"Puerto Rico’s recent financial failures have raised public awareness of underfunded pensions, as well as questions about the federal government’s proper role in pension failures.
Regrettably, the problem is not unique to state governments—with low interest rates, unrealistic benefit promises, and poor funding, pension plans are under intense financial pressure at all levels of government and throughout the private sector.
...Meanwhile, most states and localities have significantly underfunded their pension obligations, and the potential for shortfalls portends state fiscal crises that may elicit demands for federal intervention.
Political sympathy for retirees runs deep on both sides of the aisle, but federal financial intervention in a major pension failure would have a disastrous impact on the federal government’s credit and debt. It would also create a dangerous disincentive for the responsible and prudent administration of pensions at all levels.
Below is a brief overview of recent developments related to failing pensions, the mounting shortfalls faced by the federal government’s PBGC program, and the challenges faced by state pension plans
RECENT DEVELOPMENTS
While early pension challenges have been relatively small, the way in which they are handled sets an important precedent for the exponentially larger pension challenges that lie ahead. Specifically, it is likely that a combination of benefit cuts, premium increases, and better future funding will be necessary to shore up failing pensions. While painful for current beneficiaries of failing pensions, this precedent could help remove expectations for federal bailouts, reinforce the understanding that individual pension plan sponsors are responsible for their own financial solvency, and prompt pension administrators to make the difficult—but critical—decisions necessary to address shortfalls. Further, such a precedent could help PBGC and state and local governments to avoid a large and painful insolvency.
- The Detroit bankruptcy deal. The City of Detroit filed for bankruptcy in 2013 after a series of state-ordered financial reports found that the city was insolvent. The resulting bankruptcy deal set a precedent by allowing a pension sponsor, the City of Detroit, to cut benefits in order to maintain the solvency of the pension plans. Retirees’ pension payments were reduced by 4.5–20 percent.
- The Kline-Miller Multiemployer Pension Reform Act of 2014. The Kline-Miller Act, named for its bipartisan cosponsors, Representatives John Kline (R-MN) and George Miller (D-CA), empowered private multiemployer pension plans to cut benefits to a minimum of 110 percent of what PBGC insures if doing so would avert insolvency (e.g., for 30 years of service, PBGC’s maximum guarantee is $12,870 per year and may be less). The law, prompted by the increasing number of large multiemployer plans facing insolvency, envisioned that multiemployer pension funds would remain self-sufficient rather than relying on government assistance.
- Puerto Rico. The Puerto Rican debt crisis is the result of decades of government profligacy and inadequate pension funding and was ignited by a downgrade of the US territory’s debt to junk status in early 2014. Puerto Rico’s pension system was 96 percent unfunded with a $44 billion shortfall in 2014, according to the US Treasury. In dealing with the tension between government retirees and bond holders, US Treasury Secretary Jack Lew has stated, “We’ve never said that pensions should be made senior to all debt.” Lew prescribed, and Congress legislated, a fiscal oversight board for Puerto Rico with “the discretion to make the trade-off decisions,” including cuts to pension benefits. Read on.
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