Officials roll dice on contracts

By Frederic J. Cowan and W. Gordon Hamlin, Jr.,

Guest Columnists

Kentucky has the strongest protection of the pension contract of any state in the country.  The legislature long ago created the “inviolable contract” for all the major public pension plans, and the Kentucky and U.S. constitutions prohibit any legislative impairment of contracts.  According to Kentucky statutes, employee benefits are “not subject to reduction or impairment by alteration, amendment or repeal.”

Virtually all the significant recommendations for pension reform made by PFM, Gov. Matt Bevin’s consultant, require amending those inviolable contracts.  Freezing the plans in place and converting future years’ benefits to 401(k) contributions impairs the contracts made by employees when they were initially hired.

Why do we say that Kentucky has the strongest protection for public pensions?  The threshold question is the extent of the contract created by either a constitutional provision or legislation.  One prominent example is the Illinois Constitution, providing that “[m]embership in any pension or retirement system of the State, any unit of local government or school district, . . ., shall be an enforceable contractual relationship, the benefits of which shall not be diminished or impaired.”  Does this mean that the contract is enforceable from the day:  (1) of first employment, or (2)  an employee becomes eligible for retirement, or perhaps (3) of retirement?  Through interpretation, the Illinois Supreme Court has consistently held the contract applies to the first day of employment.

Over a dozen other states have followed the lead of California, with courts interpreting state statutes to reach the same conclusion as Illinois.  Still other state high courts conclude the pension plan can be altered for all employees not yet eligible to retire, but without diminishing their benefits accrued to date.

Kentucky, in contrast to every other state, has spelled out in its statutes exactly what the pension contract consists of, leaving no room for judicial interpretation.  Not until 2013 did Kentucky attempt to reserve power to amend the pension contract for future employees, as the U.S. Congress had done with the 1935 Social Security Act.

It’s instructive to examine the 2013 Illinois pension reforms.  Gov. Pat Quinn averaged one bond rating downgrade every 181 days of his tenure, with the ratings agencies always citing the unfunded pension liabilities to downgrade. The governor was desperate to stop the hemorrhaging, so he pushed pension reform through the Legislature, despite extensive legal memoranda pointing out the obstacle of the Illinois Constitution.  A major Chicago law firm which today boasts over 1,700 lawyers, produced a memorandum supporting the governor’s position, and the Legislature bought it.

Two years later, the Illinois Supreme Court unanimously rejected the arguments of that giant law firm, noting that one senator had stated during the debate that the legislation was “the one opportunity that we have to finally, finally address the most important economic issues that are facing this state, and that includes our credit ratings, our financial position, our jobs climate, and, frankly, our reputation in the global economy.”

In response, the Supreme Court easily concluded that the legislation impaired the pension contract, was not justified under the state’s “police power” and could not be so easily modified.  The Illinois justices quoted from a U.S. Supreme Court decision: “A governmental entity can always find a use for extra money, especially when taxes do not have to be raised.  If a State could reduce its financial obligations whenever it wanted to spend the money for what it regarded as an important public purpose, the Contract Clause would provide no protection at all.”

When their Supreme Court struck down the pension legislation, Illinois wound up with nothing but embittered state employees (who concluded that their elected representatives did not care about them) and frustrated taxpayers (who concluded that their elected representatives were incompetent, or worse).  Today, businesses and individuals are migrating out of Illinois, making a bad situation worse.

What happened to Illinois’ bond ratings?  In June 2013, before the pension reforms, Moody’s cut Illinois to a rating of A3.  In July 2017, again citing the unfunded pension liabilities, Moody’s downgraded Illinois again, this time to Baa3, one notch above junk status.  In his first 28 months, Gov. Bruce Rauner averaged one downgrade every 91 days, hardly a trend in the right direction.

In July 2017, Moody’s downgraded Kentucky to Aa3, barely above where Illinois was in 2013.

There is no reason for Kentucky to pursue the same futile track Illinois followed.

For starters, public employees and retirees have had little to no opportunity to be heard. 

Our mission at Pro Bono Public Pensions is to help states, counties and municipalities create fair, secure and sustainable solutions for public pensions.  We are not backed by millionaires or billionaires.  Our directors include a Fellow from Harvard’s Advanced Leadership Initiative, a former acting chief actuary of the Social Security Administration, and a former chief investment advisor for North Carolina. We provide our services on a pro bono basis.

There are solutions which can take Kentucky’s public pensions from worst to first, while honoring the service of its public employees and retirees.  If sacrifices are shared, then all the citizens of Kentucky can benefit.  Unfortunately, given our present course without serious discussion of alternatives to PFM’s recommendations, the likelihood is that all citizens will be losers.

Gordon Hamlin is president of Pro Bono Public Pensions. Fred Cowan is a former attorney general of Kentucky and retired circuit judge.

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