Rhode Island City Faces Pension Tsunami

Prof: Providence retirees may face 73% haircut in bankruptcy

February 22nd, 2012 at 6:00 am by Ted Nesi under Nesi's Notes, On the Main Site

Providence Mayor Angel Taveras and city retirees don’t agree on much, but they’d probably both acknowledge that Providence’s pension system has a sizable long-term shortfall.

The math is pretty simple. Providence has promised its workers and retirees $1.32 billion in pension benefits, but it’s saved only $362 million to pay them. Thus, the city pension fund was short $958 million as of June 30 (based on market value).

As is often pointed out, there’s no immediate crisis there. The city must pay that $1.32 billion over decades – it’s not about to receive a bill for the other $958 million, an amount that’s far more than this year’s entire $614 million city budget.

But a more immediate crisis – a bankruptcy filing by the city – could force the question sooner. And if that happens, the retirees may discover their unfunded pension promises are worthless IOUs.

That suggestion comes from David Skeel, a law professor at the University of Pennsylvania and prominent expert on bankruptcy. In a recent working paper which argues that states should be granted the same right as municipalities to file for bankruptcy, Skeel suggests public-sector workers’ property rights only cover funded pension benefits – not unfunded ones.

If a judge agreed with Skeel’s argument, Providence’s retirees would find they have a secured claim on the pension fund’s $362 million in assets, but Providence could write off all or some of the additional $958 million in unfunded benefits the city promised but hasn’t saved for, or about 73% of its total pension liability.

“With a state’s unfunded pension promises, a court would likely conclude that the promises constituted a valid property right to the extent the state set aside designated revenues for them,” Skeel writes in the paper. “But an unfunded promise would be treated as an ordinary unsecured claim, subject to restructuring.”

Skeel elaborated on his argument in an interview with Voice of San Diego, another city where bankruptcy is being discussed because of unfunded pension obligations. Skeel suggested events in Central Falls, where pensions have been cut by up to 55% in bankruptcy, has shown retiree benefits are not untouchable.

“It had previously been the third rail,” Skeel said. “But after Central Falls, it’s unclear if it’s so much of a third rail anymore.”

Skeel suggested the retirees’ property right encompasses pension funds, not pension promises. “The question is what is fully protected, the promise or the pool of funds?” he said. “There is an argument, and I think it’s a pretty powerful one, that it’s the pool of funds.”

In the working paper, Skeel cited the Fifth Amendment’s Takings Clause as the main rationale for protecting retirees’ unfunded pension promises as well as pension funds, because writing off those promises “would defeat the beneficiaries’ ‘investment backed expectations.’”

“This argument is unlikely to prevail with respect to obligations for which no funds have been set aside, because there does not appear to be a property right for bankruptcy purposes in the absence of collateral,” Skeel wrote.

There may be a historical argument for Skeel’s theory in Providence, since the benefits weighing down the city pension system were granted based on the idea that the fund was in robust health.

When the union-majority Providence Retirement Board voted to award 6% COLAs in 1989, labor leaders defended the richer benefit as affordable because the city’s pension fund was “one of the wealthiest in the country.” They also incorrectly estimated the COLAs’ cost at only $750,000, while the city put the cost at $22 million.