With approximately $160 million owed to the Evanston police and fire pension plans, the City of Evanston is now faced with a budget crisis.
In 2009, the City made a $14 million contribution to the police and fire pension plans but the plans’ assets depreciated by $18 million due to the market downturn. Throughout all of the discussions of a budget crisis, people state that the police and fire pension plans must be fully funded by 2033.
In order to better understand the issues, it would be very useful to explain the term unfunded accrued liability, the 2033 deadline, and other related issues.
Under Illinois law, the City Council must make an annual contribution sufficient to meet the annual actuarial requirements of the pension fund. In other words, the City Council must levy a tax in an amount equal to
(1) the normal cost of pensions for the year – cost of benefits that accrue for the firefighters and police officers for that particular year of services; and
(2) the annual amount necessary to amortize the funds’ unfunded accrued liability – cost of benefits that accrued for prior years of service that were not funded – over a forty-year period.
For the police officers, the City must follow 40 Ill. Comp. Stat. §5/3-127. For the firefighters, the City must follow 40 Ill. Comp. Stat. §5/4-118.
If the Illinois General Assembly requires a City to fully fund the benefits earned each year and to amortize the plan’s past underfunding over forty years, then the pension plan should be fully funded at the end of the forty-year period. The statute was enacted in 1993, so city officials have been aware of this requirement for seventeen years and now have only twenty-three years remaining until 2033. The City must comply with this statute and, if hard decisions are not made now, the City Council must make even more difficult decisions down the road.
Based upon the actuarial calculations for the required future contributions, a significant portion of the unfunded accrued liability will be paid in the last ten years of the forty-year amortization period with the annual contribution for the 2033 fiscal year being nearly $30 million.
We hope that the City Council is not backloading its contributions for these years in hopes that the Illinois General Assembly will reset the amortization period and extend the period of repayment.
There was a recent bill in the Illinois General Assembly that would allow cities until 2049 to fully fund their pension liabilities.
The bill would provide the City of Evanston with an additional sixteen years to pay off the $160 million unfunded accrued liability, but this is not a permanent solution for the residents of Evanston and would actually cause more problems in the long-run. The Police Pension Board President, Timothy Schoolmaster, explained the problem quite well in an October 2009 Daily Northwestern article:
“It’s just refinancing the mortgage….It will make annual payments go down, but the total amount taxpayers have to pay will be larger.”
If the City is able to extend the payment period and lower payments initially, this will only lower annual payments, not the amount owed. Paying smaller amounts will only result in a larger portion of the unfunded accrued liability remaining each year.
Each year the plan has an unfunded accrued liability, the plan does not have sufficient assets to fund future pension benefits and does not earn a return on that level of assets the actuary assumes is in the plan. Thus, without sufficient assets, the plan does not generate sufficient returns to properly fund future pension benefits and the unfunded accrued liability increases.
This lost return is also known as interest on the unfunded accrued liability.
If the City makes smaller contributions, then a larger portion of the unfunded accrued liability will compound interest resulting in the residents of Evanston paying a much larger amount in the long-run. If the bill was to pass and the City could lower its annual contribution, then the current City Council will be able to delay payment of its pension obligations like so many City Councils have done before, with the likely result being the same issues Evanston is facing today but only magnified.
It is critical that union members and pension board trustees ensure that a city is making its required contributions.
Danna McKitrick, P.C., was retained by the Alton, Illinois firefighters’ pension fund when the City of Alton failed to make pension contributions according to Illinois law. Instead of allowing the problem to worsen, the pension board trustees took action and sued the City of Alton to require the necessary contributions.
The settlement agreement between the City of Alton and the pension fund provided the trustees with the necessary protection to ensure the long-term financial viability of the pension plan. Since the lawsuit, the Alton city council has taken steps to meaningfully decrease the unfunded accrued liability of the Alton firefighters’ pension fund, including raising Alton’s sales tax.
As a result, the unfunded accrued liability for the Alton firefighters’ pension fund is expected to decrease in the future barring any additional unforeseen stock market declines.
Under Illinois law, the City of Evanston is required to make payments on the unfunded accrued liability in an amount sufficient to pay it off by 2033.
Although extending the period of repayment to a later year may provide an initial benefit by lowering contribution amounts, the future residents of Evanston would be faced with an even larger financial problem in the future.
A city with underfunding issues should be looking for real solutions today instead of delaying the inevitable, especially where, like in Evanston, there has been a long-term failure to address and solve the problems of police and fire pension underfunding.
By 2008, the City of Evanston was facing a $145 million unfunded accrued liability for the police and fire pension plans. The firefighters’ pension plan had a funding ratio of approximately 44% and the police pension plan had a funding ratio of approximately 42%.
As a result, the City Council established a blue ribbon committee to gain an understanding of the underfunding issues, to propose possible solutions, and to recommend best governmental financial practices for the future. After exploring the issue, the Blue Ribbon Committee released its report on October 24, 2008 concerning Evanston’s underfunded police and fire pension plans.
In their report, the Committee did not attempt to point fingers at any individuals and was resolved on developing solutions instead. Although the prior actuary had used assumptions that did not exactly coincide with what actually occurred under the police and fire pension plans, the Committee did conclude that the assumptions “were within the broad range of ‘reasonable’ as defined by industry standards.”
As to the City Manager, Finance Manager, City Council and the Mayor, the Committee concluded that hindsight now indicates that had more questions been asked, and more information sought, City officials might have chosen to increase funding at an earlier time to mitigate the depth of the current crisis. However, the Committee did not find any evidence of any wrongdoing or malfeasance.
The Committee went on to offer five types of solutions for the underfunding issue:
(1) asset sales, transfers, securitization;
(2) incremental revenue sources;
(3) alternative financing solutions;
(4) budget cuts and efficiency changes in program delivery; and
(5) economic growth and development.
However, many of these solutions are not viable for Evanston during the “Great Recession.”
The Committee suggested securitizing excess real estate owned by the City, but this solution would lead to increased fees paid by Evanston residents for the parking lots or garages located on the excess real estate.
Jon Corzine, ex-governor of New Jersey, suggested securitizing the New Jersey Turnpike. When the residents of New Jersey learned that the securitization would result in significantly higher tolls, they ardently opposed the securitization and Corzine lost a great deal of support from New Jersey voters. Corzine’s failure to correct New Jersey’s financial problem, including its own police and fire pension issues, and the securitization proposal led to his recent loss to Chris Christie in the November 2009 gubernatorial election. You can read our blog post regarding Corzine’s failure to correct New Jersey’s police and fire pension issues.
The Committee also suggested subjecting not-for-profit, charitable, and religious organizations to property tax and user fees for public services. However, this is a very disconcerting measure.
Although some organizations may have the ability to pay such property taxes, like a hospital or university, many not-for-profit entities struggle to break even. Subjecting these entities to additional costs could potentially bankrupt many of these entities. Furthermore, the City could not begin imposing property taxes on only certain entities without doing so in an arbitrary manner which would lead to constitutional challenges.
For years, there have been talks about subjecting Northwestern University to various payments in lieu of taxes to cover the cost of city services provided to the university. The university is taxed on its utilities, parking, liquor, and athletic events, but the university has taken a hard position of no payments beyond these items and the City Council has had a difficult time subjecting the university to any further payments.
Economic development through the acquisition of business, office, industrial, and retail services was another suggested solution.
However, given the current economic climate, it may be very difficult to attract any significant sources of revenue to the City without some type of tax incentive or Tax Increment Financing for the corporation, which would offset the benefits of the economic development to the City and its residents.
The Committee also found issues with the police and fire pension plans themselves. The committee suggested the City Council to take action regarding the effective maximum 45% equity allocation and the restrictions that confine fixed income investments to primarily US Treasury Bonds and Agency Bonds. However, the purpose behind such restrictions is to reduce the plans’ exposure to risk ensuring the assets are there to pay retirement benefits.
Although the riskier investments will provide the pension plans with a potentially higher return, they also subject the plan to a much higher level of risk. This strategy of increased risk to meet or exceed projected actuarial rates of return is being adopted by pension plan trustees in many locations.
As many investors discovered over the past two years, the stock market can easily drop 50% in value and a pension plan cannot afford to have this occur. Furthermore, corporations such as General Motors, Hewlett-Packard, J.C. Penney, Boeing, Federal Express and Ashland are among big corporations that have been unloading the stocks that have dominated their pension portfolios and have begun purchasing bonds.
Trustees should be authorized to invest in riskier investments, such as hedge funds, but this practice must be done in moderation so as to not jeopardize the financial integrity of the pension plan. Removing the restrictions now in place may cause more problems for the pension plans in the long run, though the future is difficult, if not impossible, to predict.
The Blue Ribbon Committee provided a good summary of Evanston’s underfunding issues and provided a number of possible solutions. However, many of these solutions are infeasible or difficult to implement. Although the report may not have provided any real solutions to the underfunding problem, the report was a pivotal point for the City of Evanston because there was finally a concerted effort on the part of the residents and city officials to correct the situation.
Now that the problem had been recognized, the real test was whether the City officials could implement steps whereby the City of Evanston could begin to correct the underfunding issues.
The City of Evanston, Illinois is a suburban municipality located directly north of the city of Chicago and has approximately 74,000 residents. This city has had a long history of underfunding its police and fire pension plans and it still dealing with these problems today despite prior litigation.
The underfunding of the police and fire pension plans continually worsened with the City now facing a $159 million unfunded accrued liability for the police and fire pension plans with plan assets covering only 42% of the benefits owed. To put these figures in context, the unfunded liability is about $2,000 per Evanston resident or $4,500 per household.
With only twenty-three years remaining for the City to adequately fund the pension plans as mandated by Illinois law, the City of Evanston must develop a solution to its police and fire pension problems now.
To truly understand the issues surrounding the City of Evanston, we must review the City’s historical failure to fully fund the police and fire pension plans, the current issues facing the City, and possible solutions to the pension underfunding problem. Over the next two weeks, we will post a number of blog posts regarding Evanston’s underfunding of its police and fire pension plans.
The City of Evanston has a long history of failing to fully fund the police and fire pension plans, which led to some tension between the City and the plans’ Boards of Trustees. The tension came to a head when the Board of Trustees for the City of Evanston Police Pension Fund filed a lawsuit in 1987 against the City arguing it was required to pay the amount certified by the police pension plan’s Board of Trustees.
In 2005, an Illinois appellate court found that the City Council was not required to accept the dollar amount recommended to it by the City of Evanston Police Pension Fund board but was required to follow Illinois law in determining the amount of its annual contribution.
(See Board of Trustees of the Police Pension Fund of the City of Evanston v. City of Evanston, 667 N.E.2d 657 (Ill. App. 1st Dist. 1996). For the police officers, the City must follow 40 Ill. Comp. Stat. §5/3-127. For the firefighters, the City must follow 40 Ill. Comp. Stat. §5/4-118.)
While the court found in favor of the City, the underlying issues that gave rise to the lawsuit seemed to go largely unheeded by the City Council. As evidence of such fact, the unfunded accrued liability increased during the litigation from $48 million in 1997 to $91 million in 2005.
Even directly after the appellate court decision, the unfunded accrued liability for the Evanston police and fire pension plans increased by $6 million in 2006 to $97 million.
Although a significant portion of the current underfunding issues was caused by insufficient contributions and low market returns, the unfunded accrued liability for the police and fire pension plans increased significantly due to changes in actuarial assumptions.
With every pension plan, the board of trustees will hire an actuarial firm to determine the present value of the benefits promised to the employees, the expected future value of plan assets, and the contributions needed to pay the benefits promised. To determine such figures, the actuarial firm must make several assumptions such as the employees’ retirement age, life expectancy, and future salary.
In 2007, the City of Evanston hired a new actuarial firm, Gabriel, Roeder, Smith & Company, which made several changes to key actuarial assumptions based upon the prior history of the Evanston police and fire pension plans. The actuarial firm increased the expected rate of salary increases and increased the life expectancy of retirees. However, these changes may still not provide the residents of Evanston with an accurate calculation of the total pension liability, so the true unfunded liability may be well over $160 million.
The actuarial firm lowered the rate of return on plan investments from 7.5% to 7.25%, but the average rate of return from 1998 to 2007 was 6.04% for the Evanston fire pension plan and 6.38% for the Evanston police pension plan. The actuarial firm decreased the expected retirement age from 56 to 54, but actual experience based on March 1, 2007 data indicated that the average retirement age was 53 years.
As a result of these changes in key actuarial assumptions, the unfunded accrued liability for the fire and police pension plans increased from $99 million to $140 million.
All of the assumptions used by the prior actuary, Ted Windsor & Associates, were within the broad range of “reasonable” as defined by industry standards, but the revised unfunded accrued liability calculation made residents aware of how large of an issue the underfunded police and fire pension plans had become.
By 2007, the City of Evanston had an ever-growing problem with the underfunding of its police and fire pension plans. Litigation over the City’s contribution level had resulted in a 2005 appellate court decision declaring the City was required to make a certain level of contribution but it did not change the underlying issues facing the City.
The unfunded accrued liability continued to increase due to insufficient contributions and the changes to key actuarial assumptions in 2007. The actuary revised some key assumptions in determining the unfunded accrued liability, but these changes still may not provide the residents of Evanston with an accurate picture of the underfunding issue.
By 2008, the City stated an intention to develop solutions to the underfunding issue and established a blue ribbon committee.
The subsequent history up to the present will be addressed in the four subsequent blog posts of this five part series.
This past Tuesday, Jon Corzine lost the New Jersey gubernatorial election to Chris Christie by a margin of 5%.On that night, Christie had accomplished quite a feat: he was the first Republican in a dozen years to win a statewide contest in the heavily Democratic State of New Jersey.
Although many individuals blame the general state of the economy for his loss, Corzine’s failure to improve the state’s public pension system underfunding issue, or the state’s budget in general, was a significant contribution to his loss this Tuesday.
In the prior election, Corzine came into office as the financial guru who was going to fix all of the State’s problems involving the budget deficit and the underfunded public pension. Jon Corzine had an extensive background in the financial industry. He graduated from the University of Chicago’s MBA program while working in the Bond Department at Continental-Illinois National Bank in Chicago. He began his career with Goldman Sachs in 1975 as a bond trader and worked his way up to become the Chairman and co-CEO of Goldman Sachs in 1994. During his tenure, he converted the investment firm from a private partnership to a publicly traded corporation and made a reported $400 million. Thus, when Corzine was elected, the voters of New Jersey were expecting Corzine to fix the public pension underfunding issue or at least to make significant strides in the right direction.
During his time as governor, Corzine provided little improvement to the public pension system and the system may have become even more unstable.
New Jersey contributed more than $3.2 billion into the public pension system during Corzine’s first term, but this amount paled in comparison to the long term liabilities of the public pensions system. The pension system had an unfunded accrued liability of $34.4 billion as of June 30, 2008 and held only 72.6% of the assets needed to be fully funded.
As of 2009, the state-employee pension plan will pay out an estimated $5.6 billion this year, a rise of $370 million, or 7%, from the year before. Therefore, even though Corzine made some contributions to the public pension system, the unfunded accrued liabilities continued to increase and further weaken the public pension system.
Besides the lack of contributions by the State, the pension system was severely underfunded for other reasons as well including bad investments. The New Jersey Division of Investment purchased $182 million of common and preferred stock within six months of Lehman Brothers’ collapse even after there were reports that the investment bank might stumble.
Faced with a severe general budget deficit and an unfunded accrued liability of $34.4 billion, Corzine was restricted in the actions he could take with respect of the underfunding issue. In order to fix the problems with the state’s budget deficit and the underfunding of the public pension systems, Corzine resorted to a radical idea that resulted in significant opposition in New Jersey and the eventual collapse of the proposal.
Under his plan, the State would lease the Garden State Parkway, the New Jersey Turnpike, and other toll roads for at least 75 years to a new public benefit corporation that could sell bonds secured by future tolls. To pay that money back, the tolls would increase 50% in 2010, 2014, 2018 and 2022. Those increases would include inflation adjustments and, after 2022, tolls would increase every four years until 2085 to reflect inflation. When citizens were faced with transportation costs rising by thousands of dollars over the next several years, they fiercely opposed Corzine’s proposal.
Faced with opposition from the majority of voters and the legislature, Corzine abandoned the toll road proposal long before the election date. However, he may have shot himself in the foot in October when he stated in a New York Times article that he may revisit his proposal to lease the New Jersey Turnpike to raise cash. Thus, Corzine’s only proposal that could have put the public pension system in the right direction was too radical and quickly defeated by voters.
Without some unforeseeable improvement in the future, the pension system was doomed from the State’s lack of contributions or a plan on how to raise the needed money to fund the unfunded accrued liability of the public pension system.
Despite his issues, many of the unions supported and endorsed Corzine for governor.
Stating “I believe you have put our pension system back on track,” the President of the New Jersey state Policeman’s Benevolent Association endorsed Corzine back on October 1, 2009. Furthermore, Corzine’s website for reelection even noted that Corzine had secured the support of every major law enforcement and firefighter union in New Jersey, which is surprising given the fact that he proposed to reduce the annual State contribution made to the pension system if he was reelected. However, all of these endorsements may have been a decision by the unions to go with the lesser of two evils for public employees.
In Chris Christie’s plan to balance the budget, he made several cuts to the public pension system.
Chris Christie would defer pension contributions by the State while the system remains seriously underfunded. Christie would also direct future state employees into a 401k-type plan, which would be disastrous for such a severely underfunded pension system.
Steve Wollmer, the communications director of the New Jersey Education explained it best when stating “The people working now are helping pay for the benefits for those already collecting. As a result, they’re going to weaken the existing pension system.” Although Corzine was promising to further weaken the pension system by lowering State contributions, Christie’s actions would cause even further damage by reducing the number of current employees whose contributions would help fund current benefits that are being paid.
In this election, the voters and the public employees had a very difficult decision.
On one side, they had Corzine. He was the financial guru who was supposed to fix the underfunding issue. During his time as governor, he had made no progress in solving the issue and his plans to balance the budget would further weaken the pension system’s viability.
However, on the other side, they had Christie. Christie was proposing the same lowered State contribution and was intending on shifting new hires out of the current pension system.
In voting for Corzine, I believe the people of New Jersey thought they had given Corzine his opportunity to fix the public pension underfunding issue. When he did not make adequate State contributions and proposed the radical toll program, the people of New Jersey decided that even this financial guru could not solve the State’s problems. They were ready for another governor with new ideas to fix these ongoing, worsening problems.
In the end, the Chairman and co-CEO of Goldman Sachs had lost the confidence of the people of New Jersey.
The difficulties of these pension funding problems are great. However, in the City of St. Louis pension disputes, Danna McKitrick attorneys won a case before the Missouri Supreme Court that required full funding. Also on the same night Governor Corzine lost, the City of Springfield, Mo. passed a sales tax, which had failed nine months before. Many things contributed to that changed outcome, but a significant part of it was due to our efforts. We’re not sure we could have helped Governor Corzine, because of the magnitude of the problems he faced, but obviously he wasn’t able to do it himself, though no doubt, he was “the smartest guy in the room.”
The St. Louis Post-Dispatch recently reported upon the vote of the Board of the Missouri State Employees Retirement System (“MOSERS”) concerning state funding for the upcoming fiscal year. The Post’s heading “Missouri to increase funding of employee pension fund” was simultaneously accurate and misleading.
The $276 million was $20 million greater than the State had hoped to pay. However, pension funds such as MOSERS are operated on an actuarial basis, and Gabriel Roeder Smith & Company, the system’s actuary (and a nationally recognized firm in the public pension area) said that the proper contribution amount was $303 million. Even this number would have been much higher, except MOSERS uses a smoothing system that spreads out market gains and losses over a five year period.
One can understand why Governor Nixon and Missouri taxpayers may favor the approach taken by the MOSERS Board. If the actuarial amount had been contributed, the state budget would have had less money available for other state spending, or consideration would have had to have been given to a possible tax increase.
The strong objections from State Senator Jason Crowell, R-Cape Girardeau, are well taken, however. The retirement system is disregarding or minimizing actuarial calculations to reduce the contribution rate, but in the process of doing this, is creating uncertainty and possibly severe future problems.
Senator Crowell, a MOSERS Board Member, stated “We’ve put in jeopardy the actuarial soundness of the plan.”
Senator Crowell has special expertise in this area, since he is the chair of the Joint Commission of Public Employee Retirement Systems, and is a very knowledgeable legislator on the subject of public pensions. Though it is not made clear from the Post-Dispatch article, the MOSERS contribution level is also lowered by its expectation of investment returns at 8.5%. (Most public pension plans are currently forecasting investment returns between 7.25 and 7.75%.)
The wisdom of this year’s decision concerning funding of MOSERS can be meaningfully argued by both sides. However, my fear is that MOSERS and its Board may be getting on a slippery slope.
Once the Board decides not to follow actuarial funding guidelines in any given year, it is certainly subject to more political pressure to continue to do that in future years. If MOSERS Board had a publicly articulated a one-year only variance , due to extraordinary market and economic conditions, the actions of the MOSERS Board would be easier to justify.
With “5 year smoothing,” last year’s negative investment returns will impact contribution levels for years to come, so the funding issues are not likely to disappear in the next several years. When will MOSERS Board return to following the actuarial advice necessary to keep MOSERS sound?
The Missouri Constitution mandates that most public pension plans in Missouri, those having COLA benefits, must maintain actuarial soundness. If Senator Crowell’s predictions about future actuarial soundness problems do occur, the State of Missouri and the MOSERS Board will both regret this decision to fund at less than the actuarially recommended amounts.
