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(Reuters) — For years, some U.S. states and cities failed to put enough money into their retirement systems, leaving an estimated $1 trillion gap in public pension funds across the country.
Until lately, there was little anyone could do about it. But in two of the states with the biggest pension problems, New Jersey and Illinois, recent reforms allow lawsuits to seek to compel full contributions.
“The newest generation of pension reform says we’re creating an enforceable obligation,” said James Spiotto, a managing director at Chapman Strategic Advisors in Chicago. “That hasn’t really been tested yet because it’s so new.”
The first test comes this week in a New Jersey court, where public sector unions are trying to block Gov. Chris Christie’s move to slash pension contributions to close a huge budget shortfall. An initial hearing is set for Wednesday.
States and cities that repeatedly short-changed their retirement systems exacerbated shortfalls, though the failure to kick in enough money is not the only reason for big public pension gaps. Poor investment returns during the recession and, in some cases, overly generous benefit packages also contributed.
“If public employees can’t stop this kind of thing under legislation designed to let them stop it, then it would make one very, very dubious about the future of defined benefit public pension plans in the United States,” said Sean Anderson, who lectures about employee benefit plans at the University of Illinois College of Law.
New Jersey’s Democratic legislative leaders worked with Gov. Christie, a possible 2016 Republican presidential candidate, to craft the 2011 pension reform. It mandated annual increases in the state’s pension contribution to make up for years of skimping, with a target for reaching the full actuarially required contribution of $4.8 billion in fiscal 2018.
Although the state had been on track to meet the new requirements even as revenue projections proved to be overly optimistic for three years, the challenge became more acute this year after April personal income tax collections fell far short of the mark. Gov. Christie’s administration had to lower expected revenues by $2.75 billion through fiscal 2015.
Rather than raise taxes or pull funding from education or social programs, Christie slashed $904 million from this year’s pension contribution. Then he directed the legislature to cut $1.57 billion from next year’s budget, too.
But a clause in the 2011 reform made state pension contributions a contractual obligation and gave plan participants the right to sue if it’s not met.
The Christie administration has asked the court to throw the case out, arguing the plan is not at immediate risk of collapse and it would be improper for the court to intervene in a fiscal emergency.
David Rousseau, a former state treasurer now with the research group New Jersey Policy Perspective, said there is a conflict between a balanced budget, a contractual right to sue, and the constitutional provision that limits elected officials’ ability to burden future lawmakers and administrations with expenditures that weren’t voter-approved.
“So maybe the 2011 law isn’t worth the paper it was printed on,” he said. “We don’t know if it’s a guarantee yet until the court decides.”
Wednesday’s hearing in New Jersey Superior Court in Trenton comes just five days before state lawmakers must approve next year’s budget.
If the union suit succeeds, it would make Christie’s task of closing the budget hole far more challenging, Rousseau said.
Most states and U.S. territories are now current on their obligations. In 2012, a median 99.6% paid their annual pension costs, including previously unpaid balances, according to data from Richard Ciccarone, head of Merritt Research Services in Hiawatha, Iowa.
New Jersey’s annual pension costs should be making up about 13% of its general fund expenditures, Ciccarone said. That’s compared to a median of 5% for what all states and territories should be paying.
The New Jersey system is 64.5% funded, compared with 87% for neighboring New York.
This is not the first time that unions have sued over New Jersey’s failing to meet its pension-funding obligations. Previous efforts failed, but they predated the explicit right to sue included in the 2011 reform.
A similar clause is included in Illinois’ pension reform enacted this year. A court challenge has put those reforms on hold, but Illinois pension officials are monitoring the New Jersey pension contribution case, said Dave Urbanek, a spokesman for the Teachers’ Retirement System in Illinois.