A 19-year COLA freeze cuts a pension by $13,000 by the end
October 20th, 2011 at 2:09 pm by Ted Nesi under Nesi's Notes
The average Rhode Island state worker’s retirement income would drop from $52,000 to roughly $39,000 over the course of a 19-year freeze on cost-of-living adjustments, estimates by the state’s actuary show.
While the dollar amount of a retiree’s pension check would not change over the course of the 19 years, the continuing rise in the cost of living would slowly erode how much the benefit can buy. That reduces its value in practice, though not in nominal dollars.
The average state worker who retired over the last three years earns $52,000 a year in retirement, with a pension benefit of $33,000 and a Social Security benefit of $19,000, according to the charts shown below, presented by actuary Joe Newton of Gabriel Roeder Smith & Co. to the pension advisory group in September.
The new Raimondo-Chafee bill would suspend pensioners’ COLAs until the state system is 80% funded, which will take an estimated 19 years, unless they receive $20,000 or less. Retirees could keep any COLAs they received in prior years, but they would not get new ones for the duration of the freeze.
This chart Newton prepared for the advisory group shows how the average state retiree’s purchasing power would change over a 29-year period under four different COLA policies. The blue line at the bottom shows the reduction over time if no COLAs are granted:
The proposal raises an additional set of concerns for municipal employees whose communities do not let them collect Social Security, which includes as many as half of teachers in Rhode Island. With no Social Security benefit, their $33,000 in pension-only retirement income shrinks to $19,000 over 19 years.
Put another way, the average retiree without Social Security would lose 42% of their purchasing power, while the average retiree with Social Security would lose about 25%. Here’s Newton’s chart for those without Social Security:
Update: Two clarifications.
First, as Al and Paul correctly point out in comments, the $13,000 loss is only for the final year (i.e., year 19) of the COLA freeze – the retiree’s cumulative loss would be much more than that, because the retiree lost, say, $12,500 in year 18, $12,000 in year 17, etc. As they note, the cumulative loss would be in the six-figures. I’ve tweaked the headline in an effort to make that clearer.
Second, a reader caught what appears to be an error in Joe Newton’s charts shown above:
Current retirees only receive the 3.0% COLA in the third January after retirement (for other employees it is the third anniversary after retirement). At a bare minimum then, a retiree goes two full years without a COLA after retirement.
Thus, the red lines on the graphs are inaccurate as they assume Full CPI COLA immediately upon retirement.
Tags: COLAs, cost of living, general assembly, pensions, raimondo-chafee, state government, teachers
Nesi's Notes covers politics and the economy in and around Rhode Island for WPRI.com. (Twitter: 
Issue: Does the “important public interest” concept trump constitutionally protected contract rights and the law contract principle of promissory estopple?
The Law:
RI’s COLA statute states “for life” per RI General Law 36-10-35. RIGL 36-9-2 states that state employees’ participation in the pension system is contractual. State retirees are collecting COLAs and pensions that are “vested”. This kicks in constitutional contract protection arguments – No ex post factor laws, no government action to change executed contracts. They also relied upon these laws when making retirement financial decisions.
The Facts:
There is a critical financial crisis, billions of unfunded liability, caused by greedy and ambitious RI politicians and budget directors. Allegedly, there is no money but no effort has been made to reduce the state or municipal expenditures particularly via regionalizing municipal functions into county governments or serious tax reform.
RI’s has a unique legal history and fact pattern that may prevent the application of other jurisdictions legal conclusions : 1. The COLA statutes awards 3% compounded per year and it is not based on any underlying formula that would permit change as courts have found in some other states. 2. The legislature has never changed current state retirees’ COLAS. Therefore there is no legislative history of COLA changes for state retirees as courts have found in some states. 3. The legal doctrine of promissory estopple. Retirees relied in good faith on the annual COLAs when making important retirement financial decisions. In litigation the state will hard pressed from saying for life did not mean life.
The State’s Case:
The state will present two arguments, legal and equity: 1.There is no contract. In the event the court finds a contract then the state will argue that there is an “important public interest” that prevails over any contract. 2. Despite intentionally not funding the pension plan, the state will probably present an “equity/moral” argument based on the premise there is no money to fund essential public functions such as education, transportation, public safety, etc.
The state’s case faces two problems: It intentionally did not meet proper state funds to match employee contributions. It was the state that created the unfunded liability. In equity matters, only those with clean hands can seek an equity relief in court.
Secondly, once the state presents the funding of essential functions argument, it will be pressed to open the financial books to prove, perhaps over the last several decades, that funds were used exclusively for essential state functions and not to further the interest of greedy and ambitious people. (Only 19% of the state’s 7 billion dollar annual budget is spent on personnel. How much of the remaining 81% is actually spent on essential state functions? )
The Courts dilemma:
The court can take the position that the legislature, duly elected by us, under the
Constitution is the only body empowered to raise and allocate public funds and, therefore, the courts cannot review legislative budgets, past or present. The state’s financial books remain closed.
However, the court probably cannot escape its responsibility to determine to what extent the “important public interest” concept can reduce pension benefits, i.e., impair existing contracts. Also existing in law is the matter that employees do have a “reasonable expectation” under the compulsory contract created in the state pension statute.
Practical solution:
The political drama and road show should be put aside. This is a legal matter with grave consequences for current retirees, taxpayers, and the solvency of the State of RI. and its municipalities. Legal issues can be framed by the RI Gen. Assembly and presented to the RI Supreme Court for quick disposition saving taxpayers’ dollars, retiree angst and, by passing the buck. It also is a slick move by politicians to save their careers.
Alternative: Let retired state employees’ voluntarily enter new contracts temporarily waiving the 3% compounded COLA replacing it with the Social Security CPI based COLA with the added provision that those who voluntarily assist the state at this time of economic crisis would receive any increase in COLA awarded in the future.
TLAW, two questions. First, what mechanism would you use to make that request of retirees? As we saw in Central Falls, just asking may not lead to many people agreeing (though that proposal was far more Draconian than this). Second, what do you mean “replacing it with the Social Security CPI-based COLA,” since most pensioners already get Social Security anyway?
1. Letter format with attached legal waiver to compounded 3% COLA for life coupled with an invitation to a series of local debates about what the stakeholders can lose in litigation.
2. Replace COLA with non-compounded COLA based on consumer price index issued in Sept. of each year that provides formula for Social
Security. Granted, the Soc. Sec. formula understates inflation, but a carrot could induce many to consent when faced with the prospect losing all COLAs for life from an adverse court ruling.
Frankly, the stakes for both sides in litigation are enormous. The state may lose and have to pay huge amounts through tax increases and service reductions. Current retirees could lose COLA for life.
Those current employees with state pensions over a certain amount, should be asked to forfeit COLAs for 5 years, not 19 years that is essentially life.
It is time for the wealthy to assist in this crisis. They are currently benefiting from the lowest tax rates in decades. Historically, they earn more when the masses have more to spend.
Sadly, the pension crisis is just a symptom of critical unaddressed structural issues facing RI state and municipal governments. Part of the pension reform should be replacing municipal with county governments, and ending funding for non-essential programs. 81% of the state budget is for contracts while 19% is for personnel.
The stakes for both sides in litigation are enormous. The state may lose and have to pay huge amounts through increased taxation. Current retirees could lose COLAs for life.
If I have failed to answer the questions, just let me know.
I hope you’re right, because I, for one, am a little bit worried. Things are quickly spinning out of control, with all kinds of groups jumping in against retirees (see journal’s piece or wait for it here) where they mention Cato Institute amongest others.
Here’s the Projo’s brief referenced by Paul on the Cato &c scholars who plan to weigh in on the pension plan:
http://news.providencejournal.com/breaking-news/2011/10/new-ri-think-ta.html#.TqCBvPEzKPR
Hi Ted, the title of this article may very well mislead retirees. Their loss is not $13,000 under the plan.
To calculate the retirees loss you would have to calculate what is owed to the retirees over an actuarially assumed remaining life span for the contracted COLA. That is the amount of their loss, and I’m certain it will average well over $100,000 per retiree over their remaining years.
Also, have you followed pension discussions in other states. Much of what Raimondo uses as talking points is verbatim from elected officials in other states you have attempted to take earned, accrued, fully-vested, contracted COLA benefits.
Al, that’s correct – and I wasn’t intending to mislead. (The perils of headline-writing.) I’ve added a clarification to the original post to make that clearer.)
I don’t doubt that the treasurer is using similar statements as officials in other states pushing for the same policies.
The $13000 is the loss in the final year. I did a quick spreadsheet assuming an inflation rate of 2.54%. The loss of the 3% compounded cola for 25 or so years showed a CUMLATIVE loss of over $200,000 in one case with no SS.
How can RI judges hear any of the legal arguments you cite above? They have a conflict of interest and stand to personally gain financially from their rulings. In the case of such an overwhelming conflict of interest, can such lawsuits be heard by another state’s judiciary or the federal judiciary? How can the taxpayers get a fair ruling? Also, the costs of litigation will be huge — can these costs be paid for from the 48% funded pension liability as the outcomes benefit state-union covered employees and retirees vs the taxpayers?
Deborah,
Did you forget that the people collecting the pensions and paying into the pension system are taxpayers too?
This same group of people are paying for your Social Security? I don’t have Social Security. I would never support cutting the benefits that you have paid into your entire life.
I think that the people in the state need to stop turning on each other and start addressing the real issue – tax breaks to the rich, and corporate greed.
I think you will find that most teachers and state workers are willing to make a sacrifice as long as it is fair. This was heard over and over again. I would like to have the facts straight first. If you watched the hearings there are a lot of unanswered questions.
Peace!
[...] workers will begin to see their incomes erode at an alarming rate over the next two decades. From Ted Nesi, God Bless his young heart for doing some actual reporting. The average Rhode Island state worker’s retirement income would drop from $52,000 to roughly [...]
High stakes
Nothing drops as it is projections of growth. It is simply “never realized”.
Don’t get me wrong, I would be furious if it were my pension. But your leadership and the Dems are accountable for leaving the plan on shaky financial grounds for decades. This did not happen in many states across the US. How did they do it? Those other states did it by using conservative fundementals, not gambles that the stock market would take care of this problem.
Other states have the same type of investment portfolio as ERSRI. The fgact is, despite a poor decade of performace by ERSI and other state pension systems, the systems actually have beaten their investment return assumptions over a prolonged 25 year period.
The problem in RI was not “gambling” on returns. The problem is that the fund was created in 1936 and only employee contributions were collected until the late 1970s. That’s four decades of not state contributions under the arrogant assumptuion that “we’re the state, we’ll always be here, and we’ll always pay our debt.” Since the 1980s, the state has been dligent (with some notable exceptions) at paying the contributions necessary to bring the fund into balance. So it’s simply wrong to blame current politicians (despite my own temptation to do so) and union leaders for the problem. In sum, the problem is that state workers and teachers priovided services in the 1950s, 1960s, 1970s etc, and they are notw retired and the state failed to put money away for them. Other states did a beter job of prefunding and whern the stock market took off in the late 1990s, essentially doubling in a 4 year peruiod, they reaped enormous rewards. Unfortunately, at that tiome, RI had not socked away enough funds in the pension so they did not get as much benefit. Then, just when RI waws getting close to catching up, we had two almost unprecedented (in the post WW2 era) market declines in the same decade (2001-2 and 2008-9).
A sad story indeed. But there are not many villians among the living. Of course that does not excuse the Treasurer’s larcenous proposal to solve the problem, which is owned by all taxpayers, by relieving 40% of the the taxpayer burden and putting it on active and retired workers. This, at the end of a decade where the most wealthy citizens have been provided with two enormous tax cuts at the state level and similiar cuts at the federal level.
All taxpayers own the problem because the unfunded service, from the 1930′s through the 1970s, was provided to all taxpayers. Current workers and retirees do not somehow have a special obligation to pay for that service.
The numbers are calculated for a state worker and not a teacher (straight COLA vs “compounded” COLA for teachers) The compounded COLA makes things worse of course.
But of course this is going to be challenged in court. And based on the current ruling by Judge Taft (her written statement that “a pension and a COLA are one”), the state is on shaky grounds. So assuming Judge Tafts ruling holds up, the debate on COLA’s, and the size of the savings, is academic until we know that outcome.
What I would really like to know is what percentage of the $3 billion in projected savings is coming from just the COLA suspension. If we lose that legal argument, how much have we really saved and thus were more Draconian measures needed. We are putting our hope on a very shaky foundation.
Gary, I thought state workers still received “compounded” COLAs even after the 2005-2010 changes. Is that incorrect to your knowledge?
Headline should read “A 19-year COLA freeze cuts a pension by $13,000 in the 19th yr”
The 19-yr COLA freeze reduces future pension dollars by 75.4%, for a retiree already receiving a 3% COLA (Your do the math). The headline is misleading. The $13,000 referred to is the reduction is purchasing power over the same period.
It takes 23.45 yrs for the pension benefit to double. The clock starts when the first COLA is received (assumed COLA rate is 3%).
My calculation, assuming a 3% cola, is that the pensioner loses $178,676 through the 19 years (with a 2 year wait). He/She loses $535K over 30 years.
The discussion of what a retiree receives should only include ERS payments because this is the issue that is being discussed. Adding social security
to the argument just adds more confusion and is used to make it look like a retiree doesn’t need any more money than what they are receiving. Depending on your years of paying into social security and what your wages were determine what you receive. Saying that someone averages $13,000 a year can be very misleading.
Also, nowhere in the reform bill does it state how a 401k plan would be administated and this is a big piece of the reform bill. More details need
to be in the bill. What would the investment options be for an employee and who would run the fund?
There is also a formula for reducing someones pension
if they are not 62 when they retire. What is the formula?
Lastly, if the pension system needs cash why would a hybrid plan be used
to divert employees money away from it?
The hybrid is a subterfuge to reduce benefits going forward and increase the reirement age. By reducing the pension accrual to 1% per year, they can essentially combine that with the existing cost rate structure to lower the required contribution to the plan. This actuarial methodolgy. Despite what the Treasurer says, they are not “freezing” accruals, they are devaluing existing accrued benefits by raising the retirement age. This is likely to be found illegal.
For retirees that are receiving a 3% COLA already, the 19-year freeze equals a 75.4% reduction in benefits that would have been received over this period.
So retirees are not only being told they will not receive over 75% of their future pension dolalrs but must now brace themselves for a reduction in their purchasing power.
How on earth can anyone see this as fair?
Why are elected officials EXEMPTED in this legislation?
What do you mean? The COLA freeze applies to them, too.
[...] prescription for pension reform will be a painful one, especially the COLA freeze that could mean nearly two decades of eroding purchasing power for retirees, some of whom don’t receive Social Security. Does that worry [...]
[...] Katz acknowledged The Poverty Institute worries about the erosion of purchasing power the COLA freeze will cause for those who get a [...]
Put another way, the average retiree without Social Security would lose 42% of their purchasing power,
No, the loss in purchasing power depends on the change in prices of the goods and services over time. This is highly dependent upon the individual consumption behavior of each retiree. However, for aggregate purposes, what is the change in prices over the next 19 years was 0? Then there is no loss in purchasing power.
Unrealistic you might say. Okay – but in 3 of the last 19, the COLA adjustment for Social Security has been less than 3%. In looking at the yearly inflation rate, only in 5 of those years has the rate been greater than 3% — and one year it was negative (09).