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The Equity Factor

What Does Pension Reform Look Like?

Mounting pension debt, experts say, is the canary in the coalmine. Detroit is a harbinger for the future of more than a few U.S. cities, and pension reform is on the horizon.

Columnists and talking heads often call for pension reform without offering any solutions. But what exactly does reform look like? It’s an admittedly arcane field, littered with land mines.

Reform could come in the form of changes to the Cost-of-Living Adjustment (COLA), which alters benefits year to year. These changes could be limits on how high the COLA can go, less frequent adjustments, or a cap on how much COLA applies to a pension. Reform could also mean lesser benefits. In many cities it likely spells a straight-up end to pensions altogether for new employees, in favor of employer contribution models routinely used in the private sector.

But it will vary from state to state depending on local protections and the fiscal stability of the city or state in question. Last week, U.S. Judge Steven Rhodes ruled that Detroit’s pensions — strongly guarded by Michigan’s constitution — were not “entitled to any extraordinary protection.” Basically, they’re the same as any other debt the city faces. The decision was a blow to pensioners.

This is hugely important as the Motor City takes on the sad but necessary task of pension reform. Retirees could see their benefits chopped dramatically. Payments could be drastically reduced. Retired firefighters, police officers and city employees could end up looking for work as a result. For now, the pension fund is staying mum on what might happen.

“We’re going through mediation sessions between the pension fund’s restructuring team and the city’s restructuring team, and by court order those are confidential discussions,” said Bruce Babiarz, spokesperson for the Detroit Police and Fire Retirement System.

The state of Illinois — which has one of the worst-endowed pension funds in the country, racking up a $100 billion shortfall — passed a deal last week to overhaul its pension system. Unions are expected to file a lawsuit to overturn the bill, which raises the retirement age and proposes skipping some annual COLA, but keeps benefits for some of the longest-serving and lowest-paid workers. Some workers will have the opportunity to invest in a 401(k)-style plan.

Rachel Barkley, a municipal credit analyst at the investment research firm Morningstar, Inc., said the Illinois changes are in line with what experts feel pension reform will look like in states and cities not protected by Chapter 9 bankruptcy. Defined contribution plans like a 401(k) offer more security and diminished liability for municipalities. “Going forward [cities and states] would be responsible for funding the annual contribution and wouldn’t have to worry about market forces going forward,” Barkley said.

But she warned that not every pension fund in the country is doomed and ripe for reform. Some cities, like Austin, Texas, have fully funded pensions and an influx of residents and tax base. They can fund their pensions. “I don’t want people to see pensions and think, ‘Oh my god, the house is burning down,‘” Barkley said. “It’s burning in strategic areas.”

Detroit was ruled eligible for bankruptcy last week. Though unsavory and unfortunate, this gives Emergency Manager Kevyn Orr a more clear path to reform, which in Detroit will look different than reform in Chicago and California. Asked if Detroit’s pensions have a less rocky — though emotionally charged — path to reform, Barkley said, “I think it’s a little more clear-cut how they will be able to do that.”

Cities like Chicago that are not yet eligible for bankruptcy protection can’t keep kicking the can down the road, as Detroit did. Reform has to come. But like Michigan, Illinois has a state constitution protecting pensions. Cities can’t simply lower retiree benefits. Chicago has until November 2015 to resolve its pension problems, or it will have to increase its contributions by $590 million for an annual contribution of $1.4 billion.

The biggest problem? “Any cuts have to be approved by participating parties,” Barkley said. That’s why we’ll see ugly, protracted battles in cities and states across the country. Retirees want the benefits they were promised during their tenure as a city employee. Problem is, many cities can’t afford it anymore, which may result in anything from reduced benefits to slashes in monthly payments. Like it or not, hardworking retirees might end up on the wrong side of history.

The Equity Factor is made possible with the support of the Surdna Foundation.

Bill Bradley is a writer and reporter living in Brooklyn. His work has appeared in Deadspin, GQ, and Vanity Fair, among others.

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