Public Pension Plan Problems

Amy B. Monahan, Public Pension Plan Reform: The Legal Framework, 5 Educ., Fin. & Policy 617 (2010).

One of the more noticeable effects of the on-going global financial crisis is the increased attention being paid to the amount of money being spent by state governments on public pension plans. Unlike private sector pension plans, which are governed by the federal Employee Retirement Income Security Act of 1974 (ERISA), public pensions are instead covered by a vast array of complex state laws and regulations.  So while most people are pointing out that something must be done about the burgeoning public pension funding deficits, many have been stymied about how to undertake the amendment of these plans in a legal fashion.

Part of the problem is that states have adopted different legal theories to protect public pension rights. To some states, pension rights are property rights, while in other states, pension rights are contractual in nature.  Still a few states adhere to the traditional approach and see public pensions as mere gratuities.  In any event, and as many states have found out much to their dismay, the business of amending a public pension plan is a tricky one, filled with legal minefields. Just ask the states of Colorado, Minnesota, and South Dakota, which have been all sued after seeking to reduce the annual cost-of-living- adjustment (COLA) for current retirees.

All this chaos in the public pension plan world requires some ordering principles. At least as far as organizing states’ various legal approaches to public pension plans, Amy Monahan’s paper, Public Pension Plan Reform: The Legal Framework, does exactly that.  Understanding that many states are either currently going through a process, or contemplating a process, to amend their public pension plans to save money in these difficult economic times, Monahan first explains the difference between private pension plans and public pension plans, and then effectively explains the primary legal approaches states have taken to protect public employee pension rights.

As Monahan points out, regardless of which legal theory a state has adopted to protect pension rights, most state pension plans in the United States have done a poor job securing the retirement security of its public employees.  More specifically, because “each state’s law is responsible for setting the applicable limits on changes to its own public pension plans,”  these “approaches are generally far less clear than the federal approach, often provide less flexibility, and are often administratively unwieldy.” (P. 619)

Monahan does an excellent job surveying the typical approaches to amending public pension plans and pointing out many of the problems with these approaches, especially in financially difficult times.  For example, where states treat their pension promises as contracts, she discusses federal and state constitutional contract clause challenges when states seek to amend their state pension plans. She points out, quite rightly, that such states are subject to these constitutional challenges because pension changes tend to cause a substantial impairment of the contract without being able to show that it was reasonable and necessary to an important public purpose (i.e., saving money alone has not been deemed an important public purpose).  The upshot is that it is very difficult for states with pensions based on contractual theories to reform their public pension plans even when the need to do so is obvious and dire. On the other hand, public employee’s pension rights are protected too little where states have adopted property theories because challenges to pension reforms based on the Takings Clause or based on substantive and procedural due process have generally proved to be unsuccessful.

Although a few previous articles have discussed legal issues surrounding public pension reform, what sets Monahan’s article apart is its comprehensiveness, clarity, and innovation in setting out new suggestions for reform.  More precisely, Monahan suggests that a specific version of the contract approach be adopted by states.  Identifying the problem with current contract-based approaches as being the lack of a definite time period, she maintains that states should find “a contract to exist but specify[ ] that the contract is formed on an ongoing basis as services are performed.” (P. 642)  The advantage of this approach is that it allows either side to modify the terms of the contract and makes future pension reform possible.  In other words, pension plan participants would be protected in already accrued benefits, but public employers would have more flexibility in changing the future rate of benefit accrual.   Monahan’s overall point is that, “advocates for reform [should] . . . argue for jurisprudential changes based on changing conditions.  Public sector plans have not kept pace with the market as a whole, in large part because state jurisprudence has fixed such plans in time.” (P. 646).

Although I believe Monahan’s paper to be an indispensable read for anyone contemplating the legal problems surrounding the amendment of public pension plans, I do have some minor criticisms.  First, some states, like Wisconsin, have adopted more than one type of legal theory upon which to base their public pension plans. Some case law in Wisconsin recognizes the contractual basis of pension rights, while other cases focus on pension rights as property rights.  Does such a hybrid approach do a better job of protecting accrued pension rights while at the same time providing public employers the needed flexibility to amend plans in difficult financial times?

Second, I would have liked more discussion about whether public pension plans should switch from a defined benefit approach to a defined contribution approach as part of the solution to the larger problem of underfunded public pension plans.  A high percentage of private-sector pension plans are now defined contribution plans, meaning that employers are generally not responsible for having sufficient funds on hand when employees retire. These employers simply make a one-time contribution and there are no subsequent pension funding responsibilities. On the other hand, because most public pension plans are defined benefit plans, employers are responsible for maintaining the financial health and actuarial soundness of these plans so that sufficient funds exist to pay their employees pensions during their retirements.  For instance, would a shift to defined contribution plans in the public sector solve the financial issues without undermining the “significant labor market effects [of] influencing who enters public service and how long they remain employed[?]” (P. 618)

Nevertheless, with these additional ideas for extending the reach of this article placed to one side, Monahan acquits herself exceedingly well in reviewing this complex, and often neglected, regulatory landscape.  Additionally, we certainly concur in believing that the time is well past nigh “for state courts to revisit their public pension plan jurisprudence.” (P. 646)

 
 
Discussion

1 comment
  1. 1

    I’d like to offer some additional facts and resources for you to consider — as well as a reference to other legal documents — which includes Ms. Monahan’s 2010 paper ( http://wikipension.com/index.php?title=Legal):

    – On average, state and local government spending on public pensions is only 3% of total spending: http://www.nasra.org/resources/NASRACostsBrief1202.pdf

    – From 2010-2011, 41 states have enacted changes to their pension systems: http://www.ncsl.org/documents/employ/2011EnactmentsFinalReport.pdf

    – Converting from defined benefit to defined contributions does not save money; in fact, the efficiencies of pension enable them to deliver the same retirement income at 46% lower cost than an individual defined contribution account: http://www.nirsonline.org/index.php?option=com_content&task=view&id=121&Itemid=48 (see also state-specific: http://wikipension.com/index.php?title=Costs_of_Switching_From_a_DB_to_a_DC_Plan)