Your Pension: Now Even Less Safe

07/02/2012 9:00 am EST

Focus: RETIREMENT

Terry Savage

Author, The Savage Truth on Money

The next phase of the public pension war is unfolding in a small California city, where retirees are in danger of losing their promised benefits, writes MoneyShow.com personal finance expert Terry Savage.

When I wrote about the coming “Public Pension Wars” a few years ago, the responses ranged from astounded to angry. The very idea that a state or municipality could change pension contribution requirements in the middle of an employee’s career was shocking.

Now we’re about to see the next level of state and municipal pension warfare: changes in benefits for those already retired!

Municipal Bankruptcy
The city of Stockton, California filed for bankruptcy late last week, creating a new challenge to public employee pensions and health-care promises.

Other cities and districts have filed for bankruptcy in the past—notably Orange County, CA, Bridgeport, CT, and Vallejo, CA, along with dozens of others. But not only is Stockton the largest municipal bankruptcy in terms of debt load and population, it appears to be the first one in which the court will be asked to void retiree health care and pension promises.

Cities and municipalities can file for bankruptcy under Chapter 9, which was created during the Depression, when many cities were going broke. It provides for some form of state supervision over the finances of the city or district—a humiliating process. In fact, the city of Detroit is currently caught up in that process and subject to a state-appointed financial advisory board.

In Stockton’s Chapter 9 bankruptcy filing (after a 90-day state mandated mediation), the city said it will eliminate the city’s contribution to retiree health care, along with suspending interest payments to bondholders and making cuts in union contracts. It can do that as part of the bankruptcy process.

But after the filing, the retirees become general creditors, along with bondholders and others. It appears that Stockton will be the first municipality to ask the court to adjust retirees' pension payments.

No Guarantees for Municipalities
When corporations go bankrupt, pension plans become a creditor. Just think back to the United Airlines (UAL) bankruptcy filing in 2002—or the bankruptcies of almost every major airline.

Or remember other headline corporate bankruptcies, including General Motors (GM), Chrysler, Worldcom, Texaco, and the list goes on. What happened to their employee pensions?

The Pension Benefit Guaranty Corporation guarantees corporate pensions—up to a limit. So lower-paid workers are generally made whole on the pension payments. But higher-paid executives and pilots who retired took a big haircut on their monthly payout.

For 2012, the maximum guaranteed amount is $4,653.41 per month ($55,840.92 per year) for workers who begin receiving payments from PBGC at age 65.

But the PBGC does not guarantee state or municipal pension plans!

And that’s the crux of the state and municipal pension wars. State taxpayers have to come up with the money to fund the pensions—at the expense of other state expenditures for things like education, social services, and infrastructure.

I live in Chicago, Illinois. We’ve come a long way in the past few years toward a general understanding that Illinois’ state pensions are shockingly underfunded. Our legislature is still trying to come up with a workable plan that gives older workers security, while providing a realistic way for younger workers to save for retirement.

But every debate has passed the buck—or billions of bucks, literally—to the next meeting of the legislature. No one has mentioned bankruptcy for the state. In fact, that would be unprecedented—although California has come close in the past, even paying its bills in scrip (state-printed paper).

But if in its struggle to maintain state obligations, Illinois were to cut off various forms of funding it sends to cities and other local municipal districts, you could see local bankruptcies across the state.

And if that happened, the municipalities would be subject to state financial control under the Local Government Financial Planning and Supervision Act. That is, the governor would set up a commission to run the finances of the bankrupt municipalities. In other words, a state that could not run its own finances would be sending officials to run city finances!

That is what is at stake in several states in the debate over pension reform. It’s the one huge obligation that looms over the state budget.

And if you keep watching the bankruptcy proceedings of the city of Stockton, it is very likely that for the first time you will see a bankruptcy court cut not only retiree health-care benefits (which are less protected), but actual monthly pension payouts to former employees who are already retired!

That would set a dangerous precedent. And that’s The Savage Truth.