Stockton bankruptcy case could test security of public pensions

Published Saturday, Sep. 08, 2012 - The Sacramento Bee

Going to work for the government has always come with an ironclad promise: Your pension benefits will be there when you retire.

It's a level of security not found in the private sector, and it's a big reason that government jobs are so prized in Sacramento.

Now, however, the city of Stockton's bankruptcy case and the financial problems of other cities are testing whether that promise can be broken.

Legal battles over this question loom even though the Legislature just approved an overhaul of public retirement plans throughout California. Lawmakers trimmed billions in pension benefits, but mainly at the expense of future workers rather than those already on the payroll.

The debate is about to reach a whole new level.

In Stockton, two bond-insurance companies, in danger of losing millions of dollars in the bankruptcy filing, have launched an assault against the city's pension system. They're demanding that city tax dollars earmarked for CalPERS, the state's massive public pension system, go to them instead – even if it means scaling back retirement benefits for current employees and those who already have retired.

In San Jose and San Diego, voters have taken matters into their own hands, passing ballot initiatives curtailing pension benefits for current and future municipal employees. Unions are suing to overturn the initiatives.

If benefits for current workers and retirees get reduced, it would shatter decades of conventional wisdom, backed by the courts, about the sanctity of public pensions.

"The clear precedent in California is that public employee pensions are guaranteed. Once you enter employment, the retirement benefit cannot be changed," said Amy Monahan, a pension law expert at the University of Minnesota.

The biggest test of that theory is in Stockton, which filed for Chapter 9 municipal bankruptcy protection June 28 after concluding it couldn't pay its bills.

Contracts routinely get severed in bankruptcy. Corporations have used bankruptcy to cancel their pensions. But few municipal governments have ever filed for bankruptcy, and until now, no one's ever tried to use bankruptcy to erase the pension promise made to a government worker.

"It's always been sacrosanct in California, and it may prove to be," said Rick Roeder, a pension consultant in La Mesa. "But it may be trumped by federal bankruptcy law."

Standing against the insurance companies are Stockton city officials, who say municipal employees have suffered enough through pay cuts and layoffs, and CalPERS itself.

The powerful California Public Employees' Retirement System, the nation's largest public pension system, runs the retirement program for 1.6 million Californians. It gets $29 million a year in pension contributions from Stockton and stands ready to keep things the way they are.

In a prepared statement, CalPERS cited the U.S. and state constitutions and other legal authorities as safeguards against raiding the pension fund's cash flow. Simply put, CalPERS argues Stockton must continue paying into the fund, even if has to stiff other creditors.

"It is surprising that sophisticated Wall Street firms, which are in the business of underwriting and insuring municipal bonds, were not aware of the priority rights of CalPERS and its members when they evaluated the ability of Stockton to repay hundreds of millions of dollars in bond debt," CalPERS said.

Insurers fight back

Back when the economy was booming, Stockton went on a spending spree. It issued tens of millions of dollars in bonds to build amenities such as a marina and a baseball stadium. It even borrowed $125 million, ironically, to help pay its obligations to CalPERS.

To make the bonds marketable, the city purchased bond insurance. Investors could buy the bonds with confidence, knowing they'd get paid by the insurers if something went wrong.

Now, with the bankruptcy filing, the city has declared it won't honor much of its bond debt, leaving the insurance companies holding the bag. Two of the big ones – National Public Finance Guarantee Corp. of New York and Assured Guaranty Corp. of Bermuda – are fighting back.

Assured and National Public, in papers filed in U.S. Bankruptcy Court in Sacramento, said the city should pay them instead of feeding CalPERS.

"The city never asked for a single dollar in reduction of its liability to CalPERS," National Public complained in a court filing last month. The company would lose $30 million under the city's bankruptcy plan.

What would happen if the insurers win and the money to CalPERS is cut off? The Stockton pension plans could be terminated. The money already contributed by the city over the years would be put in a special CalPERS fund. Stockton wouldn't contribute any more money, and the pensions would depend entirely on how well CalPERS invests the existing pool of money.

It's likely the pension benefits would be reduced.

Not long ago, few dared to raise the idea that governments could cut employee pensions. After Vallejo filed for bankruptcy protection in 2008, the city briefly considered doing so. Then CalPERS filed a legal brief warning that pensions "are constitutionally protected," and the city backed off.

"CalPERS scared them away," said David Skeel, a pension expert at the University of Pennsylvania law school.

In the Stockton case, however, experts say the insurers won't shy away from a fight with CalPERS.

"You've got some large companies involved with a lot at risk who are willing to pay lawyers' fees. You've mobilized a potent adversary," Roeder said.

More challenges could emerge as local governments grapple with fiscal crises. San Bernardino also has filed for bankruptcy protection, although so far no one has suggested cutting pensions there.

Current workers on alert

Until recently, tackling public pensions meant reducing benefits for newly hired workers only. The plan approved by the Legislature in late August gets most of its savings by pushing back the retirement age, and imposing a less generous pension formula, for workers hired in 2013 and beyond. Current workers will have to contribute more toward their pensions, but the benefits themselves have been left intact.

But as state and local governments become increasingly anxious to reduce expenses, Roeder and others said current workers and retirees are becoming fair game.

Colorado, Minnesota and South Dakota have cut cost-of-living increases that were part of their retirement plans. Retired police and firefighters in tiny Central Falls, R.I., agreed to a 25 percent cut in pension benefits after the city went bankrupt and threatened to eliminate the pensions altogether.

The brush fire reached California in June, when voters in San Diego and San Jose enacted sweeping local reforms for current and future workers. In San Jose, for instance, current workers must contribute more to their pensions or accept a less generous retirement package.

Workers are suing in both cities.

"Promises were made to these employees," said Christopher Platten, an attorney for San Jose firefighters. "You put in your 30 years and you're going to get this benefit."

Even if public employee groups win in court, they're seeing support for their position erode in the court of public opinion. Citizens are upset that, as CalPERS investment returns have faltered in the down economy, more of their tax dollars are going for public pensions.

"Private sector people see their 401(k)s going nowhere, while they pay more for public pensions," said Alicia Munnell of Boston College's Center for Retirement Research. "There is pension envy, as well there should be."

Traditional defined-benefit pensions, like the ones enjoyed by most public workers, are disappearing in the private sector. Barely 15 percent of private employees have defined-benefit plans, in which the amount of the benefit is guaranteed, according to the Employee Benefit Research Institute.

What's more, private-sector pensions aren't nearly as sacred as public pensions in the eyes of the law.

Corporations in financial distress have the right to cancel their pension plans, and plenty have done so, including Polaroid, Circuit City, US Airways and others.

There is a cushion of sorts: The federal Pension Benefit Guaranty Corp. insures individual private pensions for up to a maximum of $55,840 a year. The agency pays retirees their annual benefit but in some cases the workers don't get the full amount they were originally promised.

There's no such agency to guarantee public employee pensions. Because they've been considered invincible, Skeel said, there's never been a need for one.

"We don't have the same kind of safety net," the Pennsylvania professor said. "We don't know what happens ... if the employer begins to monkey with the pensions."

STOCKTON