STUMP » Articles » Public Pensions Watch: On COLAs (and Chicago) » 25 March 2016, 07:00

In my post on pension spiking, I wrote the following:

Spiking is one of those things, like politicians accruing public pensions that perhaps they shouldn’t be allowed to have, that makes public pensions less popular with taxpayers… but doesn’t boost the pension liabilities all that much (see the less than 4% boost mentioned above) — because generally it’s only a handful of people doing it.

…..
My own interest isn’t the small beer, though. I want to dig into the larger trends…

….but that’s for another time.

This is that other time.

COLAS: BAD FOR YOUR TEETH AND BAD FOR PENSION SOLVENCY

Okay, cola (the soda kind) is probably okay (as a mixer), but what about its all-caps relative: COLA?

COLAs are “cost of living adjustments”, and they show up often in public sector salaries and pensions. COLAs are part of Social Security.

And it’s the key to the recent pension reform court case that went against Chicago.

The simplest kind of COLA is just a level percentage increase every year, such as 3%.

Some of them are more complicated, like with Social Security, which uses an inflation index to adjust benefit amounts for retirees.

The point of COLAs is to try to keep up the buying power of the benefit, as inflation can eat away at a fixed pension payment.

The problem is that the COLAs compound and eat away at the pension fund. To be sure, the pension valuations can include COLAs (and sometimes they don’t, but I’m not going down that alley right now.) So it should be baked in already in the unfunded liability.

BREAK FOR QUICK MATH

Compounding interest really makes things grow.

Let’s see what a level 3% COLA will do to a payment over various periods.

Obviously, after one year, the payment increases 3%.

After 10 years, the increase over the original payment is 34% (no, not 30%. Interest does not add.)

After 20 years, the increase over the original payment is 81%.

After 30 years, the increase over the original payment is 143%.

If you have people retiring in their 50s (and one expects most people to die in their 80s), you can see how this may be a problem.

It’s pretty clear that the unfunded liability is way too large for some plans, and the savings from reducing pensions for new employees was limited… there needed to be a way to cut pensions for those who were already retired and current employees to really make a dent in the liability.

But there is generally constitutional protections for pensions earned (and not yet earned for those already employed, but again, that’s for another time).

COLAs were seen as a possibility of a cut — “we’re not cutting the base benefit”, sayeth the pension reformers, “just how fast it grows in retirement”, crossing their fingers and hoping it would get past state courts.

It didn’t work in the case of Chicago.

Let’s look at some other places.

CALIFORNIA COLAS

Let’s look at COLAs for places other than Chicago.

How about California:

No Social Security raise, but pensions up 1.5-4%

Social Security recipients get no raise this year because inflation last year was near zero. But more than half of CalPERS pensions will get a raise in May of 1.5 to 4 percent.

How does this happen, when both Social Security and the California Public Employees Retirement System have annual cost-of-living adjustments based on the rate of inflation?

“The law does not permit an increase in benefits when there is no increase in the cost of living,” Social Security recipients were told of the federal program‘s rules. “So your benefit will stay the same in 2016.”

That seems simple and straight forward. In contrast, the CalPERS method for a cost-of-living adjustment, even though its inflation index shows little or no inflation this year, seems almost comically convoluted.

I’m not laughing. You can go to the Calpensions link to read about the details.

Here is the upshot:

I just want to point out that I was born in 1974. That chart includes a 1974 breakpoint for retirement year. I’m sure there aren’t a lot of people in that bucket, but they obviously exist. I can imagine that widows of some men who retired over 40 years ago are still alive. And if you retire in your 40s… anyway.

Here was an interesting factoid in Ed Mendel’s piece:

A federal Bureau of Labor Statistics survey in 2000 found that only 9 percent of blue collar and service industry employees who are in traditional pension plans received an automatic cost-of-living adjustment.

I imagine the percentage is smaller today, 16 years later. I imagine the percentage of the population this represents is pretty dang small — you had to restrict it to blue collar & service employees who are in DB plans to begin with, a shrinking percentage.

RHODE ISLAND NON-COLAS

Back in 2011, Rhode Island passed a law freezing COLAs while the pension fund was grossly underfunded.

It’s still grossly underfunded. They’ve not had any COLAs in years.

Victims of R.I. pension reform:

According to a recent survey by the Rhode Island Retired Teachers’ Association, 93 percent of retired teachers feel they have been victimized by Rhode Island’s so-called pension reform.

….
Retired teachers and public servants are directly suffering from what is supposed to be the temporary loss of their cost-of-living adjustment (COLA). According to AARP, “COLAs may be even more important to retirees who do not receive Social Security, because without their pension COLA they may have no retirement income that increases with inflation.” These are not raises, but the amount needed for retirees to stay even with the cost of living.

One retired teacher commented: “I made my decision to retire based on the 3 percent COLA. … I don’t have the funds I thought I could count on.” This betrayal of trust is made worse by the fact that Wall Street fees and bad performance dim the likelihood of a COLA ever coming back.

The Raimondo plan only reinstates COLAs when the funded ratio of the plan gets to 80 percent. Last year,
the funding ratio fell from 59 percent to 58 percent because of bad investment returns.

Oh, that pesky 80%.

By the way, teachers, be happy that the target mentioned was 80%. Imagine how long you’d have to wait if the target were 100%.

SOCIAL SECURITY COLAS

Inflation is not a steady 3% per year, by the way.

Now, Social Security-related law has changed over time, but get a load of this COLA history:

For easy comparison, the red line is a level 3%. COLAs have been relatively low for a while.

If you can’t see the image I made, here’s the table:

Automatic Cost-Of-Living Adjustments
July 1975 — 8.0%
July 1976 — 6.4%
July 1977 — 5.9%
July 1978 — 6.5%
July 1979 — 9.9%
July 1980 — 14.3%
July 1981 — 11.2%
July 1982 — 7.4%
January 1984 — 3.5%
January 1985 — 3.5%
January 1986 — 3.1%
January 1987 — 1.3%
January 1988 — 4.2%
January 1989 — 4.0%
January 1990 — 4.7%
January 1991 — 5.4%
January 1992 — 3.7%
January 1993 — 3.0%
January 1994 — 2.6%
January 1995 — 2.8%
January 1996 — 2.6%
January 1997 — 2.9%
January 1998 — 2.1%
January 1999 — 1.3%
January 2000 — 2.5%(1)
January 2001 — 3.5%
January 2002 — 2.6%
January 2003 — 1.4%
January 2004 — 2.1%
January 2005 — 2.7%
January 2006 — 4.1%
January 2007 — 3.3%
January 2008 — 2.3%
January 2009 — 5.8%
January 2010 — 0.0%
January 2011 — 0.0%
January 2012 — 3.6%
January 2013 — 1.7%
January 2014 — 1.5%
January 2015 — 1.7%
January 2016 — 0.0%

Note that in 2010, 2011, and 2016 the COLAs were 0.

Anyway, I understand that it is difficult when you’re not part of the Social Security program, you want a pension with COLAs.

But the Rhode Island pensions provided amounts far above Social Security.

And the plan is still grossly underfunded.

Not as bad as Chicago, but still.

NEW JERSEY COLAS

I can’t predict this case, though it seems likely to me that NJ is going to lose.

Justices Hear Public-Sector Retirees’ COLA Lawsuit:

The New Jersey Supreme Court heard arguments March 14 over whether a 1997 pension law guarantees yearly cost-of-living adjustments to pensions received by retired state and local public-sector workers.

The administration of Republican Gov. Chris Christie asked the justices to overturn an Appellate Division ruling in Berg v. Christie that said the 1997 statute created non-forfeitable COLAs.

Conversely, the lead plaintiffs, 26 retired attorneys who previously worked for state or local governments, urged the court to affirm the appeals court’s ruling, saying the Legislature purposefully used the statute to guarantee pension benefits and COLAs. Public-sector unions filed a separate lawsuit and the Supreme Court has consolidated the cases.

The court will have to determine if the COLA portion of Christie’s landmark 2011 pension reform statute known as Chapter 78–which guaranteed that the state would fully fund financially troubled pension plans in exchange for an increase in contributions from public-sector workers and a *COLA freeze*–is enforceable.

The court, in a divided ruling last year in Burgos v. Christie, sided against public-sector unions and with Christie. Christie had initially championed Chapter 78 but later argued that its funding mandate was unconstitutional after diverting $2.5 billion from the scheduled pension fund payments to balance the state’s budget.

……
Assistant Attorney General Jean Reilly said that, like in Burgos, future legislatures cannot be bound by statutes created by earlier legislatures that contractually require them to make certain appropriations.
“The sovereign power to set policy cannot be surrendered,” Reilly said.

Only the voters, through constitutional amendments, can require future legislatures to make appropriations, she argued.

“The stakes are so high,” Reilly said.

A ruling in the plaintiffs’ favor, she said, would lead to “drastic limitations on the power of the state.”
Appellate Division Judge Mary Cuff, temporarily assigned, asked whether the state could ever move to eliminate COLAs altogether.

Reilly said that since that wasn’t the issue here, that question hasn’t been researched.

“That’s not what’s happening,” she said. “The state is not reducing anything.”

Hmmm. Good luck with that.

I am not a pension law-type person, much a state constitution and pension law-type person. I don’t know what the ruling will be…

…but I will note that though the court previously allowed the state to not make statutorily-required pension fund contributions, I think it’s because these law-type people don’t see that not funding the pensions is the same as not paying the benefits. Too much of a delay in the cause-effect, I suppose.

But they can definitely see that not making an expected increase in benefits is obviously a benefit cut.

Also, they can see that if they allow this, their own pensions could be cut.

John Bury did a multi-post on this case recently. If you start with this first post: NJ COLA Case Orals (1) – Videos, you can navigate though the series.

I want to excerpt from the second post in Bury’s series:

COLAs were costed for. When actuaries did their reports they presumed that COLAs would be paid as part of a retiree’s benefit until 2011 when they presumed they wouldn’t be (thus resulting in lower liability and contribution amounts for 2011 and later years). Therefore, in theory, through 2011 there was money contributed to pay for those COLAs. What happens to that money? It would seem like a fair question but, for those of who haven’t yet caught on to this three-step tango:

1. Public plan actuarial reports are a mechanism designed to generate the lowest contribution possible using any method generally accepted in the public-plan world (translation – any method) which leads to…

2. Taxpayers through their politician representatives in cahoots with public employees through their union representatives abiding this farce and funding these lowball amounts (except when legislatures or governors further reduce them) which leads to…

3. Arbitrary benefit cuts.

So you see what would seem like a logical argument to make is really an absurd conceit in the world of public-pension funding.

Back in 2012, Bury made a post on his arguments against cutting COLAs:

It’s in the handbook

If you retire and your retiree handbook says you get a cost-of-living-adjustment on your pension based on external factors then rescinding that promise is theft. It doesn’t matter that you don’t have a fixed number. The pension itself is based on some salary that is unknown when the promises are being made. If a participant’s salary rose more than anticipated, can the state at retirement arbitrarily reduce a 50% of pay pension to 40% of pay because the base salary rose too high (in their opinion)?

It’s theoretically paid for

The COLA-theft law was passed on June 28, 2011 allowing actuaries to ‘revise’ their July 1, 2010 valuation reports (upon which the costs that appear in the 2012 taxes are based) to lower contributions. Contributions for all prior years were based on continued COLAs and money was set aside for future COLA increases. If those COLA increases are eliminated then the money set aside for them was improperly obtained and now represents a transfer from some (future retirees/past taxpayers) to others (current/future taxpayers).

Being a taxpayer and never expecting to get a public pension these arguments both work against my personal financial interest but there is one overriding incentive for proposing them. If you can’t trust your government there can be no law. Maybe that’s a third argument.

Yes, about law….

WHEN THE MONEY RUNS OUT, THE LAW IS IRRELEVANT

Those benefits will be getting cut. They don’t have enough money. I like the “it’s theoretically paid for” line from Bury — the NJ pension was (and is) grossly underfunded. When the money runs out, will they cut the COLAs for the years where payments weren’t being paid? Or underpaid?

Ultimately, the NJ and Chicago pensions will get cut, either directly or indirectly. Oh, and I’m sure the taxpayers and bondholders will also get screwed. If all parties to this think they’re going to get some sort of federal bailout… nope, the feds don’t have enough money for you, either.

And yes, it will look arbitrary to those on the receiving end of the cuts.

It won’t stop the cuts from coming.

Those who did fully fund their promises, as they should… guess what? They should probably be okay.

And they won’t be interested in bailing out the grasshoppers who didn’t lay by enough for the days of necessity:

IN a field one summer’s day a Grasshopper was hopping about, chirping and singing to its heart’s content. An Ant passed by, bearing along with great toil an ear of corn he was taking to the nest.

“Why not come and chat with me,” said the Grasshopper, “instead of toiling and moiling in that way?”

“I am helping to lay up food for the winter,” said the Ant, “and recommend you to do the same.”

“Why bother about winter?” said the Grasshopper; “we have got plenty of food at present.” But the Ant went on its way and continued its toil. When the winter came the Grasshopper had no food, and found itself dying of hunger, while it saw the ants distributing every day corn and grain from the stores they had collected in the summer. Then the Grasshopper knew:

“IT IS BEST TO PREPARE FOR THE DAYS OF NECESSITY.”

So even if you “win” the court case, public employees, you may ultimately lose.

Compilation of Chicago posts.