts. The outcome of these challenges will provide some information on how much freedom states actually have to change future benefits for current employees. The answer may well hinge on whether the court accepts the argument that there is an important public purpose for such changes.

A failure to permit such changes would have serious consequences. First, limiting pension reductions to new workers reduces pension costs only slowly over time. Second, exempting current workers from cuts creates a two-tiered compensa­tion system under which workers doing similar jobs would receive different amounts based solely on when they were hired. Finally, allowing public employees to enjoy greater protections than their private-sector counter­parts is perceived by many as unfair.

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    • Like G. Lee, my husband was a public employee – a high school teacher in Illinois. For 39 years he paid his portion, but the state put their portion into current operating expenses or capital projects. Since the system hasn’t been fully funded for many years, the funds are now woefully inadequate. I agree with those who say the politicians need to be turned out. The only problem is there is rarely anyone new and truly interested in his / her constituency who runs for office, at least in our area. Beyond that, when my husband started working and until the past 10 – 15 years or so, salaries in the private sector were considerably higher than what he and his colleagues were making,taking into account the education and experience level, along with their contributions to society. Remember when new attorneys took in starting salaries greater than what teachers made after 40 years? Now, however, with the current economic crisis, the tables have turned. The Chicago Tribune has printed a series of exposes and I applaud that. What I don’t understand is the claim that retired public employees get free medical insurance. We’ve been paying an average of $1,750 monthly for ours. I don’t know who those other retirees are. Clearly, something must be done and change that starts with new hires will not make a big difference for many years. So that doesn’t seem feasible either. Someone who can think creatively and without bias needs to start contributing ideas to solve this funding / taxing problem.

    • Well, it’s readily apaprent that the Baby Boomers have no problem with devouring their own children (and everyone else’s.)So, I know that I will never receive a pension or social security benefits with anything near the spending power they will enjoy. They will clean the carcass and leave the rest of us with the bones. Has it occurred to anyone else that the Social Welfare State has caused the declining birth rate in the West? I mean, why bear the expense of having children when “the government” will look after you in your old age. Hence, the current demographic disaster. Democracy is nothing more than a tyranny of the majority. The Baby Boomers can still outvote the rest of us because of their sheer numbers. They will vote to steal our money. When they begin to die off and the younger generations outnumber them, they will vote to withdraw the level of benefits now supplied. So, those of us in the middle (Gen Xers) will be doubly screwed. Wewill have to fund those ahead of us and will be denied benefits by those behind us. Has anyone else heard that Social Security recipients are now demanding they also get this recession bailout money?God help us.

    • Everyone assumes that States and Municipalities are in fiscal trouble because of pensions. Shouldn’t we investigate where the tax money actually went, before implementing austerity measures? I suspect that a large amount went to unnecessary redevelopment projects, financed with outlandish bond schemes, which nobody wants to take credit for. Let’s open the books, and start indicting government leaders who made these fiscal problems possible.

    • it is time for the young of our country to grasp the fact that they have no future as long as the government continues to make believe that they will be able to pay the outlandish obligations to state local and federal retired persons. The main difference between us and Greece is the Chinese willingness to hold our dept. If only one party could appeal to this group which has no interest in the rest of the republican social agenda. I assume this maturation of the republicans will take place in 8 yrs. So enjoy your pensions for the time being in 8 yrs the rest of us will be making things more equal.

About Encore

  • Encore examines the changing nature of retirement, from new rules and guidelines for financial security to the shifting identities and priorities of today’s retirees. The blog also explores news that affects retirement, from the Wall Street Journal Digital Network and around the web. Lead bloggers are reporter Catey Hill and senior editor Jeremy Olshan. Other contributors include The Wall Street Journal’s retirement columnists Glenn Ruffenach and Anne Tergesen; the Director for the Center for Retirement Research at Boston College, Alicia Munnell; and the Director of Research for Pinnacle Advisory Group, Michael Kitces, CFP.

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