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Retirement Planning > Retirement Investing

California town’s pension plight a lesson to others

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The municipal bankruptcy of Vallejo, Calif., might be viewed as a cautionary tale for other cities that fail to get a handle on their pension costs.

There’s no debate that cities around the country are facing budget pressures because of the slow economic recovery and that the annual contributions required to meet future pension liabilities are a huge part of the problem, siphoning away money needed to pay for essential services. Unfortunately, there’s often no easy way to change the pension contribution equation.

“Bankruptcy can’t always help,” said Frank Shafroth, director of the Center for State and Local Government Leadership at George Mason University.

Related story: Detroit bankruptcy tests state pension protections

The tale of Vallejo, a city of about 118,000 people, began in 2008 when it declared bankruptcy following the closing of a naval base and the start of the recession. It is a case study in what can happen if pension obligations are not dealt with. Cuts to basic services like fire and police protection and reductions to retiree health benefits helped erase an $18.2 million budget deficit and pulled the city of Chapter 9 protection in 2011.

But an unsuccessful attempt at renegotiating pension obligations has again landed the city on the precipice of insolvency. The major drag on its finances? Payments that must be made to CalPERS, the nation’s largest public employee retirement system. Those annual payments have ballooned from $8.82 million in 2008 (11 percent of the city’s budget) to $11 million in 2011 (14 percent) and $15 million (18 percent) in the current budget.

Cities like Vallejo and Detroit face a tough road when trying to solve the pension finance riddle.

“It depends by state,” Shafroth said. “In California and Michigan, they have strong constitutional protections. (On the other) extreme is Central Falls, R.I., where the receiver was able to cut benefits unilaterally. … There’s not always rhyme or reason to what cities can do.”

While cutting retiree benefits would ease the burden on municipalities, such a move has consequences that could cause other problems.

“We’re going to have to rethink how we offer retirement benefits, but it’s really hard,” Shafroth said. “In Detroit, the average retirement pay is $19,000 (a year). If we cut it, it might have a domino effect.” For instance, retirees may lose homes, cars or not be able to pay for food, all of which would put more financial pressure on the city, as well as the state and federal governments.

In any case, the patchwork nature of state laws governing public pensions means that solving the problem must be done on a case-by-case basis.

“The thing to know about public pensions is that the trouble they’re in is specific to the plans,” said Keith Brainard, research director of the National Association of State Retirement Administrators. “Generalizations can’t be made.”

For instance, in Detroit, Brainard said, “The pension fund isn’t in very bad shape. The plan sponsor, the city, is in very bad shape.”

The grim prospects faced by other public pension funds were caused by the failure of officials to make payments to retirement systems.

“There are some cities and some states that are in big trouble,” Brainard said. “Illinois is in trouble for not paying their contributions for years. New Jersey is in a similar spot.”

And back in Vallejo? The city is attempting to dig out of its financial hole by cutting health benefits paid to retired police officers. Coverage would be reduced to a monthly benefit of $300 from 100 percent coverage. Similar changes imposed during bankruptcy to other retired public employee health benefits saved the city an estimated $100 million.

But changing pension deals is another matter altogether. CalPERS has vowed to fight any changes to pension contributions.

Whether courts will side with CalPERS or decide the federal bankruptcy law takes precedence is unknown. But until the issue is resolved, Vallejo and other cities will continue to be vexed by the strain of pension contributions.

“There is no doubt that pensions have to be dealt with,” Shafroth said.

But how is the big question.

Karol Denniston, a municipal bankruptcy attorney in San Francisco, doesn’t think there’s much choice in the matter.

“Any municipal bankruptcy that doesn’t restructure pension obligations is going to be a failure because pension obligations are the largest debt a city has,” Denniston said.

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