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October 18, 2017

Money talks–retirement matters

In my last blog we began exploring the public-sector pension crisis.  There is in fact a pension crisis being felt in both the private and public pension plans but our discussion will focus on just the public sector.  Let’s begin this entry with a warning: unless you are a numbers person even a general discussion like this one is complex and, well, kind of boring.  I’ll do the best I can with it because it is important.  Millions of families will be affected and the services you receive may be impacted.

 

The public employee pension crisis is one shared across much of the United States and even internationally. I recently read an article about this same discussion taking place in Australia.  While there is room for informed debate it may be argued government has overpromised on its ability to pay for many of the pension plans it has approved.

 

The cost of pensions has been a factor in recent municipal bankruptcies.  Since 2010 there have been 61 filings for municipal bankruptcy in the United States.  Some of my colleagues in other cities are beginning to predict when their cities will file for bankruptcy unless something changes.  Madera is not in that kind of position but reports like that demand your attention.  While the reasons for bankruptcy vary the cost of pensions is an often-identified factor in expenses that are outpacing revenues.

 

The Hoover Institute is a think tank at Stanford University.  A study they produced in 2016 stated, “While state and local government across the US largely claimed they ran balanced budgets, in fact they ran deficits through their pensions systems of $167 billion.”  The study goes on to observe that almost every State and local government has an unbalanced budget due to “runaway pension fund costs that are continually chipping away at already inadequate budgets.”

 

There is also a parallel and largely unrecognized crisis in promises made to public employees for lifetime health care.  Many local governments have promised lifetime health care for employees who retire with 20, 10, or even 5 years of service.  Estimates place the nation-wide costs of these unfunded promises at three to four times the costs of unfunded pension liabilities.  This will push many, many local governments into bankruptcy sooner rather than later.  Fortunately, Madera has avoided the lifetime health care trap.

 

California Pensions

 

The California Public Employees Retirement System (PERS) is the second largest retirement system in the United States with over $300 billion in assets and nearly 2 million members.  It ranks only behind the Social Security System in size.  The seeds of the California pension crisis were planted in 1999 when then Governor Gray Davis signed legislation that gave prison guards, Cal State professors, and other State employees enhanced retirement plans.  Legislation followed soon thereafter providing similar plans for local government.  Proponents and PERS analysts argued there would be no additional costs to taxpayers because at that time the pension system was “super-funded”, meaning investments and anticipated growth in those investments would cover the future costs.  They were wrong by billions of dollars.  The new plans provided both new levels of benefits to those hired after the date of adoption as well as benefits retroactively to those already in the system.  The retroactive features of the new plans created immediate, unfunded liabilities (promises to pay) that we now struggle with.

 

The recession that began in 2007 should have been a wake-up call.  PERS experienced an investment loss of a little more than $56 billion, almost 24% of its total portfolio.  There was resistance to lowering the assumed return on investment because it would require increased contributions from PERS members.  The PERS board waited fully 9 years before implementing a phased increase in member contributions.  To this day some members of the PERS Board remain in denial and some have called for new, enhanced retirement plans.

 

In December 2016, the PERS Board voted to decrease the assumed return on investment from 7.5% to 7.0% over a five-year period.  This created an increase in member contribution rates.  Lower costs pension plans for new hires have been adopted by many cities including Madera.  These plans reduce the growth of payments required into the PERS system but do not solve our problem.

 

Madera

 

Madera has largely been successful in limiting the impacts felt by this crisis.  The recent change in the assumed rate of return on PERS investments and the possibility that they may lower that factor even further should be considered game changers.  Many analysts believe the assumed long-term rate of return on investments should be 4% as opposed to the 7% figure PERS has proposed.  That means our contributions might increase many times more than what is currently projected.

 

Based on tools we received from PERS here is the current estimated impact on the City of Madera:

Projected CalPERS Contributions - City of Madera

Does the City have “rainy day funds” to lessen this impact?  Yes, the City has a rainy-day fund of over $13 million.  That money is set aside for cash flow and catastrophic events.  But operating losses only increase over time unless addressed.  The lessons from Vallejo, Stockton, San Bernardino, and Desert Hot Springs, California cities that have gone bankrupt, should not be lost on Madera’s decision makers.

 

So what can we do to address this crisis?  Throwing more money at the problem isn’t going to work; the numbers are too large. We need pension reform, but — pension reform is limited right now due to a number of court decisions.  The big one has become known as the California Rule and has been adopted by 12 States.  The court ruling maintains that “pension benefits in effect the day a government employee is hired must be honored throughout the employee’s entire career, and cannot be reduced without an offsetting benefit”.  Courts have interpreted this ruling to mean an equal offsetting benefit.  This effectively limits any meaningful pension reform.  There are cases going through the appeal process that challenge this ruling but until the courts provide relief and until the legislature gives us new tools pension reform will not proceed.

 

In the meantime, we are left with what can be characterized as the NASCAR race strategy.  Every fan of NASCAR knows there is a good chance there is going to be a wreck at some point during the race and the race doesn’t really start until after the wreck.  There is going to be a wreck created by pension promises made.  Our task is to steer clear of the wreck by making carefully thought out financial decisions and keeping our car (local government) running until the courts and legislature gives us the tools to reform pensions.

 

Pension reform may be the greatest challenge facing the current generation of state and local elected officials.  It isn’t going to be easy.  Public employees have families, hopes, and dreams just like everyone else.  Is it fair to change a promise made many years ago?  Tax payers in California pay an enormous burden for the services they receive.  Is it fair to ask them to pay more for a retirement system that is not financially sustainable?

 

Stay tuned; this story will be written in headlines about cities across the nation exploring or declaring bankruptcy for several years to come.

David Tooley
Madera City Administrator