Bankruptcy Judge Calls for Better Pension Funding

Detroit bankruptcy Judge Steven Rhodes called on the state to address the underfunding of local government pension benefits in his oral opinion. He stated that the state has a “constitutional, legal and moral obligation to assure that the municipalities in this state adequately fund their pension obligation.”

A government’s own employees should not be its largest creditors, nor should retirement benefits they have earned be placed at risk, as happened in Detroit.

There are a number of current bills that would help local governments avoid underfunding, and the Legislature should consider passing them.

When an employee earns pension benefits, the government creates a long-term liability. If the employer puts aside enough money to cover that liability, pension benefits will not be a problem. But if governments underestimate the costs, then there is a problem. This effect is more pronounced if the community has become less prosperous since the employee earned his or her pension.

Unfortunately, most Michigan cities find themselves in this situation. There are $3.1 billion in underfunded pension benefits in Michigan’s largest cities. The worst offenders have less than 50 cents saved for every dollar of pension benefits earned.

The easiest way for governments to ensure they can pay employees what was promised is to get out of the defined benefit pension business by closing the systems to newly hired employees. They can instead provide defined-contribution plans that offer generous retirement savings without generating long-term liabilities on taxpayers.

This can also help governments to catch up on the underfunding of promises made to employees in the closed system, while offering benefits to new employees that will be there when they retire.

Local governments, however, have been hindered in offering these plans because retirement benefits are a mandatory subject of collective bargaining when employees are unionized. Unions have been ideologically inclined toward defined-benefit pension systems. For example, Detroit unions fought to keep a defined benefit system around for new employees even as benefits were being cut for current retirees.

Judge Rhodes also made an appeal to unions to be pension system hawks, ensuring that these plans do not get underfunded. This would certainly help, but too often unions have argued for pension sweeteners and early retirement incentives that blow further holes in pension finances.

Legislation currently pending in the House Local Government committee would allow local governments to close their pension systems without having to negotiate this benefit with their unions. Under House Bill 4804, locals could simply choose to close these pension systems on their own.

Detroit’s bankruptcy judge does not want to see other governments go through what that city faced. He implored stakeholders to ensure that governments set aside the necessary money to pay for pension benefits. As legislators consider laws in this lame duck and beyond, they should be responsive to Judge Rhodes’ plea.