The Rhode Island Supreme Court upheld the city of Cranston’s decision to suspend cost-of-living-adjustments (COLAs) on police and fire pensions even though these COLAs had been written into collective bargaining agreements.
The state Supreme Court’s ruling may set a precedent for fiscally distressed local governments grappling with unfunded pension liabilities since it upheld reductions in otherwise legally sacrosanct pension benefits in the interest of sustaining the fiscal solvency of the plan’s governmental sponsor.
Cranston is “the first government entity in Rhode Island to reform its troubled pension system while withstanding a full legal challenge,” Cranston Mayor Allan Fung said.
The retired police officers who sued the city contended that suspending the COLAs violated the Contract Clause of the US Constitution, which generally prohibits states (and, by extension, municipalities) from impairing contractual obligations, with limited exceptions. While the court agreed that the COLA benefits were a contractual obligation and that the city’s decision to suspend them substantially impacted retirees, the justices noted that a government could impair a contract, if such an impairment “is reasonable and necessary to fulfill an important public purpose,” citing a U.S. Supreme Court decision in the case of Energy Reserves Group, Inc. v. Kansas Power & Light Co., 459 U.S. 400 (1983).
In Cranston’s case, the court agreed that addressing the city’s serious fiscal crisis was an important public purpose that justified the COLA suspension. In a previous decision, the court had concluded that protecting the solvency of a pension system was also an important public purpose.
At the time that Cranston suspended COLAs for its closed single-employer public safety plan, the city was in fiscal jeopardy and the plan was facing insolvency. Unfortunately, both of these still conditions persist today. When the city acted, its Police and Fire Plan had reported a funded ratio of just 16 percent and Cranston’s governmental fund liabilities exceeded its assets, yielding a negative net position (although this red ink was offset by a positive balance in the city’s “business-type activities” such as the municipal sewer system). “In June 2011, the unfunded liability in Cranston had risen to $256 million,” the Providence Journal reported.
Since then, the pension system’s funded position has improved somewhat — reaching 22 percent funded in 2017, according to its most recently published actuarial valuation report. Note that 22 percent is still well below the 60 percent threshold Rhode Island uses to categorize a plan as being in “critical status.” The plan’s $66 million in assets were dwarfed by $302 million of actuarially accrued liabilities. Worse, the liabilities were discounted based on an assumed rate of return of 7.9 percent. Had actuaries used a more realistic and conservative investment return assumption of 6.9 percent, the system’s unfunded liability would have been $31 million higher.
One reason that the plan’s financial position has not improved more is that the original 2013 pension reform was watered down to settle an earlier lawsuit. The city council planned to suspend the three percent COLA for 10 years, but, under the settlement, agreed with its public safety unions to grant the COLA every other year through 2023.
As for the city overall, it remains underwater. Since 2013, Government Accounting Standards have changed so that filers are required to recognize the full value of net pension and other post-employment benefits (OPEB) liabilities on their Statements of Net Position, so Cranston’s latest Comprehensive Annual Financial Report (CAFR) is not comparable to its 2013 report. That said, the 2018 numbers are quite concerning. Government-wide liabilities of $597 million dwarfed Cranston’s assets of $298 million.
Although Cranston’s financial situation is difficult, it is not unique. The Rhode Island State Treasurer reviewed financial reports from 34 local pension systems in the state and found that 20 of them had funded ratios below 60 percent in fiscal year 2016. One relatively large plan in critical status is the Employee Retirement System (ERS) of Providence, the state’s capitol and largest city. As of July 1, 2017, ERS had a funded ratio of 26 percent and $1 billion in unfunded liabilities.
Additionally, Rhode Island cities have less flexibility to control employee personnel costs due to a new state law that locks in employee salaries and benefits after collective bargaining agreements expire.
At some point, if conditions in these jurisdictions fail to improve, we may see Providence and other cities in Rhode Island avail themselves of the legal precedent Cranston and the state Supreme Court have now set.