How Some Cities Dodge the Unfunded Pension Liability Trap

When a city fails to properly fund employee pensions in the year they are earned, it creates an unfunded liability that will require more money later to backfill the obligation. Since municipalities have limited budgets, they typically cut from police, fire, and other community services to pay the deferred pension costs.

Flint is one example out of many. The cost of catching up on past pension underfunding has skyrocketed, and the city now pays $20.4 million every year — a 50 percent increase since 2010. Filling this hole now consumes 42 percent of Flint’s general fund budget.

But some local governments have managed to contain these costs. Bloomfield Township closed its defined benefit system to new hires on April 1, 2005. It now offers the 401(k) defined contribution benefit that has become standard in private sector workplaces.

Township Supervisor Leo Savoie served on the board of trustees in 2004. He said the board moved to shift new employees out of the pension system to get a handle on long-term debt.

“We looked at how sustainable our benefit package was, and in order to make it viable and to keep legacy costs from crippling the community, we needed to switch from the defined benefit plan to the defined contribution plan,” he said.

By closing the defined benefit system, Bloomfield Township capped its unfunded pension liabilities. The city then borrowed $80.3 million by issuing 20-year pension obligation bonds to set the cost of already-earned pension benefits at around $6 million per year.

Savoie said if the city had not reformed its pensions, the defined benefit system would have cost $10 million to $13 million per year, and the city would have incurred a deficit of $5 million to $8 million per year. This would have choked off funding to essential government services such as police and fire. The city has 153 police and fire department employees.

“Two-thirds of what Bloomfield Township spends are employee costs, and if we had a $6 million deficit that we had to make up, we would have to cut 40 to 50 police and fire employees,” Savoie said.

He added that Bloomfield’s fully staffed and funded police and fire services allow the township to be “one of the best in the state” with an average response time of four to six minutes.

The head of Livonia's finance department, Michael Slater, said some employees in his city have concerns about defined contribution plans.

“The defined contribution plan is not guaranteed income,” Slater said. “Some say it is too risky.”

Livonia closed its defined benefit plan to all employees in 1998 and instead began offering contributions to 401(k) accounts. According to Slater, the major advantage is cost certainty. Payments to the retirement system are determined beforehand, based on employees’ salaries. Cities do not speculate on how much they will have to pay out.

“With 25-30 years of service, employees should be able to accumulate $1.5 million in the pension plan,” said Savoie, who is covered by the defined contribution plan. “Personally, I like it better than I do the defined benefit plan. It gives security and comfort.”

Savoie believes that defined benefit systems have disadvantages that go beyond often having unfunded liabilities. For example, if both a retiree and that person's spouse die while collecting retirement payments, the defined benefit plan does not transfer to another heir. But under a defined contribution approach, employees own their investments.

“With the DC plan, there is a pot of money we help employees invest, so if they act prudently and allow financial advisers to do their job, at the end of the day there is an asset that can be passed onto their kids,” he said.

Bloomfield Township’s defined contribution plan does not take more from the employee’s paycheck than the defined benefit plan. According to Bloomfield Township Finance Director Jason Theis, the police and fire’s defined contribution plan requires 3.5 percent of an employee's salary. Other employees are not required to make contributions.

The city’s defined benefit plan requires 5 percent from police department employees and between 1 and 3.5 percent for other employees.

In the defined contribution plan, unlike the defined benefit plan, the township’s payments are predetermined. Theis said the defined contribution plan requires the township to contribute 14 percent for police and fire and 10 percent for other employees.

Bloomfield Township’s audit states, “The Township must provide annual contributions sufficient to satisfy the actuarially determined contribution requirements as mandated by the plan.”

“Cities and townships should take a look at the perks of defined contribution," Savoie said. "It gives employees a good nest egg to live off and something they can give to their children, and it is a good resource to attract good employees."

Pensions are a very clear example of the divide between Republicans and Democrats.

Republicans see pensions as a means of attracting the best workers.

Democrats see pensions as a means of getting people to vote Democrat.

Republicans get workers.

Democrats get voters.

Workers.....voters.....

I wonder why the Democrats have a hard time getting things done?

Republicans see pensions as a means of attracting the best workers.

Democrats see pensions as a means of getting people to vote Democrat.

Republicans get workers.

Democrats get voters.

We have an interesting situation in Washington State. The previous pension system for firefighters and police officers has been “over-funded” and has over a billion dollar surplus. Where have you heard that before? It wasn't necessarily that the participants, the state and cities acted responsibly; the participants just tended to die off at fairly youthful ages.

The teacher's pension system is underfunded by over Billions of dollars. The unions negotiated huge increases in their participants benefits and also cut the amount of money participants were required to contribute. How can we expect the poor teachers to contribute their fair share to their pensions? Compounding this problem it turns out that teachers tend to live far long time in retirement as compared to firefighters and police. But state legislators have come up with a simple solution... share the wealth! The state is planning on raiding the firefighter and police pension system and giving the money to the teacher's pension system.

Currently to help keep the current firefighter and police pension system solvent, participants have voted repeatedly to increase their contributions to make up for the state and cities who have repeatedly chosen to cut their contributions. The state and cities claim the current system is again “over-funded”. If the state successfully raids the previous system, my guess is that the sentiment will change on this. The incentive to act responsibly will be gone.

In California the unions successfully negotiated their retirement benefits to the point where their members receive almost twice as much in retirement benefits as police officers and firefighters from Washington. This has created a huge “unfunded liability”. In 2003 their system was solvent, but now the city of Los Angeles alone has a $3 Billion dollar deficit in just current fire fighter and police pensions.

The totals for underfunded pension systems for state and local government employees in California is several hundred Billion dollars. Yet, I have talked to some of these guys before and they seem to have no concern at all that not enough money was paid in by them, the cities and the state to cover their pension benefits. They seem to have no concerns... They think that if their benefits bankrupt the cities or the state that the Federal Government will step in, as they just have in Puerto Rico. The government is again providing a negative incentive to act responsibly.

Moving their pension plans into 401(k)’s is a good idea. Unfortunately from my point of view that makes them vulnerable to government desperate for money and assets that can generate or be sold for money.

Many time over the last decade we’ve seen the ‘idea’ being floated of converting 401(k)’s into a ‘new’ type of pension fund that closely resembles Social Security with the benefit to the government that when the recipient dies the Government KEEPS all of the assets. Unlike with the 401(K)’S allowing the owner of the account to transfer the assets to their heirs.

Disclaimer: Opinions posted on Free Republic are those of the individual posters and do not necessarily represent the opinion of Free Republic or its management. All materials posted herein are protected by copyright law and the exemption for fair use of copyrighted works.