Seasons of change
Long-term economic trends and new accounting standards are bringing more attention to the growing retiree health care and pension liabilities of cities and counties, which are currently unfunded or under funded by billions of dollars. As a result, governments are reconsidering collective bargaining agreements and retiree benefits. For some, municipal bankruptcy may be necessary if they cannot modify their obligations in other ways.
Historically, health care benefits were attractive to workers and their unions because, unlike wages and salaries, they are not taxed. But recently, health care cost increases have steadily outpaced inflation. In addition, an aging workforce, longer life spans and productivity improvements are resulting in more government retirees per active worker than ever before. At the same time, low equity returns coupled with low interest rates have created widespread funding shortfalls in government worker pension funds. The new Governmental Accounting Standards Board Statement No. 45 requires cities, counties, public utilities, school districts, and state funded colleges and universities to account for and disclose their large contingent health care obligations to retired and retiring workers. Those billions of dollars in newly disclosed liabilities may hurt those employers’ bond and credit ratings, making it more expensive for them to borrow.
As a result, local governments are eager to reduce those benefits. But government obligations to retirees sometimes are vested benefits granted by contract, and in many cases, they are fixed at the current levels by collective bargaining agreements. Where benefits can be modified, employers should act quickly to give workers time to plan for the changes. Common changes include freezing pension plans so that no further benefits accrue, eliminating free or almost free health benefits for retirees 65 and older, and separately rating retirees from active employees for the purpose of charging them a portion of their health benefit costs.
Modifying obligations for most government retirees is easier than it is for the private sector. Protections issued by the Employment Retirement Income Security Act, which otherwise prohibit changing vested pension benefits, do not apply to governmental pensions. Even bankruptcy is easier for governments to use in modifying retiree health and pension benefits. Many large private employers, such as United Airlines, have used bankruptcy to shed their retiree obligations. Unlike governmental bankruptcies, there are special protections for retiree medical and insurance benefits and for union contracts in a corporate Chapter 11. Companies must pass stringent tests to show that the changes are necessary for effective bankruptcy reorganization, that they are fair and equitable, that they have been rejected by the retirees’ representative without good reason, and that making the changes is clearly favored by fairness concerns.
A government unit bankruptcy can be enormously expensive and difficult, and because there have been so few city or county bankruptcies, there is some uncertainty about likely outcomes. As governments struggle with increasing retiree liabilities, there will be difficult choices ahead, including, perhaps, bankruptcy as a last alternative.
The author is an attorney and partner with San Francisco-based Farella Braun & Martel.
