We’ve been hearing about municipal bankruptcy and Chapter 9 a lot over the past few years. But to what extent has this become the norm?
Very little, according to a Governing analysis of eligible local governments that have filed for bankruptcy protection. In fact, there have been a total of only 680 bankruptcy filings since 1937.
Still, financial analysts are sounding the alarm on potential defaults amounting to billions of dollars due to underfunded pensions and retiree healthcare benefits (the latter of which are a large contributor to what is collectively known as other post-employment benefits, or OPEB). This is instilling fear in many of our cities.
We’ve all heard that pension funding, in aggregate, has been declining. But what we need to recognize is that there are both successful and struggling players.
Chapter 9 of the bankruptcy code provides a financially-distressed municipality protection from its creditors while it decides how to deal with its debts. It is more commonly used by small municipal utilities and special purpose districts, or municipalities and counties with a relatively small debt profile. One exception to this rule, of course, is Detroit in 2013.
A municipality can file for bankruptcy only if its state government authorizes it. While 12 states specifically authorize it, over 20 states do not, either failing to clarify relevant laws or prohibiting filing altogether.
Pension and retiree funding have changed over time. Whether the laws are clear or not, municipalities should educate themselves on the state of their pension and retiree healthcare funding well before they even dream of the word “bankruptcy.”
Before jumping to conclusions that declining pension funding could portend a potential default, our cities need to be asking the right questions. As Natalie Cohen writes in her recent blog, the most important question municipalities should be asking themselves is, “what caused the decline?”.
Cohen gives two potential reasons: 1) Officials may have taken recurring “payment holidays” and skipped required contributions, or 2) Officials may have lowered their discount rate assumptions, in which case municipalities would need to accumulate more assets to meet their liabilities than if the discount rate were higher.
Beyond the basics, to see if a government is headed toward bankruptcy, Cohen recommends that we look at the cost of fixed obligations as a percent of the government’s budget. This means that municipalities should take their total budget and scrutinize what part of it should be — instead of what is actually—going toward debt service, pensions and retiree healthcare.
A few states that are already using this approach are West Virginia, Maine, Rhode Island, Louisiana and Michigan.
While Chapter 9 bankruptcy filings have historically been low and should only be considered as a last resort for many municipalities, it is important to understand the state of pension and retiree healthcare funding in your city:
- If funding has been declining in your city, why?
- How have potential changes to actuarial assumptions impacted the funding in your city?
- Has your city considered what it should be contributing rather than what it is contributing?
About the Author: Anita Yadavalli is the Program Director of City Fiscal Policy at NLC. Anita leads NLC’s Public Sector Retirement initiative, with a focus on research and education for city leaders on retiree healthcare benefits, as well as research and programming on other city fiscal policy issues. Anita holds a Ph.D. in Agricultural Economics from Purdue University, an M.S. in Food and Business Economics from Rutgers University, and a B.S. in Environmental and Business Economics from Rutgers University.