Fiscal train wreck could leave state pension fund 'out of luck'

John Horak

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By John Horak

Over backyard beers and burgers with some friends this summer, a neighbor started a conversation about Connecticut's dismal finances. He grumbled about the billions of “debt” the state owed to its bondholders and the billions of “debt” owed to its underfunded pension plans. He said he had abandoned hope and is planning to move before the fiscal train wreck occurs.

Lawyers seldom miss opportunities to show off, so I tossed modesty aside and offered a technical correction to his comments.

“You realize,” I said, “that the amount owed to bondholders is debt in the legal sense, but that the state's obligation to alleviate the pension underfunding is not, even though it is commonly referred to as debt.”

He asked curiously: “Does this mean there is room for hope?”

“Well,” I said, “there may be a glimmer if the pension funds and retirees understand the difference, which is that people to whom the state is indebted (bondholders) are owed a fixed non-negotiable amount and can sue the state if they are not paid; but the pension funds are owed a variable amount that's easier to negotiate and they cannot sue if the state stops making payments to remedy the underfunding. So, if the train crashes the bondholders will be paid in full — but the pension funds will be SOL (sorrowfully out of luck), and retirees will be forced to live on what's already in the plan's coffers — or pennies on the dollar.”

My explanation drew stares of skepticism, so I offered the following clarification:

First, the starting point is the doctrine of “sovereign immunity,” under which state government cannot be sued on any obligation (including its debt) unless it actually consents to being sued or has waived immunity in advance.

Second, a bond represents an actual loan to the state. It recites the principal, interest rate and maturity date, similar to a bank loan to buy a car. When the state needs cash it goes to Wall Street where underwriters solicit investors to buy its bonds. Investors would not buy bonds (a bank would not make loans) if they could not sue in the event of nonpayment.

Consequently, there is a statute waiving sovereign immunity for bondholders, which states that the courts “shall have jurisdiction to enter judgment against the state founded upon any express contract between the state and the purchasers … of bonds,” and that if sued the state has all legal defenses “except governmental immunity … .”

Third, the state's obligation to the pension funds is the result of an actuarial (mathematical) calculation (a highly professional guesstimate) of how much more must be set aside in the retirement plan coffers to be able to pay in full the benefits promised to current and retired employees.

Unlike the bond debt, the unfunded amount is variable. Retiree longevity and lower investment returns on monies already set aside will increase the amount that must be added, whereas early deaths and robust investment returns will do the opposite — as would a voluntary agreement to negotiate a reduction in the size of the retirement benefits.

Fourth, sovereign immunity would prevent the pension funds from suing to compel the state to make the additional contributions needed to reach full funding. This conclusion is explained in a Nov. 2014 paper prepared for the Connecticut Policy Institute by William and Mary Law School Professor Christopher Griffin: “Connecticut's Public Pension Liabilities — How Big They Are and What Can be Done About Them.”

In his words, the state “cannot be compelled to make additional payments into its pension funds … [which] means that the state could decline to pay its annual actuarially required contributions and that the state cannot be compelled to pay out its pension benefits in the event that the underfunding leads to insolvency [of the plans].” Griffin speaks only to the obligations to make additional contributions to fix the underfunding, not to monies already set aside in the pension funds to which retirees have legal rights.

My neighbor asked quizzically, “Are you saying that the state should not pay its pensions?”

“Not at all,” I replied. “What I'm saying is that the state does not have unlimited resources, and if the fiscal train really crashes, bondholders will be in the courthouse getting paid in full, but the pension funds will be standing outside on the sidewalk dealing with angry retirees.”

“So,” my neighbor said, “I think I understand, but still don't see the reason for hope.”

I replied, “The hope is that the pension funds and retirees realize they are caught in a predicament both circular and ironic. The Connecticut train is in danger of going off the tracks because it is over laden with pension promises it can't afford, but if it goes off the tracks it's retirees who depend on the pensions who will be SOL.

“We can hope,” I said, “ that the pension funds will realize that a reasonable negotiated reduction in promised retirement benefits will stabilize the train and provide greater retirement security (albeit with reduced benefits).”

“Hmmm,” my neighbor murmured. “I think I understand, but what if this does not happen?”

“Well,” I said as I poured another beer, “in that case there will be an exodus of folks buying one-way train tickets to destinations better able to keep their financial affairs in balance.”

John M. Horak has practiced law at Reid and Riege P.C. in Hartford since 1980. The views expressed are his own.

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