Pros explain city’s pension woes

Photo by Norman Schimmel

Sarasota has three pension funds. One is for general employees, another for police and a third for city firefighters from 1996 and earlier, before the city and county fire departments merged.

All three pension funds are in trouble. On Wednesday, Sept. 6, the city commissioners held a workshop with the lawyers, financial consultants and actuaries for each of the funds. It was an afternoon full of big numbers and bad news.

Each pension fund is independent, run by its own board of governors who are responsible for its operation. Only a judge can override their decisions. However, the Sarasota City Commission holds the ultimate responsibility of keeping the plans solvent.

Nearly 700 people today depend on a monthly retirement check from the city. Given an estimated city population of 50,000, one out of every 72 people is a city retiree.

There are 149 retired police officers (or surviving spouses), 157 retired firefighters (or surviving spouses) and 385 retired general employees (or surviving spouses) who rely on the three pension plans.

The city last year moved its employees away from a conventional pension plan into a “defined contribution” plan in which employees sock away their own funds (with a city match), like an Individual Retirement Account. But the three legacy pension plans mean financial headaches for city commissioners now and in decades to come. The pain is only beginning.

The firefighters

Florida law is relatively simple. In a nutshell, pension funds are managed to produce income from investments. Workers might contribute some from their paychecks, and there is even a local tax on fire insurance policies collected by the state and refunded to local entities to help out firefighter and police pensions.

Every month the pension fund sends checks to retirees. Any gap between the income and the payout must be made up by the “employer,” in this case Sarasota City Government. For the firefighters, only 20 of the merged Sarasota crews are still on the job and contributing into the pension fund. By 2014, even the youngest of them will be eligible to retire.

But the fund must remain viable for the next 50 years, until the last beneficiary dies. Ideally, when that last survivor dies, the final check would bring the account balance to zero. Unfortunately, the balance could hit zero long before then.

Investment income is the crucial part of the equation. And for the past decade, the fund managers have assumed a much higher rate of return than they actually have received. In other words, they thought they were going to make a lot more money in the stock market than they did. They were thinking an 8% rate of return was about right, a view supported by long historical evidence.

But two recessions intervened, the bottom fell out of property values, unemployment soared, the Euro crisis exploded and rates of return cratered. The pension funds were starved for new money just as the municipal baby boomers were getting ready for retirement.

The picture is not getting much better. “In a low-interest rate environment today, that’s forcing a lower rate of return based on your portfolio asset allocations,” said financial consultant Charlie Mulfinger, a managing director with Greystone Consulting. He manages the firefighters’ pension. “We believe we won’t be looking at returns as high as the last 20 or 30 years.”

The fund’s actuary – who calculates dollars versus lifespans – put it another way. “The annual cost of the plan will trend towards cash flows. Sixty-two cents of benefit cash will be paid by investment returns,” said Brad Armstrong. “The remainder will be funded by the city and county” — as in the city and county taxpayers, making up the missing 38% because of bad estimates on the investment returns.

This is a compound interest problem of nightmarish proportions. Had the city chipped in some cash over the past decade to make up for the gap between estimates and reality, this “unfunded liability,” as it’s called, would not have reached $55 million.

The consultants were clearly trying to avoid saying that number. At the end of an hour-long presentation, City Manager Tom Barwin finally asked Armstrong point-blank: “How much is in the pension fund now? And what’s the amount to get to full funding?”

Armstrong said the fund has $90 million, “and it needs $55 million.”

The rate of return the firefighters’ pension board is using for its future planning is 7.75% at a time when short-term certificates of deposit are getting below 1%.

The general employees

In some respects, this is the simplest plan. It is funded by the city government, employee contributions and investment returns.

“Our investment horizon is longer than the fire plan,” said attorney Scott Christiansen. The rate of return used by the General Employees Pension trustees is 8%, down from 8.5%.

A new wrinkle comes here, because it takes awhile to record paper losses on investments. “In two years, we’ll have to change the way we calculate the numbers,” said the fund’s actuary, Steve Palmquist. At present the city pays $5.5 million to cover the “payroll” of retirees. That’s 25% of the total, while investment income covers the remainder.

“As we recognize market losses over the new few years, it will put pressure on the ratios,” he said. “For your [2013] and ’14 numbers, it will be more than 25%.”

In one long sentence, Palquist capsulized the city’s dilemma: “We’ve had such a terrible past 11 years, the funded ratios have gone south, required contributions have gone north, and your revenues are flat or declining. We’re trying to stop the bleeding,” he said.

Palquist’s colleague and fellow actuary trotted out the bad numbers without being asked. “Your unfunded liability is $40.3 million with the current 8% rate of return,” he said. “If you drop the estimated rate of return to 6%, it pushes the unfunded liability to $80 million.”

This is why the estimated versus actual rate of return on investments is important. If the rate is down, the city has to dig deeper to fill the gap with tax dollars.

Barwin asked another question. How many people are in the program now?

Palmquist said 385 general employees are retired, 374 current employees are in the plan, 15 have retired with a disability and 13 are vested but too young to retire yet.

The police pension

Sarasota’s unionized police officers are working without a contract. Negotiations broke down; then, mediation broke down.

However, their pension fund is doing better than the other two funds. It is about 84% funded, with a $38 million unfunded liability at an estimated 7.75% rate of return. If the estimated rate of return was cut to 6%, the unfunded liability would rise to $93 million, Palmquist said.

There are 141 active officers in the plan, and 149 retired (or their beneficiaries), while 34 are retired and disabled, and three are vested but too young to retire. “This is a very mature plan,” said Palmquist, who is also the actuary for the police pension.

“You’re trying to save this plan and you’re to be commended,” said Larry Cole, the investment consultant. “We have had a decade of bad markets, but for the last three years did about 11.5% [rate of return] overall.”

Pandora’s tar baby

An easy way to understand the pension plight is to substitute “unfunded liability” with the words “out of my pocket.” Promises were made to workers, but high estimates of stock market profits were not realized. Soon the piper must be paid. City commissioners seemed to realize it’s a “pay me now, or pay me more later” issue.

Commissioners want the independent pension boards to rein in their unrealistic estimates for rates of return.

“If we passed a resolution recommending a net 7% to the pension boards, would it be helpful and legal?” asked Turner.

“Yes, to both [questions]. My clients would find it helpful and proper,” said Bob Sugarman. He serves as the attorney for two of the city pension boards.

Commissioner Paul Caragiulo asked, “What’s to stop us from contributing more than you say you need? Does anything stop us from putting more money in?”

Armstrong, the actuary for the Firefighters Pension Fund, said, “You could set it up as a reserve. But you can’t take it out once you put it in.”

Commissioner Shannon Snyder said, “We may not have the ability to pay it later. We need to tell the public what the long-term cost really is. If we cannot show it to our constituents, we’re kicking the can down the road.”

As the commissioners sat down to dinner later, across the state, another set of city commissioners, this time in Fort Lauderdale, sat down to work on the same problem. They approved a $340 million bond issue to cover three-quarters of their unfunded pension liability.

Such bonds – called taxable pension obligation bonds – can ease a city’s pension crisis. There are already $64 billion in such bonds outstanding. In 2011, some $4 billion in those types of bonds were issued. Fort Lauderdale is hoping for an interest rate below 4%, but the latest market figures peg the deal at 4.11%.

If Fort Lauderdale’s pension managers can’t beat 4.11% every year for the duration of the bonds, the issue will end up costing the city even more money, on top of the $1.8 million cost to float the bonds.

Sarasota’s commissioners aren’t quite that desperate. At a rare Thursday morning meeting on Sept. 6, they agreed to develop a resolution to pass along to the three independent pension boards. It will “suggest” the boards cut their rate-of-return figure to 7% for next year and to 6.5% in the year after that.

“I understand a very long-term horizon is appropriate for them, but the city needs a shorter-term fiscal horizon,” said Turner.

“This is the difference between making it 10 years from now or not making it at all,” said Snyder. “This is the big issue.”