Detroit Emergency Manager Kevyn Orr’s possible solution of cutting benefits for pensioners of the City of Detroit has highlighted Article IX, Section 24 of the 1963 Michigan Constitution.  To better understand what the drafters of this constitutional provision intended with its inclusion, CRC reviewed the proceedings of the delegates’ debate in the “State of Michigan 1961 Constitutional Convention Official Record.”

This provision was new to this iteration of the Michigan Constitution, as there had not been similar provisions in the 1835, 1850, nor 1908 Michigan Constitutions.  It was initiated for debate among delegates to the 1961 constitutional convention as Proposal 40.  As introduced to the convention and debated on February 6, 1962, the exact proposal was as follows:

The accrued financial benefits of each pension plan and retirement system of the state and its political subdivisions shall be a contractual obligation thereof, which shall not be diminished or impaired thereby.

All such benefits arising on account of service rendered in each fiscal year shall be funded during that year and such funding shall not be usable for financing unfunded accrued liabilities.

Drafters Intentions

There were two primary objectives of this proposal, as the members of the finance and taxation committee (“committee”) put forth.  The first objective was to secure accrued pension benefits for public employees, which the committee felt was not being accomplished at the time.  Previous Supreme Court decisions had regarded pension benefits as a gratuity rather than a form of deferred compensation.  The committee asserted that this provision did not prevent a municipality or public employer from changing pension benefit structures for future employment, but instead, it guaranteed accrued pension benefits for an employee once he or she fulfilled the respective service requirements.  The committee believed that such employees have a contractual right to these benefits, and this concept was reiterated throughout the debate.

The second objective was to require public employers to annually contribute enough money to its pension fund to provide benefits for service rendered by employees in the current year.  All pension plans and retirement systems of the state and its political subdivisions were considered subject to this provision: schools, the state, municipalities, the courts, etc.  The committee deliberately did not require public employers to fully fund benefits accrued during prior years of service as they anticipated it would be an overwhelming financial burden.  However, they wanted to ensure that going forward, the financial burdens for funding pension benefits were not passed onto future generations.  They also wanted to prevent “back door” borrowing, which was considered to be diverting funds appropriated for pensions to general operating expenditures.

The committee did not believe that this provision was all inclusive of what ought to be done in order to keep retirement systems solvent, but felt that it is the maximum of what ought to be included in a state constitution.

The Discussion

The discussion of the proposal (read the proceedings for Proposal 40) primarily included of clarifying questions, rather than any debate with dissenting arguments.  One noteworthy question was the clarification of the term “accrued financial benefits.”  The intent of using this specific terminology was to avoid litigation by individual participants in retirement systems regarding general benefits structure or other grievances besides his/her right to receive benefits.  The committee believed that the contractual right of the employee was limited to the deferred compensation embodied in a pension plan.

Rather than using a “pay-as-you-go” system, the committee envisioned that public employers would develop a funded pension system in which the money could not be used for any other purpose.  If this was violated, an individual employee could defer to the court system, such as an injunction or mandamus, to prevent the employee from diverting the pension funds.  When asked if a public employer would not be able to invoke immunity from legal action if it failed to provide pension benefits when they became due, a delegate from the committee affirmed that this was his understanding.

It was asked whether an employee or employee’s organization could compel a public employer to put aside enough money each year to fully fund pension benefits if they did not do so.  The committee was not aware of any recourse available to compel a legislature or city council to appropriate more money.  Again, it was not intended to require the public employer to actuarially fund benefits accrued during past service, but rather require the public employer to provide the benefits when they become due.  (The actuarial funding of benefits dictates that the amounts that employers contribute each year will be based on estimates and these estimates assume a rate of return on the invested funds.  If investments fall short of the assumed rate of return, an unfunded liability can accrue.  The constitution would only require public employers to make the payments for the benefit earned in the current year, not the shortfall that is potentially building due to annually not making the assumed rate of return.)

Another delegate inquired as to whether this proposal would “hurt” units who have been borrowing from pension funds.  The committee stated that it was designed to prevent cities from using funds designated for pensions for any other purpose.  The provision would “hurt” cities to the extent that they had borrowed against their pension funds.  However, it would not prevent the pension fund from investing in a city’s special assessments, revenue or general obligation bonds.

Four of the delegates who spoke during the proceedings expressed that they had initial reservations about the proposal and were later satisfied by the answers provided.  The only dissenting comments pertained to the language that was used.  The delegate petitioned that committee to re-write it such that it would be “readily comprehensible to a high school graduate.”  That delegate claimed that one of the criticisms of the 1908 Michigan Constitution was that people without a law degree could not understand it.  The committee said that, although they could enlarge the proposal with non-technical vocabulary, their aim was to make it concise, a quality they believed that a constitution should possess.  They maintained that the vocabulary was well-understood by accountants and actuaries, the parties who would primarily deal with these issues.

Conclusion

Proposal 40, with some minor adjustments to the second paragraph, was adopted by the convention on April 19, 1962 with a 117-1 vote.

§ 24 Public pension plans and retirement systems, obligation.

The accrued financial benefits of each pension plan and retirement system of the state and its political subdivisions shall be a contractual obligation thereof which shall not be diminished or impaired thereby.

Financial benefits arising on account of service rendered in each fiscal year shall be funded during that year and such funding shall not be used for financing unfunded accrued liabilities.

The debates over the this provision and its ability to protect pension promises under Chapter 9 bankruptcy proceedings will be a primary focus of the courts and the public over the next several months and years.  The implications of whether the section is held to mean what it says could affect the ability of the state to permit municipal bankruptcies; the City of Detroit to get out from under its unfunded liabilities; and the financial well being of current and past city employees.  The implications of diminishing its meaning, even if only in the limited circumstances of municipal bankruptcy, extend far beyond Michigan’s boundaries.

Michigan is one of seven states with constitutional provisions that expressly prevent the state or its subdivisions from reducing benefits that public employees understood to be in place at the time of their employment.  The Center for Retirement Research at Boston College identifies 34 other states have statutes that expressly define pension benefits as contractual obligations of the governments or have had previous judicial decisions that have ruled the relationships to be contractual.  As such, these states rely upon the Contract Clause in the U.S. Constitution and similar provisions in their state constitutions.

A fundamental question before the bankruptcy court is a determination of whether the constitutional and statutory definitions of accrued financial benefits of their pension plans as contracts between the governments and the workers carry the same weight.  Does the inclusion in a state constitution afford the contract greater protection than inclusion in statutes?  Are public pensions afforded all of the protections of contracts, no more or no less, and so in bankruptcy they should be treated as such and put together with all other contractual obligations of the city?  Or does the wording in the Michigan Constitution “shall not be diminished or impaired thereby” imply some sort of additional protection above and beyond the standard legal protections for contracts?

With the daunting task of writing a new state constitution before the convention delegates and the relative scarcity of municipal bankruptcies in the period leading to the early 1960s, we cannot presume that the delegates had any idea that this would be an issue for consideration in that regard.  In the general context, we can conclude that the constitutional convention delegates clearly intended that the provision should ensure that public employers keep the promises they make to their employees and retirees based on the discussion that followed introduction of Proposal 40 to the drafting what was to become the 1963 Michigan Constitution.  They believed that pension benefits are not just a gratuity, but are part of an employee’s compensation package and should be protected as such.