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Puerto Rico’s Faux Pension Reform

Ike Brannon

It is official: Puerto Rico has entered into the “Title III”
bankruptcy that many feared would be the ultimate outcome of the
Puerto Rico Oversight, Management, and Economic Stability Act
passed by Congress last summer. This includes the island’s largest
public pension plan, the Employee Retirement System, for which the
Commonwealth commenced bankruptcy proceedings this week.

Some conservatives initially rejoiced upon the passage of
PROMESA, believing that it could prove to be a formula to fix the
pension problems that plague many of the states, especially my home
state of Illinois. That seemed to have been the intent, at least:
When Congress passed PROMESA the House leadership made it clear
that it hoped to facilitate serious reforms across the Puerto Rican
government, including its underfunded pension systems.

PROMESA opens the door to significant pension reform through
three provisions. First, the legislation contemplates that the
board would engage an independent actuary to analyze funding and
the sustainability of existing benefits for any territorial pension
plan that is materially underfunded (as are every one of Puerto
Rico’s pension plans).

Congress passed
legislation that sought to help the commonwealth and establish a
formula for other states, but the resulting plan won’t fix
much.

Second, PROMESA requires that a fiscal plan only provide
“adequate” funding to pensions during the restructuring process
(that is, it does not specify that the board achieve “full” funding
at or near current benefit levels in perpetuity).

Third, it specifies that the Commonwealth and other covered
entities (such as its myriad public corporations) that are
participating employers are afforded the authority to restructure
their pension obligations as well under Title III.

However, it is important to note that the House Natural
Resources Committee responsible for drafting PROMESA clearly
indicated in its section-by-section summary of the bill
that the bill does not “reprioritize pension liabilities ahead of
the lawful priorities or liens of bondholders as established under
the territory’s constitution, laws, or other agreements.”

This provision was included to avoid a repeat of the costly
mistakes made in Detroit, where pension reform was shunted aside
and the city simply got out of its financial morass by forcing
bondholders to take a disproportionate share of the losses, often
out of line with the city’s legal debt hierarchy. To this day,
Detroit cannot access the municipal lending market on traditional
terms.

In spite of these explicit provisions, the oversight board
approved a fiscal plan that does just the opposite while doing
little to reform Puerto Rico’s retirement systems.

The oversight board retained Pension Trustee Advisors, a
Colorado-based firm, to undertake the required review of funding
and the sustainability of the pension system, but this has yet to
be done. Given the alacrity by which the island’s government
embraced bankruptcy,
PTA seems to have been retained instead to merely validate a
pre-wired, aggregate 10 percent reduction in pension
obligations
. This matches an
arbitrary number publicly proposed by the board in a January letter
to the commonwealth
.

This is a missed opportunity and is a manifestation of the
oversight board’s apparent ambivalence toward PROMESA.

The ostensibly independent actuary should have been permitted to
analyze the financial situation and offer creative solutions to
Puerto Rico’s pension problems, where—admittedly—one
size does not necessarily fit all. For example, contractually based
“basic” benefits earned through years of service should be treated
differently than legislatively based “system administered benefits”
(which include assorted bonuses and cost-of-living adjustments)
that might be taken away by the same legislative pen with which
they were bestowed. Likewise, existing retirees should be treated
differently than active employees, whose accumulated contributions
might be returned and invested in a 401(k) style system in lieu of
further accruing pension benefits.

At a minimum, the oversight board could greenlight a reform for
the Puerto Rico Teachers Retirement System—struck down in
2014 on a technicality—that would have provided an estimated
$3.7 billion of savings. There are myriad other ideas that an
engaged actuary and a motivated oversight board could explore to
achieve meaningful and sustainable reform for Puerto Rico.

The lack of serious reform is made all the more glaring by a
recent government move that served to exacerbate the pension issue.
Governor Ricardo Rossello signed into law a single employer
legislation, which creates the risk that all employee retirement
systems liabilities—including those of the commonwealth’s
municipalities and public corporations—could be shifted to
the commonwealth’s general fund. It’s problematic because the
commonwealth and its central government agencies were responsible
for only 60 percent of the unfunded actuarial liability, as just
one of many participating employers.

This faux reform will prove a costly mistake for many
stakeholders. Unfortunately, it seems that both Judge Laura Taylor
Swain, who is overseeing the bankruptcy proceeding, and Governor
Rossello may nonetheless support it. The governor has adopted an
increasingly populist tone toward protecting the pensions in full
since being elected on a platform of working with bondholders.
Meanwhile, Judge Swain recently made a point of stating that her
vision strived to “safeguard pensions.”

If “safeguard” means moving forward without serious reform, then
Puerto Rico is on the path to wasting this golden opportunity
presented by PROMESA to make significant changes to the
government’s various retirement systems that would make them
solvent over the long term. Any short-run political gain of the
sort that seems to preoccupy the current government will only
entail a far larger degree of long-run economic and financial pain,
as a post-Rossello and post-oversight-board Puerto Rico would be
left to grapple with the same spiraling problem down the road with
far less leeway to enact unilateral fixes. The unstated purpose of
the board—as it has been whenever it’s been used—is to
take the political heat off of the government and allow it to do
economically beneficial but politically unpopular reforms. Puerto
Rico’s government seems to not recognize this.

Ike Brannon is
president of Capital Policy Analytics and a visiting fellow at the
Cato Institute.