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Examining the Constitutionality of State Pension Schemes

State Budget Solutions | by Kristen De Pena | January 27, 2012

At the forefront of most state-related discussions is debt; how big the hole is, how big it's going to get, and how to fix it. Debt's lesser-known evil twin, state pension liability, plays an enormous role in determining the answers to those questions. The total pension bill facing states is somewhere between one-half trillion and 3 trillion dollars, depending on who you ask.

The heart of the issue is how these pension schemes overwhelmed states' budget in the first place. More than half of all states have amended their constitutions to incorporate pension provisions, primarily as a restraint on government. Yet, by allowing pensions to drain state budgets and become unsustainable, state legislatures violate the reasoning supporting the inclusion of such rights.  

Why would a state go to the trouble of amending the Constitution to include pension provisions, if the legislature cannot assure citizens that these benefits, and in some cases, these rights, will exist in the future? Below is an analysis of the pension provisions in some state constitutions and how to reconcile the debt that these states face.

California

CA ConstitutionComing in number one on the list of states with the highest unfunded pension liability is California. According to the American Enterprise Institute (AEI), California has $398,490,573 of unfunded pension liability. Interestingly, the California Constitution is one of the longest in the world. The length is attributed to a number of factors, among them, a lack of faith in elected officials. The California Constitution includes individual rights that are more broad than in the federal Bill of Rights, suggesting that Californians placed a lot of emphasis on protecting individual liberties and ensuring the government does not have an undue influence on the people.

The California Constitution specifically addresses public pensions in Article 16, Sec. 17. Here, the Constitution states:

Notwithstanding any other provisions of law or this Constitution to the contrary, the retirement board of a public pension or retirement system shall have plenary authority and fiduciary responsibility for investment of moneys and administration of the system. [Emphasis added].

The "retirement board" refers to the entity of administration. In addition to the broad duties stated above, the Constitution highlights in detailed subparagraphs that the retirement board has "sole and exclusive fiduciary responsibility" over the system and makes a point to emphasize that the board is to act in the interest of the beneficiaries, with "the care, skill, prudence, and diligence under the circumstances then prevailing that a prudent person acting in a like capacity and familiar with these matters would use in the conduct of an enterprise of a like character and with like aims."

The idea of a "fiduciary duty" is generally used in a business, contractual context, and its usage, combined with the detailing of specific duties, indicates that the drafters of this Constitutional provision placed the utmost trust and confidence in these members to manage and protect the pension account. Requiring the same care and diligence of a "prudent person" mandates that these members exercise discretion and average intelligence in making investments that would be generally acceptable as sound.

So, how can Californians reconcile this sacred duty with the grossly negligent actions of the retirement board in allowing the state to accrue the highest pension liability in the nation? It is readily apparent that the spirit of the California Constitution is no longer of any importance. A solid case can be made that allowing the accrual of such impressive pension debt satisfies neither the "fiduciary duty" nor the "prudent person" requirements. Given the rich history of the California Constitution and the emphasis placed on maintaining individual rights, Californians should be in an uproar about the fiscal state of their retirement benefits system.

Illinois

In comparison to the lengthy, detailed provisions of its California counterpart, the Illinois Constitutional provision regarding pensions is short, but its purpose is abundantly clear. Article XIII, Sec. 5, Pension and Retirement Rights, states:

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. [Emphasis added].

As the title of the provision demonstrates, the drafters of the Illinois Constitution intended this provision to convey a right, rather than simply a benefit. One interpretation is that the drafters intended to liken the receipt of pension benefits to those rights guaranteed in the Illinois Bill of Rights, which includes well-known rights such as religious freedom and due process and equal protection. This type of correlation should not be taken lightly; according to the Supreme Court of the United States, even education is not a "right" granted to citizens by the federal Constitution.

Of additional importance is the language stating that receiving pension and retirement rights is an enforceable contractual right. This language indicates that the right to sue alleging a violation of this right is on the table. The extent of that ability is somewhat arguable, but including that type of language again demonstrates the importance of the provision, that the drafters truly intended to make access to pension funding a reliable promise. And yet, Illinois ranks second in its abysmal pension funding failure, with $192,458,660 in unfunded liability.

New York

Similar to the Illinois Constitution, the New York Constitution also guarantees that receiving pension benefits, once bestowed, is an enforceable contractual obligation. Unlike Illinois, however, New York does not label the receipt of benefits a "right." In full, the New York provision, Article V, Sec. 7, Membership in retirement systems; benefits not to be diminished nor impaired, states:

After July first, nineteen hundred forty, membership in any pension or retirement system of the state or of a civil division thereof shall be a contractual relationship, the benefits of which shall not be diminished or impaired. [Emphasis added].

Ahead of its time, New York was one of the first states to adopt a pension provision in 1940. Despite informal "promises" made to veterans of the Revolutionary and Civil Wars, civilian pensions didn't come around until 1920, and the Federal Employees Retirement System (FERS) wasn't implemented until 1987. Still, New York incorporates numerous references to pensions throughout the state constitution, but its format is similar to that of Illinois, as opposed to the lengthy format found in the California Constitution.

As one of the early adopters of such a provision, drafters of the New York Constitution presumably placed emphasis on the importance of a reliable pension system. Nonetheless, New York ranks number four on the list of states looking at massive debts associated with funding current pensions, let alone future payouts.

What This All Means

Breaking down the duties that states owe to citizens participating in the public pension system can lead to a number of outcomes. It is not possible to simply cut public pension benefits without considering a host of legal concerns. State governments must consider beneficiaries suing for injunctive relief to block reforming earned or vested benefits. A takings clause violation pursuant to the federal Constitution may be asserted, claiming that cutting benefits constitutes a property rights violation. Basically, any action that will limit benefits may well end up costing the state more in expensive litigation than gained instituting the cuts.

And litigation is already occurring nationwide. In 2010, a group of Minnesota retirees sued the state for attempting to decrease cost-of-living adjustments. That suit, and a similar Colorado suit, were thrown out after the court found that the retirees do not have a constitutionally protected cost of living adjustment guarantee. The holding did, however, reiterate that the retirees do have a contractual right to their pensions. A lawsuit alleging a violation of that right is on the backburner until a plaintiff asserts a violation after not receiving his/her full pension.

Looking Forward

Comparatively, states that do not include constitutional pension provisions, such as Delaware, Idaho, and North Dakota have better funded pension plans and less than $10 million in unfunded pension liability. Whether the correlation is a coincidence is debatable, but it does suggest that a state constitutional provision does not ensure proper pension funding, and the lack thereof does not abdicate the state from adequate pension administration.

On the whole, many state pension systems are in shambles, states face the problem of being accountable for the promises made to their residents in the highest legal document and balancing their budget for the present and in the future. States need to reform their pension systems so that they do not break legal contracts with or violate the guarantees to its citizens.  Defined contribution retirement plans are step in the right direction.  Defined benefit plans guarantee specific levels of service regardless of cost, whereas defined contribution plans establish a fixed payment toward services, similar to a 401(k). Some 84% of state and local workers enjoy defined benefit plans compared to 21% of private-sector employees.

Instituting defined contribution plans would help end the endless cost escalations of non-salary compensation, but states must also address the massive problem of pensions for employees enrolled in defined contribution plans. Lousiana's Gov. Bobby Jindal recently introduced a plan for pension reform that includes raising the retirement age and shifting employees to a 401(k)-style plan. Jindal's explanation applies to many states, not just Louisiana.  He said, "The path we are on is unsustainable and irresponsible, and if we don't act now to reform state pension systems, then the state will be forced to chose among several unacceptable options: break our promise to workers, be forced to cut critical services like higher education and health care, or saddle future generations with debt and higher taxes."

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