In what is described as, “the quickest bankruptcy adjustment in U.S. history,” Central Falls, Rhode Island has reached an agreement to exit from bankruptcy with a plan that will fully repay bondholders (including any legal fees incurred), while slashing worker pensions by as much as 55 percent. None of Central Falls’ workers will get less than $10,000 and all will have to contribute 20 percent more for their health care until they are 65 and eligible for Medicare, according to Bloomberg News. The agreement was reached when the state promised to help supplement retiree pensions for five years.
Bondholders will be repaid via higher municipal taxes, or a four percent increase in property taxes each year for the next five years. No one escapes unscathed, except the bondholders, which is attributable to the fact that Rhode Island passed a law explicitly protecting them from municipal default last year. The bondholder protection law appears to have the intended effect with Moody’s promising to increase Central Falls’ credit rating.
Retirees are understandably upset but it’s important that the cause for plan underfunding be properly diagnosed. Accounting distortions rooted in risky discount rates are to blame. Central Falls’ Police and Fire Plan was deeply underfunded based on numbers that underestimated the liability. That is the lesson to be learned and the inescapable problem facing many other jurisdictions with defined benefit plans in the US. It is in the best interest of governments to accurately calculate their unfunded liabilities with reference to a risk-free discount rate and come up with a plan today. Waiting and gambling on a future market boom doesn’t do retirees any favors.