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Pension Benefits For Current Employees Could Face Legal Challenges

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For government workers who've toiled for decades, some pension promises aren't as ironclad as they seem.

As local governments scramble to cut costs to fill massive holes in their budgets, current workers' promised future benefits -- which don't have explicit constitutional protection in some states -- could be vulnerable.

Proposals to shrink benefits have so far focused mostly on new hires, treating current workers as immune. But, as Joshua Rauh, a professor at Northwestern University's Kellogg School of Management, told HuffPost, there's a legal "gray area." While nearly all state constitutions explicitly guarantee benefits accrued from work already completed, the status of future benefits -- benefits promised to current employees in exchange for future work -- is less certain. And lawmakers are looking for ways to cut costs.

"The assets that the cities have don't come anywhere near generating the benefit payments that are being made now and the projected payments over the next decade," Robert Novy-Marx, a professor at the University of Rochester's Simon School of Business, told HuffPost. "As it is now, if people just keep business as usual, the number we have is going to get worse."

For government employees, the promise of retirement benefits is sacred. Even when cities declare bankruptcy, as Vallejo, Calif., did in 2008, the benefits get paid. In the decades leading up to the recent financial crisis, public pension plans became steadily more generous. In 2007, government pensioners earned an average of $3.04 an hour, compared to $0.92 an hour for their private sector counterparts.

But the financial crisis has dealt a blow to the system. From the end of 2007 through the beginning of 2009, state and local government pension funds lost a combined $835 billion or 29 percent of their value. The Dow, during that period, dropped about 46 percent. The funds had piled their money into risky investments, both to pursue higher returns and, they say, to diversify their portfolios. But those expected returns, of around 8 percent, that they took for granted -- and still take for granted -- didn't materialize.

Compounding that problem was the fact that many governments chose to delay paying their pension obligations, racking up "off-balance-sheet" debt, as they expected the good times to last. A study released this week, authored by professors Novy-Marx and Rauh, calculates the total value of municipalities' unfunded pension promises to be $574 billion -- in addition to the roughly $3 trillion that states have promised to pay. And that's not even counting the future benefits promised to current employees.

Governments, like workers, have mostly treated pension promises for current employees as unbreakable. Ronald Snell, director of the state services division for the National Conference of State Legislatures, wrote in a July report that "More states have enacted significant retirement legislation in 2010 than in any other year in memory," but, as his October report demonstrates, the vast majority of that legislation concerns plans for new hires. When New York City Mayor Michael Bloomberg spoke last week about cuts to pension benefits, he discussed only future employees' plans. Current employees and retirees, for the most part, have been shielded.

But current employees aren't as protected as the last few decades have made it seem. As Rauh explained, the promise of future benefits doesn't receive explicit constitutional backing in all states. Governments won't inflict retroactive cutbacks, but they could, in some cases, try to inflict freezes or increase the amount an employee has to contribute to a retirement plan.

"Are you allowed to say, 'You know what, you've earned the right to a pension based on, say, 10 years of work, because you're 45 years old and you've worked for the city for ten years, but we're going to stop it at that, and going forward we're going to open a 401(k) plan for you, and you're going to be paying into that'?" Rauh said. "That is a legally very contentious matter."

The strength of protection for municipal pension benefits depends on the particular state's constitution. The constitutions of seven states -- New York, Illinois, Louisiana, Michigan, Alaska, Arizona and Hawaii -- say pension benefits cannot be "diminished or impaired." That wording, Rauh said, is fairly airtight, and in those seven states, any challenges to benefits for current employees are likely to be struck down.

Still, even in those states, ambiguities remain. It is unclear, for example, if workers are owed benefits for work they haven't yet done: The "diminished or impaired" clause arguably could apply only to benefits for work already completed, Rauh said.

Other state constitutions, where wording is less forceful, leave benefit protections relatively open to interpretation. A study released in March, authored by University of Minnesota professor Amy Monahan, compares the pension legalese in a variety of state constitutions. In at least two states, Indiana and Texas, pensions are called "gratuities." The Indiana Court of Appeals has called pensions "mere gratuities springing from the appreciation and graciousness of the state."

Rauh called those states "outliers," and Monahan notes in the study that 2009 Texas pension legislation didn't touch current employee benefits. Where pensions don't have full and explicit constitutional protection, governments often protect them. But as municipalities look to balance their budgets, these conventional protections could be tested.

"In a lot of states the question is open to judicial review," Snell, the NCSL state services division director, told HuffPost. "They are certainly open to judicial review, of which there has not been a lot over the years, and certainly not comprehensive in most states."

Retirees in Colorado, Minnesota and South Dakota are currently suing those states, which have passed laws that trim the benefits for current pensioners. State lawmakers have reduced pensions funds' annual cost of living adjustments, reducing the amount of money owed to retirees on pension plans. Meredith Williams, chief executive of the Colorado Public Employees' Retirement Association, a Colorado pension fund, told the Wall Street Journal that cuts to new hires' benefits simply weren't enough to address budget shortfalls, and the state had to turn its knife on current pensioners' plans.

"They're watching those court battles in Minnesota very closely, as all of us are," Gregory Floyd, president of the Teamsters Local 237 union, told HuffPost, referring to New York lawmakers. "They would use this as an excuse to try it [to alter benefits for current pensioners.]"

Floyd, who sits on the board of the New York City Employees Retirement System, the city's largest pension fund, and whose union, Local 237, is, according to its website, the largest local division of the International Brotherhood of Teamsters, said the city's budget problems, and the generosity of pension benefits, have been exaggerated. Lawmakers, he said, are just looking for an excuse to trim benefits.

"They're starting to attack us now. The steady drumbeat. Municipal workers making too much money, costing too much -- I've read at least five or six articles in the last week all saying the same thing," he said. "And not only existing employees. What about retirees right now? What about their benefits? They may be looking to cut those too."

Steven Kreisberg, director of collective bargaining for the American Federation of State, County and Municipal Employees, was similarly skeptical about the need to reform pension plans. "I think that this is a real challenge. But it's a challenge that can be managed," he told HuffPost.

Still, he said that changes will come in the future, for new hires. "We're going to see an increase in pension fund contributions, both from employees and from employers," he said.

Floyd, for his part, said he thinks "Wall Street" should foot the bill. "The truth is municipal workers are not the cause of this crisis," he said. "And municipal workers are not the solution."

But Snell took a different view. "I think there's a growing realization among public employees that, happy or not, this is a problem of such magnitude that they have to be part of the solution," he said.

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