The sky is not falling: Chapter 9 can help rescue and secure state and local pensions
Sen. Mitch McConnell’s (R-Ky.) April 22 comments on the Hugh Hewitt radio show about “allowing states to use the bankruptcy route” generated a firestorm of reactions, ranging from New York’s Gov. Andrew Cuomo declaring it “one of the really dumb ideas of all time” to Maryland’s Gov. Larry Hogan saying “I think it just slipped out.”
If political leaders can set aside the heated rhetoric, there’s an opportunity to put troubled pension plans on a sound footing, thereby saving those plans for public employees and retirees while also helping to stabilize state and local finances.
Two years ago, along with Andrew Silton (an attorney), Mary Pat Campbell (an actuary) and the late Jim Spiotto (perhaps the country’s leading Chapter 9 bankruptcy expert) we published an article titled “Embracing Shared Risk and Chapter 9 to Create Sustainable Public Pensions,” in which we discussed how states and local governments could transition their underfunded public pension plans into a more secure and sustainable solution through the use of pre-packaged Chapter 9 Plans of Debt Adjustment. We focused on the New Brunswick Public Service Shared Risk Plan, although laudable elements of risk-sharing also exist in plans like the Wisconsin Retirement System, the Pension Fund of the Christian Church (Disciples of Christ), and the Board of Pensions of the Presbyterian Church (U.S.A.).
Let’s examine the meaningful reforms in New Brunswick, which transitioned to a shared risk plan on Jan. 1, 2014. To properly account for its pension liabilities, New Brunswick decreased its discount rate used to calculate liabilities from 6.25 percent to 4.75 percent.
To offset the more realistic estimate of its liability, New Brunswick implemented a series of reforms: (1) transitioning to a career average benefit formula from an end-of-career formula (that most American public plans still use); (2) eliminating automatic inflation adjustments in favor of indexing benefit payments based on pension funding status and market performance; and (3) transitioning to longer working careers for retirement eligibility. These three steps combined more than compensated for the increased liabilities created by the change in discount rate.
How has New Brunswick fared over the past 6+ years? The spring newsletter indicates that their investment return for 2019 was 11.65 percent, which means that the fair value of their assets was up some $715 million from the previous year end. At the end of 2018, their annual reports stated the Termination Value Funded Ratio and the 15-Year Open Group Funded Ratio, two critical indicators of financial health, stood at 108.0 percent and 125.8 percent, respectively.
The Open Group Funded Ratio is critical to the functioning of the plan. It takes the present value of the “excess” contributions (above the normal cost of 11.51 percent), discounted at the same 4.75 percent the plan uses to calculate liabilities. Given the increase in asset value for 2019, it’s easy to estimate that the Open Group Funded Ratio was well above 130 percent at the beginning of 2020. That’s enough to keep paying cost-of-living adjustments (COLA’s).
No American public pension plan can claim that level of funding, but the Wisconsin Retirement System comes close. The Wisconsin Retirement System has published performance results through March 31, 2020, showing declines of 11.6 percent in the Core Fund and 21.8 percent in the Variable Fund (which about 15 percent of retirees use). They reported that overall assets were about $101 billion. Both funds had very strong performance in 2019. Assuming that liabilities did not soar in 2019, the plan should still be about 100 percent funded, even after the sharp market losses in March.
Wisconsin has many features in its retirement system that should be emulated elsewhere, including a realistic discount rate of 5.4 percent.
So, how does Chapter 9 help get us to this better place?
With the freefall in tax collections — property, sales, hotel occupancy, and income taxes — virtually every local government potentially can meet the “insolvency” criteria for filing a Plan of Debt Adjustment under Chapter 9. About half the states have authorized such filings.
But here’s the key part of Chapter 9 that’s different from other bankruptcy proceedings: These filings have to be voluntary, and the bankruptcy judge can’t “cram down” any plan without the consent of at least one group of impaired creditors, who have to vote in favor of that impairment with a majority by number and two-thirds (2/3) by amount of the claims voted.
So, picture a local government Plan of Debt Adjustment that proposes to create a shared risk plan along the lines of New Brunswick, perhaps with some Wisconsin elements thrown in.
Here is what Congress could do immediately to improve matters.
After carefully evaluating the requests by governors for $500 billion in relief and by counties, cities and mayors for another $250 billion, Congress should condition such relief aid on the commitment by states to transition their local government employees to a shared risk plan that can become fully funded (or better) within no more than 25 years (even shorter for better funded States). Alternatively, the relief should be given in the form of loans, which convert into grants when the transition is completed, along with secure funding streams.
Second, Congress should amend Chapter 9 to exclude this relief aid from being considered as part of the cash flow and insolvency analysis that each local government must present with its filing.
Third, Congress should strongly emphasize pre-petition negotiations under 11 U.S.C. § 109(c)(5)(A) as a means to secure the approvals contemplated under 11 U.S.C. § 1126(c) by at least one class of creditors whose interests are impaired by the Plan of Debt Adjustment.
Fourth, Congress should amend 11 U.S.C. § 109(c) to permit States to employ Chapter 9 for the limited purpose to transitioning their state employees to a shared risk pension environment; alternatively, Congress could borrow Jim Spiotto’s ideas of creating a special federal bankruptcy court for public pensions or a Public Pension Funding Authority.
Fifth, Congress should permit joint governmental filings with combined classes of current employees, inactive employees and retirees when a single current plan is involved or when consolidation of smaller plans is contemplated.
Without these changes, America’s public pension plans will sink even deeper into the quagmire, an unfunded debt that the Federal Reserve estimated at about $4 trillion at the end of 2017.
Risk sharing is the way of the future. It does not place all the risk on the individual (like a 401(k)) or on the taxpayer (like public pensions). Risk sharing is fair, secure and sustainable.
W. Gordon Hamlin, Jr. is a retired lawyer now residing in Tuscumbia, Ala. He is president of Pro Bono Public Pensions, a non-profit which seeks to create fair, secure, and sustainable public pension solutions. A 1978 graduate of Harvard Law School, Mr. Hamlin practiced with a large Atlanta law firm for over 32 years, and was a 2016 Fellow in Harvard’s Advanced Leadership Initiative.