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Cities Struggle to Finance Pension Plans

Posted by admin On June 16th

Many Florida communities, including three Southwest Florida cities, are pumping millions to shore up municipal employee pension plans.

Nov. 15, 2011  

Written by

Denes Husty III


Included in the proposed reforms is reducing the amount the city sets aside for retirement from 3 percent of an employee’s salary a year to 1.6 percent. Tom O’Malley, president of the general city employees union, said that for an employee earning $50,000 at retirement after 30 years on the job, that would decrease his or her annual pension from $40,000 to $30,000 annually, a 25 percent decrease.
As an alternative, he said the union proposes to increase the amount of salary that employees contribute to their own retirement from 3.1 percent to 6 percent. Firefighters contribute 8 percent of their salaries and 106 police officers contribute 10 percent of their wages to their respective pension plans.

In Cape Coral, costs for life and health insurance benefits for employees were factored into the institute’s calculations for pension plans, said Connie Barron, city spokeswoman. She said the city meets those costs annually.
The city set aside $1 million two years ago to start saving for those insurance costs. No extra money for long-term funding was set aside this year because the city is re-evaluating factors involved in calculating the costs.

 Pension plans for employees of three cities inSouthwest Floridaand other large communities across the state received average to failing grades in a recent report, meaning millions of taxpayer dollars are being diverted to shore up funding.

The nonpartisan LeRoy Collins Institute – working with the state university system – gave F grades forFort Myers’ general city employees, police and firefighters, based on 2009 records.Naplesreceived D grades in all three categories, andCape Coralreceived C grades for police and firefighter pension plans and a D for other city employees.

BonitaSpringsand Sanibel were not included because the report focused on the 100 largest cities inFlorida.

Higher grades mean plans are mostly self-sufficient or there are enough assets to cover pensions. An F grade means less than 60 percent of the plan is funded at the city level.

“We are looking at pension reform. We’re not pleased. Who would be?” said Debra Emerson, the city ofFort Myerspension plan manager.

The report states that Cape Coral– along with Miami, Jacksonville and Hollywood– has initiated pension plan reforms after facing budget shortfalls. Naples officials said they have also made recent changes to bring up their grades.

The poor grades don’t mean that employees won’t get their pensions but that more taxpayer money must be used to help. This is money that could instead be spent for services instead of retirement benefits for municipal workers, said David Matkin, assistant professor inFloridaStateUniversity’s Askew School of Public Administration and Policy, who contributed research for the report issued this month.

“Escalating pension costs mean that taxpayers are on the hook to make good the promises made on the pensions,” Matkin said. For example, about $40 million was needed to shore upFort Myers firefighters’ $81.7 million pension plan, money that could have been spent elsewhere if the plan were fully funded, according to Matkin’s findings. Specific Fort Myers city and police dollar amounts were not readily available.

Connie Barron, spokeswoman for the city ofCape Coral, said in 2009 the liability for the city’s general employee pension fund was $189 million and the assets were $117 million. Barron stressed that the 2009 numbers were static and assumed no changes in the plans since then. She said the city had more than 80 percent coverage in 2007 – a grade of “B” – but a buyout in 2008 bumped up the liability/asset ratio and dropped the grade.

Cape Coral was 70 to 80 percent funded for police and firefighter pension plans in 2009 and 60-70 percent funded for general city employees pension plans. Specific dollar amounts were not readily available for police and firefighter plans.

Naples police, fire and general city employee pension plans were between 60-70 percent funded in 2009.  Specific dollar amounts for Naples were not available.

Matkin said theFort Myers plan would need contributions of at least $32 million to bring the grade up to an “A.” Barron said theCape’s general employee pension fund would need an additional $53 million in assets to raise its grade to an “A.”

Consultants from Foster & Foster, an actuary firm that works with public pension plans inFlorida, disputed the Collins Institute report and said the findings were based upon information officials there didn’t understand and that assigning grades to the plans is too simplistic.

‘Basically broke’

Times are tough inFort Myersand ways have to be found to provide money for other needed services, saidFort Myers attorney and taxpayer Neil Potter.

“The city’s basically broke. They’ve let half of code enforcement go,” Potter said. He said that means there aren’t enough people to clean up abandoned properties, which is a vital service.

Matkin said that pension reforms, including cutting benefits and requiring more employee contributions, are needed.

The poor economy might be responsible for dropping a pension plan’s grade by one letter because of poorer returns on stocks, bonds, mutual funds and other investments, Matkin said.

However, he said the major cause of a bad grade resulted from increases in benefits.

“In many situations, there are higher pay increases during the end years” just before retirement that bump up pension obligations, Matkin said.

That leaves many pension plans underfunded for the long term and cities have to refinance the obligations over terms as long as 30 years to keep up, Matkin said.

For example, the Fort Myers General Employees Pension Plan in 2009 was only funded at a rate of 52 percent, or 52 cents on the dollar, the study shows.The city’s firefighters’ and police pension plans were both funded at almost 51 percent.

One reason for the Fort Myers’ plans failing grades are the more than 200 employee buyouts initiated citywide in 2008, the year before the statistics were compiled, said Matt Galewski, chairman of the firefighters pension fund, which has 167 members.

“It increased the unfunded liability of the plans tremendously by giving employees four more years under the buyouts,” Galewski said.

Indeed, “it was a sweetheart deal for those who took advantage of it, but we’re paying for it now” with a larger unfunded portion of the pension plan with some 548 members, said Tom O’Malley, president of the general city employees union.

Galewski said he doesn’t foresee a change in the plans for firefighters and police, until the current contracts expire in two years.

“The only way the grades would change is if we have a greater return on our investments,” Galewski said. He said that the firefighters’ plan used to get a 15 to 20 percent return on investments, but the current bad economy has dropped that to 8.5 percent.

Pension reforms are now being negotiated withFort Myersgeneral city employees in current negotiations to renew their contract, which expired last year, Emerson said.

“I’m thinking if we can get to a C or B grade, that would be our goal in the short term,” she said.

 Actuaries and Consultants

Foster & Foster Memo

 Regarding: Leroy Collins Institute Article, “Report Card:FloridaMunicipal Pension Plans”

Never before in the 32 year history of Foster & Foster have we felt compelled to issue a public response to a publication regarding Florida public pension plans, but the recent Collins Institute report was so far off the mark, we felt an immediate desire to respond.

As the actuaries for nearly 200 public pension plans in the State of Florida, we are qualified to comment on the accuracy of the findings in the article. It should be noted that our firm shares in the Institute’s objective of attempting to improve transparency and increase public awareness of all pension funds in the State. With that said, however, the findings in this report were based upon actuarial information that the Institute clearly does not understand. While our objective in this response is not to attack the Collins Institute or the individual authors of their report, we feel a responsibility to correct many of their findings so that plan sponsors, taxpayers, and members of these plans do not draw the wrong conclusions or ultimately make misinformed decisions. The report begins by stating that it “focuses on two critical measurements of a municipal pension funds’ sustainability—funding levels and costs.” The report goes on to assign letter grades to funds based upon funding levels and cost per active plan member.

Unfortunately, the Institute (of nonactuaries),do not understand how funding levels are calculated, nor do they understand what makes a plan sustainable. Furthermore, we feel that it is borderline irresponsible to label a pension as passing or failing based upon these two measurements. The balance of our response will correct some of the misinformation found in their report.

First, let’s address the issue of sustainability. Contrary to what the Institute may infer, the sustainability of a pension plan has very little to do with funding level or absolute cost. The sustainability of a pension plan has far more to do with the sponsor’s ability to continue to make the annual payment each year. If the sponsor is flush with cash, the funding level or cost per member does not matter. Likewise, a plan could have a funded ratio of 100% and a relatively small annual payment, but if the sponsor’s tax revenues will not support this payment, the plan’s sustainability may be in question.

In its description regarding the sustainability of a pension plan, the Institute provides an illustration on page 1 (continued to page 2) that describes how an actuary determines the funded ratio.  Unfortunately the Institute’s example is materially incorrect, and this illustration helps to form the basis for their conclusions. The author describes how the plan’s total liability of $4 million is calculated by discounting all of the projected future payments. This is a true statement. The author continues, however, to describe that the funded ratio of 75% is calculated by taking the $3 million in plan assetsdivided by the total liability ($4 million). Unfortunately, this characterization is false. The funded ratio is calculated by dividing the Actuarial Value of Assets (which the author also misrepresents) by the Actuarial Accrued Liability. The Actuarial Accrued Liability is NOT the present value of projected future payments. It is a description of the liability that is developed in accordance with one of a few acceptable actuarial cost methods. Depending upon which actuarial cost method you employ, you will develop significantly different answers. For example, there are plans that received an “A” grade that could have gotten “C” or “D” grades if a different actuarial cost method was used. Furthermore, plans who were given “C,” D”, or even “F” grades could have been given “A” grades if a different method was  used. Not every public plan uses the same cost method. The point is that assigning letter grades to a subjective, non-uniform measure is dangerous, and reflects a material misunderstanding of the actuarial information being reflected.

After providing the erroneous funding level illustration, the Institute attempts to refute the “mortgage analogy” by stating that a plan with a 75% funding ratio “is misleading because it implies that the plan is well on the way to covering a fixed liability that is not due in full for many years.” The author later attempts to simplify the mischaracterization by stating that “if the pension plan was terminated today and no further contributions were made to the fund, a pension plan that is 75% funded would be expected to pay about 75 cents on the dollar of pension benefits earned.” Both statements are false.

First, a portion of the sponsor’s contribution each year is made to systematically improve the funded ratio, and many pension boards have made the decision to increase the size of the payments so that funding levels increase at a faster rate than what is statutorily required. Second, as mentioned in the prior paragraph, the funded ratio is dependent upon the actuarial cost method used, and is not a fair reflection of the percentage of earned benefits that are covered by current assets. In fact, it is possible that the plan with the 75% funded ratio in this illustration could cover 100% of the liabilities that have been accrued to date based upon current levels of compensation and service. So yes, a plan that has a 75% funded ratio could easily be 100% funded on a “plan termination” basis.

There are two additional thoughts to consider with regards to the funded ratio that have not already been mentioned. In addition to being largely dependent upon the actuarial cost method chosen, it is also dependent upon the age of the plan, much like a mortgage. When someone purchases a home and makes a 20% down payment, he is 20% funded in his house. A 20% funded ratio for that individual should not be frowned upon, and if that individual had increased the ratio up to 40% in 10 years, that would not be too bad either. The same can be said for pension plans. Many ofFlorida’s municipal pension plans have not been around as long as others, and therefore it is unfair to compare these plans to one another.

Secondly, there are many municipalities that have deliberately lowered their funded ratios in order to serve an alternative purpose.Fort MyersandCape Coral, for example, have implemented Early Retirement Incentive programs to provide increased pensions to employees in return for immediate

retirements. The idea is that the cities would be able to replace the older, higher-paid workers with younger, lower paid workers. In some cases, the retirees were not even replaced. Did this tactic lower the funded ratios? Yes. Did it increase pension costs per member? Yes. Did it also likely save the cities millions of dollars in annual cash outlays and prevent a citywide layoff? Yes. The pension plan, therefore, was a tool to accomplish a financial and human resources objective. By lowering the funded ratios in the pension plans, the cities were able to balance their budget, restructure their workforce, and save cash in a difficult economic time.

It is stated on page 5 of the report regarding the “D” and “F” plans that a “full market recovery should not be expected to fundamentally improve the condition of these pension plans.” We are not sure on what basis the Institute makes this observation. Our firm is the actuary for several of these plans, and we vehemently disagree with this conclusion. In fact, for each of the plans listed that we represent, the Boards have made a conscious decision to ramp up funding over the next 10 years to completely pay for the underperformance of the market in the last ten years. If the actuarial assumptions are met prospectively, these plans will see dramatic declines in funding requirements ten years from now.

The Institute comments that the general plans tend to be better funded than either police or firefighter plans, and that general plans tend to make up a larger percentage of grade “A” plans and a smaller percentage of grade “F” plans. While this is true, the author leaves it up to the reader’s imagination as to why this might be. The reason is mostly because police and firefighter plans are partially funded by taxes on auto and home insurance premiums for city residents. The premium tax dollars are partially used to offset the funding requirements for the city, and partially used to facilitate pension plan improvements for the membership. These improvements are typically always made retroactively, but also are usually highly subsidized (if not fully funded for) by prospective premium tax dollars. So, for example, let’s say that City X Firefighters’ Pension Plan has a funded ratio of 80%. City X approves an improvement to the plan that reduces the funded ratio to 70%, but the improvement will be entirely paid for by prospective state premium tax revenues. The City’s annual cost has not increased whatsoever, but the funded ratio dropped by 10%. Should this plan receive a poorer “grade” even though an outside source is covering a piece of the bill? Since premium tax revenues only subsidize police and fire plans, naturally these plans tend to be richer and have lower funded ratios than general employee plans.

In conclusion, while we appreciate the Collins Institute’s initiative to provide an evaluation ofFlorida’s public pension plans, we believe that assigning letter grades to these plans based upon two subjective factors is misleading at best, and could potentially result in decisions that adversely affect the lives of those who serve the public. As actuaries who consult to plans in other states, we can say that the Floridapublic pension system is far better than anywhere else. First, the plans are administered by an independent Board of Trustees, who is entrusted to ensure that the plans operate efficiently and effectively. The sponsors are required to contribute AT LEAST the minimum required contribution set by the actuary (as approved by the Board), which is developed in accordance with the Actuarial Standards of Practice and reviewed by the actuaries at the Florida Division of Retirement. The system itself is very sustainable and has adequate checks and balances. The costs of these plans, unfortunately, have risen substantially over the last decade primarily due to the poor investment market, not because they have been mismanaged, misguided, or manipulated. Finally, the Senate Bill 1128 requires that the Florida Division of Retirement develop a more comprehensive evaluation of our public plans. Our understanding is that these plans will be evaluated based upon a laundry list of different criteria (as opposed to two). While we believe that this will still likely be a subjective measure, we expect it to be more comprehensive and informed. In the meantime, let’s shift our focus away from the subjective actuarial criteria for purposes of evaluating these plans, and focus rather on the benefits and associated costs with providing lifetime benefits for public servants. If these costs have risen to unsustainable levels when compared to the overall operating budget, then we should all work together to find ways to bring these costs in line. Until then, the plans will take care of themselves.

Respectfully submitted,

Bradley R. Heinrichs, FSA, EA, MAAA

Foster & Foster, Inc.

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