Blog: Legal Issues

The Wall Street Journal highlights a lawsuit going before a Minnesota court today that could significantly impact the way teacher pensions are looked at from a legal standpoint. Essentially, the state said it was broke, its teacher pension plan was too generous, and it was going to reduce future benefits, even to current retirees. The Minnesota case is the first of three key tests in the states to determine whether these actions are legal. The graphic below shows what changes other states are making to their pension plans. 

First, if you care about teacher pensions, go read a copy of the Minnesota lawsuit (.pdf). One defendant worked for the City of Duluth for 34 years as a Draftsman before he retired in 2000. The other taught at a Minnesota public school for 14 years before retiring in 2008. These two retirees are part of a potential class-action lawsuit that could include up to 130,000 persons already receiving pensions from the state of Minnesota. The state has chosen not to enroll its public-sector employees in Social Security, meaning they have no other government-provided retirement benefit. To ensure that worker pension benefits do not wear away over time, the state has used a dual-component formula to allocate regular cost-of-living adjustments (COLAs) indexed to the rate of inflation.

In 2009 and 2010, Minnesota decided the COLAs were too generous, and so they reduced them and made them contingent on the plan’s overall funding level. We’re talking about small percentage changes here, but, over time, it adds up to real money.

The state claims its pension fund is broke and it needed to make these changes to ensure the plan’s long-term survival. That claim falls short on several accounts. For one, the state pension plan has never been fully funded and, after one of the worst decades in stock market history, it looks worse than it probably should. Two, Minnesota, like other states, enacted retirement benefit enhancements during the stock market boom of the late 1990s.

Question: What do you get when you add a bad stock market + equally bad state budgets + generous pension benefits + an enhancement of those benefits + rising health costs + an aging workforce?

Answer: A large unfunded liability.

Example A is Pennsylvania, which recently announced they will be increasing the employer contribution rate for retired teacher pension and health benefits in 2010-11 by 72 percent over current levels. The projections into the future are even worse, as the Public School Employees’ Retirement System of Pennsylvania (PSERS) is currently predicting the rate to nearly triple in 2012-13.

The graph below shows a 60 year look, 30 years back and 30 years forward, at employee and employer contributions into PSERS. The blue line is the percentage of salary that the average employee contributes, and it has been pretty steady over time, although it has risen slightly. The red line is the combined contribution of school districts and the state (determined by formula, but the state contributes a little more than half), and it has fluctuated wildly. It was in double digits from 1973 to 1997, hit a low of 1.09 (1.09!!) in 2002, and is expected to reside above 30 percent from 2014 to 2020.

The projections already include an eight percent annual investment gain for the next 30 years, but even after that assumption added to the large employer contributions, the state will still have an unfunded liability of over $7 billion in 2039, in present dollars. To put that in perspective, the state and all its school districts contributed only $617 million last year.

The options to fix this situation are not very appealing, nor are they unique to Pennsylvania. State and local governments could, and probably will, raise taxes. That’s pretty much inevitable, but it’s also politically unpalatable. Because pension benefits are considered a legally binding contract, the state cannot reduce benefits to current employees. So, instead, they’re likely to address the political problem by taking what amounts to mild budgetary solutions and reducing benefits or changing the retirement structures for future employees and requiring higher employee contributions. PSERS could also seek to increase its investment performance (they’ve averaged a 9.25 percent return over the last 25 years), but to do so would require it to take on more risk.