In Puerto Rico, pensions’ decline pits retirees against lenders

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By Nick Brown

<span class="articleLocation”>As Puerto Rico attempts to sort out its tangled
financial web, retirees may face bigger cuts than those in past
U.S. municipal insolvencies, due in part to an unconventional
debt structure that pits pensioners against the very lenders
whose money was supposed to sustain them.

The U.S. territory is doing all it can to present itself as
a reliable place to invest, but resolving the pensions issue
will require a careful balance. Benefit structures are widely seen as unsustainable, but
draconian cuts to pensioners could deepen the population’s
reliance on government subsidies and compound rampant

“Many of our retirees are already under the poverty line,”
Puerto Rico Governor Ricardo Rossello told Reuters in an
interview this past week, saying any pension cuts would attempt
to protect the poorest beneficiaries. “Impacting them would be
to cast them out and challenge their livelihood.” The tropical island, struggling with a 45 percent poverty
rate and unemployment more than twice the U.S. national average,
is working to restructure nearly $70 billion in debt. Public
pensions, which owe $45 billion in benefits, are also virtually
insolvent after generations of lawmakers ignored growing funding
gaps or botched attempts to close them.

Now the pensions have almost no cash and a nearly 100
percent funding shortfall that is thought to be the largest ever
for comparably-sized U.S. public pensions. Paying pension
benefits out of the island’s general fund, on a pay-as-you-go
basis, could cost Puerto Rico $1.5 billion a year.

A federally-appointed board tasked with managing the
territory’s finances has recommended the governor cut 10 percent
in annual pension costs, or about $200 million. Rossello is
scheduled on Tuesday to present the board with a ten-year
blueprint for the island’s fiscal turnaround, which is expected
to include the proposed pension cuts.


But Puerto Rico’s pensioners will not take deep cuts to
benefits lying down. They have formed a negotiating committee,
advised by Robert Gordon, an attorney who advised retirees in
Detroit’s landmark 2013 bankruptcy, and Hector Mayol, the former
administrator of Puerto Rico’s pensions and also a lawyer.

But their prospects are dimmer than retirees in Detroit,
whose benefit cuts were generally limited to a few percentage
points, or the elimination of cost of living adjustments.

Puerto Rico’s “unusual circumstances mean that it will not
conform exactly” to recent public bankruptcies, in which “judges
reduced creditor claims far more than amounts owed to
pensioners,” Moody’s Investors Service wrote earlier this month. The sheer size of Puerto Rico’s pension gap is one such
unusual circumstance, while the peculiar debt structure that
pits some retirees against the pension’s own lenders is another.

Puerto Rico’s largest public pension, known as the Employee
Retirement System (ERS), covers nearly 100,000 retirees and is
slated to run out of cash this year. In addition to paying
retiree benefits, ERS is on the hook for $3.1 billion to repay
bonds it issued in 2008 – specifically to keep the pension
afloat. Pension obligation bonds are traditionally issued by a
government with the proceeds going to pensions. But Puerto
Rico’s were sold by the ERS itself, and secured by contributions
from public employers – a maneuver designed to skirt the need
for legislative approval.

The pension’s debt service reserves will run out by May,
according to Moody’s.

With additional employer contributions frozen, default seems
likely, setting the stage for an unusual conflict in which
retirees and pension bondholders compete over claims to some of
the same assets.

“This is a significant flashpoint of conflict,” Ted Hampton,
an analyst with Moody’s, said in an interview last week. “Retirees were promised certain benefits, and may have no other
source of income. But ERS bondholders may be people who bought
the bonds to create their own retirement nest egg.”


Like retirees, ERS bondholders have also hired lawyers. A
group led by hedge funds Claren Road and Altair tapped attorney
and bankruptcy guru Bruce Bennett.

The group sued the Puerto Rico government last fall over its
stoppage of pension contributions, eventually settling on a
stipulation to freeze contributions in a trust while debt
restructuring talks play out.

Both groups are expected to absorb cuts, and the competing
claims likely mean smaller recoveries for both sides. The
dispute highlights Puerto Rico’s extraordinarily dire financial
straits, and is indicative of the island’s penchant for testing
borrowing limits in ways that ultimately deepened its hole. The
unconventional bonds not only failed to stave off ERS’
insolvency, they added to its liabilities and muddied the path
to resolution for retirees.

Rossello has said cuts to pensioners outlined in Tuesday’s
plan will be targeted, with the biggest cuts hitting those with
the cushiest benefits. “The most vulnerable retirees are not
going to take a hit,” he said.

But such targeted cuts could run into legal challenges from
pensioners upset at the prospect of unequal treatment for
members of the same pension plan. “There’s no basis by which you could justify that, if a
person worked a set number of years and is getting the pension
the formula dictated,” said Mayol, one of the lawyers
representing the retiree committee.

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