Editor's Note: The Pension Crisis — Part 3 of 4

Part 1: Why the Municipal Pension Crisis Will Worsen

Part 2: How Legal Precedent Has Shaped Pension Policy

Part 4: Why Pensions Beat Bonds in Bankruptcy Court

In the latest instance of political futility that plagues states across the county as they try to deal with pension funding crises, a proposed constitutional amendment to ramp up funding for New Jersey's retirement plans failed to reach the ballot this year.

Legislation for the pension referendum passed in the assembly, but missed an Aug. 8 deadline to clear the state senate, meaning the earliest it can now head to voters is November 2017. Underfunded pensions have loomed large as New Jersey's credit rating sank to second-worst of the 50 U.S. states. The only state with a worse rating, Illinois, also had been stymied in addressing its pension shortfall, as political leaders put off tough decisions between tax hikes and service cuts and avoided confrontation with powerful labor unions.

New Jersey has suffered nine downgrades since Gov. Chris Christie took office in January 2010, a record that came under fire during his failed bid for the Republican presidential nomination. The Garden State is rated A2 by Moody's Investors Service and A by Fitch Ratings, S&P Global Ratings and Kroll Bond Rating Agency. Illinois is rated Baa2 at Moody's and BBB-plus at S&P and Fitch.

Christie and previous New Jersey governors since 1996 have made pension payments below what is actuarially recommended, leading to $40 billion in liabilities entering 2016, according to data from Moody's Investors Service.

"Responsible leadership should make adequate payments as a matter of good governance, without a constitutional amendment, but that has not happened in recent years," said Janney Capital Markets municipal analyst Alan Schankel. "Although focus has been on the current administration and legislature's failure to adequately fund New Jersey's pension plans, underfunding seems to be a persistent Garden State habit extending to governors from both sides of the aisle back to at least 2002, when the state's pension funds were fully funded."

The amendment if approved would have required pension payments on a quarterly basis rather than the last day of the fiscal year and put New Jersey on pace to make full actuarially required pension payments by 2022. The state's unfunded liability would have been cut by a projected $4.9 billion over 30 years. The legislation for the referendum didn't need a signature from Christie, but the governor campaigned against the plan saying it would cost taxpayers $3 billion.

Senate President Steve Sweeney, D-Gloucester, said he couldn't pass the legislation in time for this fall, because the state lacks funding for the increased pension payments until a solution is found to replenish the expired Transportation Trust Fund. Sweeney also emphasized the risks of rushing the amendment, since a defeat at the polls would have meant a three year wait before placing it on the ballot again, according to the state constitution. Sweeney's decision, however, has angered New Jersey labor leaders as he gears up for a possible gubernatorial run next year.

A 2015 National Association of State Retirement Administrators study showed that New Jersey underfunded its pensions more than any other U.S. state from 2001 to 2013. The Garden State paid an average of 38% of its annual actuarially required contribution during that 12-year period, according to the NASRA research.

Efforts to steer New Jersey's pension funding to healthier levels come on the heels of Christie slashing pension payments in recent years to address fiscal needs including $1.57 billion to balance to the 2015 fiscal budget. Christie has clashed with labor unions over promised benefits and won a victory in State Supreme Court last year, when justices ruled in a 5-2 decision that a section of his 2011 pension reform law calling for a ramp-up of pension payments over a seven-year period was not legally enforceable.

Christie took time out of his state-of-the-state speech this past January to bash the pension proposal, equating it to raising the sales tax to 10% from 7% and the state's income tax by 23%. He also has emphasized that the 2017 fiscal budget includes the largest pension payment in New Jersey history at $1.9 billion toward the state's defined benefit funds.

The bipartisan New Jersey Pension and Health Benefit Study Commission formed by Christie recommended in February utilizing roughly $2.2 billion in yearly health care savings toward covering pension costs, which drew sharp criticism from union leaders. The commission's second report from February 2015 proposed freezing pension benefits for current state employees and shifting them to a new cash balance defined benefit plan.

"Ultimately New Jersey's pension challenge rests in timing," Schankel said. "Politicians with two and four year election cycles may worry less about assuring funding for retirees in 20 or 30 years than about more immediate funding needs such as transportation and schools."

The politics behind pension ills of Illinois and Chicago – from failed funding formulas and pension holidays to costly benefit upgrades and the diversion of pension payments – came to a head in May 2015.

After fits and starts at reform efforts, the state passed sweeping reforms in 2013 that were quickly challenged by unions.

The final word came from the Illinois Supreme Court on May 8, 2015. The Heaton v. Gov. Pat Quinn opinion voided as unconstitutional legislation that cut benefits and raised employee contributions to try to rein in a now massive $113 billion tab of unfunded liabilities. The high court rejected Illinois' argument that it could cut benefits based on its sovereign powers to act in a fiscal emergency.

The ruling had a sobering impact on 2014 Chicago reforms, too, prompting Moody's Investors Service to drop the city to junk over its $20 billion of obligations. It also threw a monkey wrench into Cook County and other overlapping Chicago area governments' efforts to address ballooning pension burdens.

The high court followed up this March with an opinion rejecting an alternative argument put forth by Chicago on its reform package. City lawyers argued that cuts and higher employee and city contributions served to rescue two of its funds from certain insolvency and so didn't run afoul of state constitutional protections in a case known as Jones v. the Municipal Employees Annuity and Benefit Fund of Chicago.

At the heart of both high court rulings is the state constitutional clause that reads: "Membership in any pension or retirement system of the state, any unit of local government or school district, or any agency or instrumentality thereof, shall be an enforceable contractual relationship, the benefits of which shall not be diminished or impaired."

The language was inserted by delegates to the 1970 state constitutional convention with the intention of protecting employee benefits after decades of politically-driven tinkering.

"The purpose of the clause and its dual features have never been in dispute…..the clause served to eliminate any uncertainty as to whether state and local governments were obligated to pay pension benefits to the employees," the court's opinion read, citing delegate remarks. "The 'politically sensitive area' of how the benefits would be financed was a matter left to the other branches of government to work out."
The opinion noted that delegates hoped that the goal of establishing an enforceable obligation to pay benefits was to induce the General Assembly to meet its funding obligations, as the legislature in New York State had done when the same pension protection provision was adopted there. That did not occur in Illinois, the opinion said.

After years of diverting revenue earmarked for statutory contributions to the general fund, state lawmakers adopted a payment schedule in 1995. That plan ran afoul of the Securities Exchange Commission, which brought fraud charges in 2013 for failing to disclose that the plan significantly underfunded pension obligations and increased risk to its overall financial condition. The charges were simultaneously settled by Illinois.

In addition to a back-loaded ramp that allowed state liabilities to skyrocket, the state used more than $2 billion from its $10 billion 2003 pension sale to cover upcoming payments. At the city level, former Mayor Richard Daley's administration long warned of looming doom, a warning that was underscored by the findings of a mayoral commission. Still no action was taken.

Chicago Public Schools' payments skyrocketed several years ago when a three-year partial contribution holiday expired. Lawmakers eased the payments to help the district deal with a deficit. The district currently has more than $9 billion of unfunded liabilities and is working to close a $1 billion deficit.

Analysts and investors view Chicago and the state's current pension quagmires as a long awaited reckoning after years of neglect by political leaders.

While action on reforms was finally taken at the city and state level, the high court has now spoken and sent the officials back to the drawing board.

Some legal observers believe the path forward lies in reaching agreement on reforms through a collective bargaining process, with the city and state offering some benefit to offset a cut as contractual law allows.

Political gridlock among state leaders that followed Gov. Bruce Rauner's election last year has pushed action on a new package of pension reforms off at least until early next year, after the November elections. Rauner, a Republican, and the legislature's Democratic leaders – House Speaker Michael Madigan and Senate President John Cullerton—say they hope to act early next year but they also must resolve their differences on the state's budget crisis.

Some believe a constitutional amendment is needed on pensions given the high court's rulings.

Chicago Mayor Rahm Emanuel has offered up revised packages for the failed laborers' and municipal employees' reform package and he will seek state approval to change the payment formula during the legislature's annual veto session. They would raise the contributions of new employees and ask those hired since 2010 to contribute more in exchange for the ability to retire earlier, while also raising city contributions.

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