Unfortunately, underfunding pensions is an easy and often legal way to deal with budget pressures. In 2013, California paid less than half of its required pension contribution. Illinois has consistently shortchanged its pension system for decades. Recently, New Jersey Governor Chris Christie announced that the state will be cutting pension payments from $3.8 billion to $1.38 billion. Whether Christie's proposal is legal has yet to be determined as plan participants prepare to challenge the cuts in court.
Law professor Amy Monahan argues that states need better legal mechanisms to enforce full funding. Many states have what are called “fiscal constitutional requirements,” or provisions in state constitutions that dictate the bounds of legislative fiscal activity (i.e.: a balanced budget requirement). In her article, Monahan looks at eight states with fiscal constitutional requirements for pension funding. She finds these provisions are rarely enforced, and even these states with supposed constitutional requirements to make their pension payments were no more likely to make their contributions.
She diagnoses several complications that prevent constitutional requirements from being fully enforced: Notably, the lack of clear, specific language in the provisions themselves and the lack of judicial authority to force legislative action.
While many state fiscal constitutional requirements stipulate that the legislature maintain an “actuarially sound” pension plan, there is no precise definition for what “actuarially sound” means. As Monahan explains, states can finagle the assumptions underlying the calculation of the ARC to give the false impression that its plans are better funded than they really are. For example, plans can select their own rate of return, even if real returns are lower. The Illinois Teachers Retirement System assumes an 8.5 percent return, for example, but in 2012, the plan’s actual returns were only 0.76 percent. Monahan suggests that an outside party such as the Governmental Accounting Standards Board (GASB) or an independent actuary determine a standardized funding methodology for states to apply. In turn, a definition of sound funding and specific calculations should be included in a fiscal constitutional requirement.
Another issue is judicial authority. Courts often rule funding requirements are unenforceable because pension participants lack standing. Even if a plan fails to make its contributions in a given year, it likely doesn’t put current retirees at risk. It’s only over time, as politicians continue to skirt payments, that participants may be in danger of losing out.
Courts also lack the power to remedy a breach in funding. Monahan suggests that fiscal constitutional requirements for pension funding be amended to become self-executing (which courts generally recognize), so that no legislative action is required. Currently, state fiscal constitutional requirements for pension funding are vague enough that legislatures have wiggle room in how they are interpreted and implemented. With clearer instructions, and an explicit constitutional provision that the funding requirement is self-executing, states will be pressured to make their full payments. Additionally, many courts just don’t have the power to order money to be appropriated from the state treasury to pay pension costs. Monahan suggests instead that courts could declare an entire budget to be unconstitutional, forcing the legislature to draft a new budget with sufficient pension funding. Alternatively, she suggests that the constitution could be amended to expressly allow courts to issue a writ requiring the state treasury to appropriate the necessary funds.
A last complication to constitutional funding requirements is flexibility. In economically dire situations, it may be better for a state not to be constrained to funding requirements. Paying down a state’s pension debt may take away from other vital municipal and social services. But too often, states repeatedly put off plan funding, placing pensions last on budget priorities. Monahan recognizes this issue and suggests a compromise: a reduced required contribution if certain constitutionally-defined triggers are met, or allowing the legislature to override the fiscal constitutional requirement by a super-majority vote. Monhan’s suggestions could curb repeated underfunding while still giving lawmakers flexibility to respond to times of true economic duress.
Without a robust enforcement mechanism, many states end up shortchanging pension funding. It’s often easier to underfund pensions when budget dollars are scarce, and likewise to make generous political promises to current constituents without tax increases. Unlike pensions in the private sector, public sector pensions do not carry the statutory funding protections of the Employee Retirement Income Security Act (ERISA). Implementing a strong but flexible state legal mechanism may be one way to prevent legislatures from underfunding state pension plans.