May 24 (Bloomberg) -- It has been more than 20 years since Gilbert McLaughlin ran the fire department in Providence, Rhode Island. Yet the former chief stands to be the biggest loser as the capital of the smallest U.S. state flirts with insolvency.
McLaughlin, 75, is the highest paid of Providence’s 3,000 retired workers, collecting a $196,813 pension this year, the result of yearly 6 percent cost-of-living increases the city once bestowed on firefighters and police. Lawmakers, facing a $1 billion deficit and squeezed for cash, ended the automatic raises and capped annual payouts. Now retirees such as Gillie, as he is known, won’t see their pay outs double every 12 years.
“No one ever did the math on this,” Paul Doughty, head of the firefighters union, said in an interview in his office above the bar at the Firefighters Memorial Hall in Providence. “I don’t think anyone had any idea that if Gillie lived to 100, he’d be making $700,000.”
While a Providence official in 1989 warned such giveaways could one day “bankrupt” the city, the arrangement bought peace with labor unions, a compromise made in town halls and state capitals across the country as stock market gains fattened pension funds. Now lawmakers are trying to rein in benefits. Since 2009, more than 40 states have lifted retirement ages, cut automatic raises, or increased employee contributions, typically targeting new workers to avoid conflicts with laws or contracts.
It took the longest recession since World War II and a financial calamity that the U.S. Census Bureau says wiped out 23 percent of public retirement plan assets in 2009 to show how politicians long promised richer benefits without setting aside sufficient funds. The average retirement system in 2011 had about 75 percent of the assets needed to meet commitments, down from about 100 percent in 2000 amid the technology stock boom, according to the Boston College Center for Retirement Research.
“It is an inherently dysfunctional system,” said Steven Malanga, a senior fellow at the Manhattan Institute for Policy Research, a New York-based nonprofit that tries to foster individual responsibility and economic choice.
“It allows politicians to make promises that they will not be responsible for,” Malanga said. “That is why so many perks were granted to workers for political support that did not have an immediate impact on the budget.”
Crowding Out Spending
Politicians from Chicago’s Democratic Mayor Rahm Emanuel to New Jersey’s Republican Governor Chris Christie are seeking to overhaul plans where assets have eroded as costs accelerated, crowding out other spending. According to a report this month from the Boston College center, required employer contributions to state and local pensions rose to an average 16 percent of annual payroll last year, from 6 percent in 2002.
San Jose, the California city that will ask voters next month to make new workers contribute 50 percent of retirement-fund payments, says it may face a required $320 million retiree set-aside in 2016, up from $73 million in 2002.
The funding deficit may widen because states and cities typically have assumed annual returns on invested assets of about 8 percent when calculating their commitments to retirees. Rulemakers at the Governmental Accounting Standards Board in Norwalk, Connecticut, are weighing a change to force plans to use different assumptions, effectively widening the funding gap.
If that occurs, taxpayers and public workers would be stuck with making up the difference to cover their defined-benefit plans, which guarantee retirees an annual pension for life. Many plans also provide health-care and other benefits.
It’s Really ‘Worse’
“The bottom line is every pension system is underestimating the size of the problem,” said Eileen Norcross, senior research fellow at the Mercator Center, a research group on George Mason University’s Arlington, Virginia, campus. “While things look bad, they are actually worse.”
Providence, established in 1636 and home to Brown University, was typical of many Rhode Island municipalities in the 1980s. While failing to set aside much of what it needed to cover its obligations, the city had also scrimped on pension benefits. That left some firefighter retirees, who like many government workers don’t get Social Security, surviving on less than $300 a month, Doughty said.
That changed in 1989 after municipal unions gained control of the city’s retirement board. Backed by court rulings and over objections from former Mayor Joseph Paolino, a Democrat, the panel voted to give public-safety workers a top cost-of-living adjustment of 6 percent annually, as well as to triple the base benefit payment and reduce the minimum years of service needed to qualify for retirement.
‘Bankrupt the City’
“When I looked at the numbers, I knew it was going to be unsustainable,” said John Simmons, Mayor Paolino’s chief of administration and who now runs the Rhode Island Public Expenditure Council, a nonprofit budget group in Providence. “I knew it would bankrupt the city.”
While some police and firefighters got annual cost-of-living adjustments of 5 percent and 6 percent, most of the city’s retirees got 3 percent, officials said. Almost all guaranteed annual increases in public pensions are 3 percent or less, according to Ron Snell, a senior fellow at the National Conference of State Legislatures.
Paolino sued to block the retirement board, and refused to fund the new benefits it awarded. His successor, Vincent “Buddy” Cianci, who left office in 1984 after he pleaded guilty to an assault charge only to return eight years later, signed a consent decree in 1992 to end the dispute and pacify unions. Cianci was later convicted on unrelated corruption charges and left office again in 2002.
Similar Across U.S.
The circumstances in Providence were unique yet similar results cropped up across the U.S.
In California, the euphoria of the 1990s technology stock bubble supported promises backed by the California Public Employees’ Retirement System, which was fully funded at the time and now has about 75 percent of needed assets. Gray Davis, elected governor in 1998 with support from government unions, the next year signed SB400. The retroactive pension enhancement let prison guards, firefighters and highway patrol officers retire at 50 and collect as much as 90 percent of their pay.
The cost of those changes would cascade through California, forcing local governments to meet the new terms, which Davis later extended to more workers, according to David Crane, a former economic adviser to Republican Arnold Schwarzenegger. The movie star, who succeeded Davis in a 2003 recall election, tried to undo some of his predecessor’s enhancements.
Calpers, as the pension system is known, told lawmakers in 1999 that the added cost of the new benefits would be covered by investment gains, Crane said. Yet the state has scrambled to find billions of dollars needed to make up for losses when the dot-com market bubble burst and again after the financial crisis truncated equity values a decade later, he said.
“Eight years I worked on that thing and we got it fully funded and then see the whole thing unplugged,” Dave Elder, a former Democratic assemblyman from San Pedro who led a legislative panel overseeing pensions, said of efforts to ensure Calpers had the funds it needed. “That just makes you want to go throw up.”
In 1992, former New Jersey Governor Jim Florio, a Democrat, cut required payments to the state retirement system by raising investment-return assumptions, helping to balance the budget in the wake of a national recession. Christie Todd Whitman, his Republican successor, would follow a similar path, cutting contributions even as she lowered taxes, and then borrowing $2.8 billion in 1997 in a failed effort to make up the gap.
Closing the Gap
Governor Christie, a Republican who took office in 2010, pushed a pension overhaul last year that closed $17 billion of New Jersey’s $53.9 billion funding gap. Yet he also skipped making required contributions as he battled with unions over the changes. The law he championed requires bigger contributions from employees and raised the retirement age.
In Illinois, a pension code of more than 1,000 pages conceals abuses, said Laurence Msall, president of the Civic Federation, a nonpartisan government research group in Chicago. The tangled statute is the result of years of lawmakers in Springfield handing benefits to supporters and themselves with only occasional cost analysis, he said. In 2010, the state had the worst-funded retirement system with 45 percent of needed assets, according to a Bloomberg Rankings study.
While the Illinois Legislature in 1994 agreed to fully fund pensions, Democratic legislative leaders, working first with former Republican Governor George Ryan and then with Democrat Rod Blagojevich, found ways to circumvent the rules, Msall said. They inflated early retirement buyouts and borrowed $17.2 billion over the past decade to try to close the deficit and cover contributions.
“It is about the worst system that you could create,” Msall said in a telephone interview. “Over the last three decades, Illinois’s General Assembly has made a series of hundreds of decisions where there was very little public acknowledgment.”
Efforts to rein in retirement costs have produced mixed results because many of the benefits pledged to workers and retirees are protected by law or contracts.
While judges in Arizona, New Hampshire and Florida have blocked states from requiring greater contributions from workers, jurists in Colorado and Minnesota have allowed cuts in cost-of-living adjustments. In California, protections are so strong that even after the city of Vallejo entered bankruptcy court protection in 2008, it didn’t reduce pensions.
Avoiding Tax Increase
Illinois Governor Pat Quinn, a Democrat who replaced Blagojevich, in April proposed a package of changes that he hopes can withstand a legal challenge. Unions have pledged to sue. Emanuel, once President Barack Obama’s chief of staff, is also asking state lawmakers to let him avoid a “crushing” property-tax increase by overhauling Chicago’s pensions.
In Rhode Island, public sector unions have pledged legal action to block a law Treasurer Gina Raimondo championed last year. It will save about $3 billion largely by ending annual 3 percent cost-of-living increases for all state workers and retirees. The changes are set to take effect on July 1.
Doughty said unions representing Providence employees will head to court to challenge an ordinance signed by Mayor Angel Taveras last month. Taveras, A Democrat, said the city stood at the brink of insolvency and needed to break contract promises such as guaranteed annual pension increases to avoid the fate of Central Falls, the nearby community that last year entered bankruptcy protection partly because of commitments to retirees.
Public employees are being used as scapegoats by states and cities that haven’t set aside necessary funds, said Steven Kreisberg, director of collective bargaining at the American Federation of State, County and Municipal Employees in Washington. He said politicians are being “opportunistic” by playing up retirement-plan abuses while ignoring the fact that the average government retiree gets less than $30,000 a year.
While about two dozen city retirees collect more than $100,000 a year in Providence, the average former firefighter and police pension is about $42,000, Doughty said. McLaughlin, the fire chief who retired in 1991, when his annual salary was $63,510, with a disability related to an earlier injury, hung up when reached by telephone at his home in nearby Warwick.
“Their idea of reform is to basically break the promises to employees,” Kreisberg said of Democratic and Republican leaders trying to overhaul public pensions. “The problem is they thought funding was optional for the past 30 years.”
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