FRS Sues City of St Louis for “Sick Day” Ordinances that Contradict Missouri Law

By admin

On October 6, the Firemen’s Retirement System of St Louis and its trustees sued the City of St. Louis. Read the official press release.

Media coverage has been extensive:

KSDK News Channel 5: Firefighter retirement system sues St Louis city

KMOV TV: St Louis firefighters sue city over retirement benefits Firemen’s group sues city over cuts to sick leave

Appended: Oct 8, 3:30pm

KOAM TV: St. Louis firefighters sue city over retirement benefits

KAIT TV: Firefighters sue over city benefits St. Louis Firefighters Sue Over Sick Leave

KTVI/Fox2:  St. Louis Firefighters Retirement System Suing City

SEC’s Warning to New Jersey and Others: Do Not Misrepresent Your Public Pension Obligations

By admin

For the first time ever, the Securities and Exchange Commission accused a U.S. state of violating federal securities laws. In a recent article, it was reported that the SEC alleged that the state of New Jersey mislead investors in bond sales totaling $26 billion over a six year period ending April 2007. In fact, we had written a blog post discussing the severity of New Jersey’s public pension underfunding issues and the state’s failure to address such issues back in November 2009. New Jersey is one of a handful of states, which have pension funding crises, not just funding issues.

According to the SEC, offering documents connected to the bond sales created the false impression that the state could fund pension obligations with existing resources. However, the SEC alleged that New Jersey could not make contributions to its public pensions without raising taxes or cutting services that could impact its budget. As a result of failing to properly disclose its pension obligations, and the related financial issues, investors were not given adequate information to gauge the state’s ability to fund the pensions or assess the impact on its financial condition.

For several years now, cities and states have watched the funding of their public pensions worsen and many have filed to take any substantive action. Some of these public pensions have become dramatically underfunded, leaving the city or state in a fiscal crisis, but politicians continue to minimize the severity of these problems. They have glossed over the issues and are trying to push these issues off into the future, but the SEC has now sent out a warning that public pension underfunding can result in serious consequences. Besides penalties and fines, governmental units or responsible individuals may be criminally charged for securities fraud, which raises the stakes for the individuals involved. If the city or state creates a false impression with its citizens about its fiscal health when issuing bonds, it is also creating this false impression with potential investors.

In particular, the state of Illinois should be concerned by the SEC’s fraud charges brought against New Jersey. Recently, the state of Illinois issued a $3.5 billion bond issue and will issue another $11 billion bond issue in 2011. During this time, the state’s unfunded pension obligations have been estimated to be between $61 billion by the Illinois General Assembly’s Commission on Government Forecasting and Accountability and $166 billion by independent parties. If the state of Illinois makes misleading statements regarding its public pension underfunding issues when it issues bonds, Illinois may be the SEC’s next target. Full disclosure can solve these problems, but that would almost surely the raise the cost of borrowing funds during this time of economic uncertainty and reduced tax collections.

The SEC has taken a very important step to deal with how some cities and states mischaracterize their public pension obligations to its citizens and bond investors. Cities and states cannot be allowed to mislead investors about its pension obligations when it issuing bonds. Although there were no criminal charges or a financial penalty in the case of New Jersey, there is no guarantee this will occur again when the SEC files charges against another state or city. In fact, in San Diego, the SEC based remedies were much more severe. From this point forward, cities and states must be careful when they make statements about their public pension obligations and their ability to pay such obligations, because they could be the SEC’s next target if there is not proper and full disclosure.

The Causes of Illinois Police and Fire Pension Underfunding

By admin

Illinois COGFA Study Perspective

Last year, the Illinois Commission on Government Forecasting and Accountability conducted its first biennial study of the underfunding issues plaguing the Illinois police and fire pension systems. The report reviewed the following six Illinois municipalities and their police and fire pension underfunding issues: Arlington Heights, Bellwood, Champaign, Springfield, and Wilmette. Obviously, a number of the causes cannot be controlled by the municipalities, including past investment return and employee benefit increases which are set at the state level. However, the municipalities’ own insufficient contributions and failure to reduce the future rate of return has increased the UAL as well. The municipalities must correct their own contribution issues, especially now when many of these funds have only approximately 50% of the assets needed to pay the pension benefits already earned.

Even though it may not surprise many individuals given how the stock market has performed in the past three years, inadequate investment return was a significant cause of the UAL increase for all of the municipalities’ police and fire plans. Investment return alone caused 33% of the UAL increase for Arlington Heights and 31% of the UAL increase for Bellwood. In fact, investment return caused 51% of the UAL increase in Springfield with nearly two-thirds of that amount caused by a reduction of the plan’s assumed future rate of return from 8% to 7%. This reduction was required because it was determined that the plan going forward could not earn an 8% rate of return. Although this issue may correct itself for the municipalities after the economy has recovered, there is no guarantee.

Unfortunately, the investment return may continue to cause problems for Illinois police and fire pension plans unless the municipalities lower the plans’ expected rate of return to a reasonable rate. All of the six municipalities have an expected rate of return between 7% and 7.5%. This is the rate of return the actuary assumes the plan will earn each year. If this rate of return is not earned, the plan will have fewer assets than expected and the UAL will increase. In comparison to the 7% expected rate of return, the actual rate of return earned from 1997 to 2008 was in the 5% range for five of the six municipalities. Wilmette actually had a rate of return of 3.3%.

Although these figures may be misleading because the stock market had a steep decline in 2007 and 2008, the municipalities should reduce the expected rate of return going forward unless there is some indication that the plans will be able to begin earning those types of returns again. Otherwise, the municipalities’ contributions are held artificially low because the actuary assumes the plan assets will increase at a much higher rate than what will occur. If this continues, the municipalities will be able to make lower-than-needed current contributions to the police and fire plans and delay paying their obligations these plans.

The unfunded accrued liability (UAL) of all of the police and fire pension funds in the study increased due to insufficient employer contributions as well. With Champaign having only 6% of the UAL increase caused by the insufficient employer contributions and Arlington Heights with 19%, all of the municipalities had issues with employer contributions. Although there may be larger causes of the UAL increase, the cities are only worsening the police and fire plans’ underfunding issues by their own contributions.

Although there may be other causes of the UAL increases, the two causes that deserve the most attention are the employer contributions and future investment return. For employer contributions, these municipalities should be required to contribute an amount that will decrease the UAL, instead of increasing it, especially given the 2033 Illinois deadline to fully fund pensions. There is no reason why the municipalities’ contributions should increase the UAL for police and fire pension plans. For future investment return, the pension plans have been devastated by the recent or present recession, and the market declines of 2007 and 2008. It has been nearly three years since the beginning of this recession and it is still uncertain when the economy will return to its pre-2007 condition. With such a high level of uncertainty, the actuaries should decrease the expected rate of return so that the UAL actually reflects the true amount the municipalities owe to the police and fire pension plans and the municipalities begin paying the proper amount owed to the police and fire plans.

Although municipalities cannot control every cause of the UAL increase, the municipalities should support the financial stability of these police and fire pension plans and make the contributions needed to make these plans financially stable. Otherwise, the municipalities are just passing off even larger problems and debts to the future citizens of these municipalities. Since pension benefits are constitutionally guaranteed in Illinois, there is no basis for cities trying to delay or escape their funding responsibilities.

Evanston Pension Issues in the News

By admin

A lot of the issues we discussed in our prior series are now playing out in real time in Evanston. We will be following this story and commenting further upon it.

Read more… Evanston Review

Illinois Public Pension Underfunding: Evanston’s Public Pension Issues on a Larger Scale

By admin

A recent article in the New York Times discussed Illinois public pension underfunding issues. The problems have progressed to such a degree that 15,000 people rallied in Springfield shouting “raise my taxes!” to any lawmakers who passed by. While reading the article, it is hard not to draw similarities between the State of Illinois and the City of Evanston, a suburb just north of Chicago and the subject of a prior five-part series blog we wrote in April.

State of Illinois Public Pension Issues

The State of Illinois’ public pension plans have a 54% funding ratio, meaning that they have assets sufficient to cover only 54% of the benefits already earned by Illinois public employees. The Illinois General Assembly’s Commission on Government Forecasting and Accountability has put the shortfall at $61 billion, but other sources have placed the public pension shortfall at $79 billion and even $166 billion. The pension shortfall has been caused by a number of things, including overly optimistic projected investment returns for plan assets and insufficient contributions.

Beyond its large public pension underfunding issues, the State of Illinois is also facing severe budget deficits, which has made it difficult for the State to allocate sufficient funds for its public pension plans. The State had sold $3.47 billion in securities to make its required pension contributions this year and Governor Quinn plans to issue up to another $7 billion in 2011. Under the state legislature’s public pension reform, it has until 2045 to have its public pensions 90% financed. However, payments are expected to rise sharply next year because 2010 marks the end of a 15-year ramp-up phase toward much steeper annual contributions. Thus, the State’s public pension and budget issues will only worsen as its required annual contributions increase steeply over the coming years.

Illinois’s Public Pension Problems as Compared to Evanston’s Problems

The problems facing the State of Illinois are very similar to the problems currently facing the City of Evanston, though the State’s problems are of a much greater magnitude. Evanston, with only about 75,000 residents, owes approximately $160 million to its police and fire pension plans. Like the State of Illinois, Evanston’s pension shortfalls have been caused in part by overly optimistic actuarial assumptions that resulted in the city contributing insufficient amounts to the pension funds in the past. Both the State of Illinois and Evanston continue to use assumed rates of return that are too optimistic when compared to historical rates of return, which causes the plan’s liabilities to be underestimated and lowers the required contributions. These optimistic rates of return will only worsen the pension plans’ future viability.

Beyond its pension issues, the City of Evanston also has budgetary issues and faces a budget deficit of $8 million, which has forced Wally Bobkiewicz, the city manager, to make some difficult budget and personnel decisions. The general budget deficits have also made it difficult for the City of Evanston to make its statutorily-required police and fire pension contributions and has not allowed the City to makes extra contributions to alleviate the pension underfunding.

The State of Illinois’s 1995 public pension reform regarding police and fire plans also caused problems for the City of Evanston. Instead of requiring the City to pay the police and fire pension shortfalls under the original time table, the 1995 reform allowed the City to lower its contributions by spreading the pension shortfalls over a longer period of time. If Evanston has difficulties making its current budget now, the budgetary issues will only worsen as the City’s required police and fire pension contributions increases each year. In all, the City of Evanston is faced with an $8 million budget deficit, a $160 million police and fire pension shortfall, and growing contributions that are mandated by law.

The City of Evanston is dealing with the same issues that many other municipalities and the State of Illinois are dealing with currently. Some individuals have suggested that the State of Illinois may step in and bail out some of the smaller Illinois communities that are having police and fire pension underfunding issues, but the State of Illinois is no position to help these communities given that its three largest pension funds may run out of money by 2018. Difficult decisions must be made in the City of Evanston and the State of Illinois, and the government may have to take the 15,000 protestors up on their offer.

The Billion Dollar Question: What Actions Must be Taken by the Trustees of the Kansas Public Employees Retirement System to Correct the Underfunding Issue?

By admin

There was an interesting article recently posted on CPA Success by Bill Sheridan regarding underfunding issues with public pensions and other retirement benefits. The article described a recent study by the Pew Center on the States that found a $1 trillion gap between what states had promised their employees in retirement benefits and what those states are actually able to pay.

According to the report, as of 2008, states had set aside only $2.35 trillion for retirement benefits valued at $3.35 trillion. Thus, states had funded only approximately 70% of the retirement benefits promised to their public employees. In particular, the report found that underfunding issues had rapidly increased over the past decade. In 2000, just over half the states had fully funded pension systems. By 2008, only four states – Florida, New York, Washington, and Wisconsin – had fully funded pension systems.

A large part, but not all, of this change is because, in 2000, the stock market had just had a wonderful decade of high returns, whereas 2000-2008 contained two dramatic downturns in the stock market. As of 2008, Illinois and Kansas had the worst funding ratios and were able to pay less than 60% of the retirement benefits promised to public employees. Given the recent market downturn and the “Great Recession,” these figures have likely worsened.

Kansas Public Employees Retirement System Underfunding Issues

The underfunding issues in Illinois have long been recognized in many forums nationally and in Illinois. However, the severe problems in Kansas have stayed largely under the radar screen. Kansas has certainly created the image of being a fiscally prudent and conservative “red state,” but the problems with public pension funding in Kansas are very real.

In Kansas, the majority of the problems originate with the Kansas Public Employees Retirement System (“KPERS”). KPERS had a record unfunded accrued liability – the amount owed to the pension plan to pay for benefits previously earned by employees – of $8.3 billion in 2009. According to the Flint Hills Center for Public Policy, the Kansas Legislature has only allocated KPERS an average of 71% of the actuarially required contributions. The insufficient contributions, combined with other factors, have increased the unfunded accrued liability to nearly $10 billion, which is roughly equivalent to each Kansas resident owing $3,544.

There was also an increase in pension costs as a result of a benefit enhancement package passed by the Kansas Legislature in 1993. The package allows employers to pay the unfunded accrued liability over a forty-year period while capping employers’ contribution rate increases between 0.2% and 0.6%. While the caps seemed to have made sense during 1993 because they minimized the pensions’ potential effect on the employers’ budgets, they have materially worsened KPERS’ financial viability.

Part of this is due to the two stock market collapses that have occurred since 2000. As the plan assets lost value and suffered huge losses in the stock market, the employers’ contributions were not increased to offset these losses. As a result, KPERS’ unfunded accrued liability steadily increased and the pension plan now has a funding ratio of approximately 50%. Eighty percent funding is often viewed as acceptable, even though it is not full funding. Kansas is way below acceptable levels of funding by any standard.

It is Time to Correct the Public Pension Underfunding Issues

With these staggering figures in mind, it is critical for union officials, trustees of public pension plans, and city and state officials to take action to correct the public pension underfunding issue. Funding problems require an infusion of money, usually raised by tax increases or pension obligation bonds. Those measures are politically unpopular, especially during a recession, but are necessary.

If the governmental unit is unwilling to work with the trustees or employees to guarantee the financial viability of the pension plan, pension trustees and labor groups may need to consider litigation. Otherwise, if no action is taken to solve these problems, the issues will only worsen and will result in even tougher decisions to be made in the future.

Fortunately, some cities have recently recognized the severity of their underfunding issues and have taken measures to fully fund their public pensions. In St. Louis, Missouri, the trustees of the Firemen’s Retirement System retained Danna McKitrick, P.C. to sue the City of St. Louis to require it to properly fund the pension system. In 2007, the Supreme Court of Missouri ruled in favor of the trustees, resulting in a $49.4 million payment by the City of St. Louis.

In 2009, the City of Springfield, Missouri, a politically and fiscally conservative community, passed a 0.75% sales tax during the Great Recession to help correct underfunding issues with its police and fire pension fund without the need for litigation. We assisted Springfield in this by working with their task force while representing the IAFF Local 152 and the Springfield Police Officer Association.

The trustees of the Kansas Public Employees Retirement System must begin to deal with underfunding issues before the issues worsen. Whether it be through negotiations or litigation, those involved must find solutions to the current underfunding issues to ensure that public employees receive the benefits promised to them. Once a plan gets below 50%, it is on a “slippery slope” and recovery to financial stability becomes much more difficult. Kansas is already in trouble and immediate intervention is needed.

City of Evanston: Non-Starters & Possible Solutions to the Underfunding of the Police & Fire Pension System (Part 5 of 5)

By admin

We hope that you have found this series to be informative. In this final installment, we will eliminate some possibilities that cannot realistically be part of the solution to this problem, and then recommend other approaches that could well be part of the solution. None of this will be easy or pleasant, because this pension underfunding problem in Evanston is at, or near, crisis state. However, Evanston is not a failed and impoverished community, and very many educated, talented and resourceful people make up its population. So, if any community can solve these problems, it should be Evanston. If Evanston does solve this problem, Evanston may be perceived to be a leader in Illinois, just as we believe Springfield, Missouri, is becoming a leader in our home state. Springfield went from being a problem creator to a problem solver.

Things Can’t or Won’t Work

  1. The Illinois Constitution prohibits the reduction of benefits for existing police officers and firefighters, as well as for current retirees. Even absent this Illinois Constitutional provision, the Contracts Clause of the United States Constitution probably also protects them from reduction. Therefore, the idea that is being thrown about by some groups without much knowledge or sophistication, that current police officers and firefighters should get “401(k)-like” benefits can’t be done. It wouldn’t be a good idea, but even if it were, it can’t be done, so that is off the table. Governmental pension plans are, in most respects, not subject to ERISA, so the Pension Reform Acts enacted in connection with ERISA are not applicable.
  2. A massive tax increase to be paid only by the residents of Evanston would never be politically acceptable, or fair, so that cannot be the solution.
  3. Because the non-City of Chicago police and fire pension systems are governed by Illinois State Statute, Evanston cannot solve this problem by itself. To solve these types of issues in the long term, there needs to be state wide leadership that results in state legislation, in addition to the steps that Evanston itself can and must take on its own.

How will the problem be solved?

There are two sad truths with respect to the solution of this type of problem. The first is that a significant underfunding problem cannot ultimately be solved, except by large sums of money. Residents and some City officials don’t want to hear that truth, because of all that it implies.

The second sad truth raises questions about where we are as a country, as well as where Evanston is as a community. From the authors’ perspective, there will undoubtedly be an economic recovery. It may have already started. However, the United States is “in a hole” in multiple respects and “things will not return to normal”, as that term has been understood during the period from 1987 to 2007. The country faces massive indebtedness and the scenario for the next 10 years, regardless of which political party is in control, may very well lead to all of us paying higher taxes while, at the same time, receiving less in services and benefits. Also, if one looks at the major industrial unions, the goal now is preservation of benefits, not increased benefits; and the reality is that either pay cuts or benefit reductions are likely for them. Police officers and firefighters, therefore, cannot be exempt from also “taking some of the medicine”. So the second hard truth, that will be hard for police officers and firefighters to hear, is that pension benefits for new hires will almost certainly need to be reduced.

Everyone must remember that police officers and firefighters are not covered by Social Security, and that their work careers usually end some time between 55 and 60, if they are not disabled on the job before then. So benefits must be reduced, but not to a “401(k)” type status.

Because Illinois’ pension system for these public uniformed officials is operated on a statewide basis, such a law would need to be developed by legislature in Springfield. There would undoubtedly be significant, organized opposition against it. However, it is probably necessary to cut pension benefits for new hires in order to solve this problem long-term, both in Evanston and in other communities in Illinois. This may not be true or necessary in other states, but Illinois has become a “poster child” for funding problems with public pensions, so it seems necessary in Illinois.

Governor Quinn showed leadership with respect to statewide pension plans involving state employees in adopting such a program for state workers. However, if and when this is done regarding police and firefighter pension plans, it must be done in a very measured way, because of the lack of Social Security for these public servants. Furthermore, due to the nature of their occupations, many police officers and firefighters are disabled in the line of duty. In California, when Governor Schwarzenegger became aware of the magnitude of the deficit problems he faced there, the “Governator” considered moving the highway patrol officers and state firefighters (necessary in California, due to the wild fires) to a 401(k)-type system. After becoming aware of the Social Security issues, he modified the program so benefits would be reduced but still be greater than normal 401(k)s for workers in the private sector. However, his entire plan fell flat when California considered the cost of purchasing disability insurance for its highway patrol officers and its statewide firefighters. The cost of the disability insurance was so high, because of the danger of these occupations, that it wiped out any savings which could have been realized by the other changes and reductions.

In connection with our work in Springfield, Missouri, we raised this issue concerning disability insurance with a task force that was considering the adoption of 401(k)-type benefits. They were an open-minded enough group that they actually went out and did a request for proposal (“RFP”) concerning disability insurance for the police officers and firefighters in Springfield, Missouri. The results of the RFP were even more shocking. It was not a question of the cost of such insurance. What the trustees in Springfield, Missouri, learned was that no commercial insurance company was even willing to bid on the risk, and disability insurance couldn’t be purchased. That was the end of the “401(k)-like” approach.

Therefore, one of our conclusions is that communities in Illinois, in coordination with the state legislature, must adopt benefits for newly hired police officers and firefighters that are dramatically higher than benefits in the private sector, due to the unique nature of these jobs and the Social Security implications, but which benefits are less than those currently received. Because of the disability-related issues which are present, the ongoing pension costs for police officers and firefighters will still be higher than City officials probably expect.

This Long-Term Solution of a Two Tiered Pension Doesn’t Help Solve the Current Funding Crisis and May Only Make It Worse

We have worked with actuaries concerning plans which developed a second tier with lower pension benefits. We have learned that the benefit costs for the original tier (existing employees) actually increases, since you do not have young workers entering that pool anymore. Long-term there can be great savings with a two-tiered system, but short-term there are not. If you listen carefully to what Governor Quinn has said on the state employees new pension plan, he says that same thing, though often in a less than clear way. (People are reluctant to realize that it will take a long time to realize the large savings about which Governor Quinn speaks.)

How Then to Solve the Present Funding Crisis

1. Aggressive action needs to be taken to get not-for-profits in the Evanston community to contribute specifically to public safety

Northwestern University is one of the major assets, perhaps the major asset, of the Evanston community. However, when viewed from a taxation perspective, it is a black hole. It occupies large amounts of real estate with significant construction built upon it. Substantial economic activity occurs at Northwestern, but almost no taxes are realized by the City of Evanston. It is our understanding that sales taxes are paid, utility taxes are paid, and perhaps some additional small amounts have been paid. For PR purposes, and perhaps as a true expression of goodwill, the University apparently donated a fire truck to Evanston in the not-too-distant past. Certainly, Evanston will resist any effort to impose major taxation upon its not-for-profits, and as a matter of law, in most areas, not-for-profits could not be mandatorily taxed in any event. However, many communities receive payment in lieu of taxes (PILOTs) from their not-for-profit organizations. Because of rather desperate budget issues in the City of St. Louis, that discussion is beginning in earnest here. As a part of an article in the St. Louis Post-Dispatch concerning St. Louis’ review of possible payments from hospitals and universities, there was a comment that Princeton University makes very substantial payments to its local community, in lieu of taxes, in order to maintain high quality services in its surrounding neighborhoods.

Northwestern officials should seriously stop and think about what makes their University what it is. I cannot speak for its teachers or deans, but I know that both of my daughters looked at Northwestern University and the University of Chicago, two excellent schools, during their college searches over 10 years ago. As the parent of formerly undergraduate women, I can certainly say that my perception of what it would be like for my daughters to go walking 10 blocks off campus were dramatically different with respect to those two fine Universities. Northwestern should consider this issue, the significance of Evanston to the Northwestern experience, and realize the part that Evanston police officers and firefighters play in it.

2. Increased Taxation in Evanston 

Only residents of Evanston pay property tax, and they are already perceived to be high. Many people in the Evanston community, including Northwestern students, pay sales tax. People from adjoining communities also come to Evanston to do some of their shopping. If a tax increase is necessary to solve this problem, and it almost certainly will be, I strongly recommend that the City Council adopt an increased sales tax dedicated to the limited purpose of solving the funding crisis. Our work with the City of Springfield led to the passing of a tax increase in that conservative, anti-tax community during the heart of the recession. As noted previously, even the business leaders and the Chamber of Commerce in Springfield stepped up and provided material support for the passage of the tax. The idea of sunsetting the tax when the plan becomes appropriately funded makes the idea more acceptable to the community and its taxpayers.

3. The Problem of “Backloading” and “Resets”   

The detailed significance of actuarial funding is very esoteric. Many very intelligent people become befuddled when it is explained. After a number of years of working with actuaries, I certainly know the basics, but once we get past the basics, an actuary needs to slowly and clearly explain the details, the results and the assumption made. Pension liabilities may actually be larger than the actuarial calculations. Joshua D. Rauh of Northwestern University and Robert Novy-Marx of the University of Chicago have devised fair-value accounting principles and methodology. These techniques have been used by graduate students at Stanford who found hidden shortfalls in California’s public pensions, which will require even greater funding amounts than what were previously believed to be necessary.

What is clear is that the pension funding system adopted in Illinois with respect to the non-Chicago police and fire pensions is back loaded (i.e., payments start low and increase materially each year). Apparently, the Illinois Municipal League did this to keep payments low in the initial years, to make it more politically palatable and to placate City Managers and elected officials, who want to spend the money for other things. However, what this does is to create a constantly escalating cost for the cities and their taxpayers, even if there are no increased benefits going to police officers or firefighters. Also, the plan is set up on a 40-year payment schedule and already once there was a “pension reset” (i.e., after so many years the obligation goes back to year 1 of the 40 years). This meant that the low payments in the initial years were made, but when it came time to reach the higher levels, there was a “restart”. In today’s world, this can be easily analogized to the teaser mortgages with the expensive balloon payment or rate increases in later years. We all just saw where that led. Even though it may appear to be an easy way out for cities, and perhaps something that might be favored, even by police and fire associations and unions, it should not be done, at least not without dramatic limitations.

If, however, pension resets are considered, there should be a qualification that any municipality that wants to take advantage of it has to be at least 70% funded prior to the time of the reset. In a community such as Evanston, which is only about 50% funded, the funding gap would probably need to be filled by the issuance of pension obligation bonds (POBs). The money from the POBs would then be in the pension plan, which solves one problem, but would require the bonds to be paid off. This, in turn, would require an additional funding source (taxation), or further reductions in municipal services.

4. Solving the Funding Crisis Could Involve Layoffs or Furloughs for Police Officers and Firefighters 

Police officers and firefighters probably need to realize that this could mean a decision by the City to cut the number of uniformed officers on both forces. It is our experience that, ultimately, public safety is the strongest concern of a governmental unit and its resident taxpayers. So the hiring freezes and potential layoffs, furloughs and other types of cuts would probably be less for police officers and firefighters than for other municipal employees, but they may well occur. That needs to be accepted by everyone as an unfortunate part of the solutions. Layoffs during a period of high unemployment are very unfortunate, but may be necessary.

5. Other Interest Groups Will Need to Take Hits Including the Developers and the Corporate Welfare Crowd 

Also, some communities have become addicted to government assisted economic development, in much the same way that individuals became addicted to low rate mortgages and pulling equity out of their homes. Some small amount of economic development money spent by Evanston that produces quick and significant benefits is probably still wise policy; but large expenditures of money, or TIFs or subsidies that take a long time to produce benefits, are probably no longer viable in the new world, where everyone faces more uncertainty and downside risk. Developers and the business welfare class won’t like this, but, as we said above, there is a lot of pain to go around, and this is the part that hits that community.Finally, others are going to need to take hits. The idea that Evanston would seek to offer enhanced benefits or pension subsidies to lure or keep high level City employees, at the same time that it considers cutting benefits to police officers and firefighters, is rather disgraceful. It’s not as bad as the bailed out banks paying large bonuses to the leaders who created the problems, but it involves a related set of issues.

The Blessings that Evanston Has and Why This Set of Painful Solutions Can Work

Evanston has a relatively new Mayor and City Manager. They can claim some distance from the creation of the pension underfunding problem, and can seek to have solution of this pension underfunding problem as part of their legacies. There are no magic tricks or silver bullets, and this will be painful for all involved. But, Evanston is blessed with fairly prosperous, well-educated people, who are proud of their community. They can solve this problem, if they choose to do so. Some communities face similar problems, but lack the resources to solve them under any realistic scenario. Sacrifice, pain, lower benefits for new hires, loss of some jobs, higher taxes and less government giveaways are not popular ways to solve problems. But, Evanston, like the rest of America, has to face the new reality and figure out a way to succeed in it.

The City of Evanston: A Perspective on Police and Fire Pension Underfunding (Part 4 of 5)

By admin

The City of Evanston’s finances have deteriorated due to budget and pension plan issues. The police and fire pension plans both have a funding ratio below 50% and remain critically underfunded.

The police and fire pension plans continue to be adversely affected by the recession and market downturn for a number of years. The City is faced with its own problems and an approximate $8 million budget gap for the 2010 fiscal year. As part of the solution to this problem, the City must first correct its own financial situation so that it can then aid the police and fire pension plans, but the City may not be ready to take such steps.

Evanston Police and Fire Pension Plan Issues

The police and fire pension plans will continue to have issues that have been aggravated by the recession and related loss of investment return for a number of years that need to be addressed by the City.

In determining the unfunded accrued liability, the actuary “smooths” investment losses and spreads them over four years so as to help reduce the effect of short-term fluctuations. Thus, a portion of losses from 2007 and 2008 will still be reported until 2012 and will hamper the pension plans’ investment returns in those years.

Furthermore, although the stock market has seemed to stabilize, the plans are still faced with issues due to the stagnant stock market of the last decade. In determining the required plan contributions, the actuary assumes that the plan assets will earn a 7.25% rate of return each year. If the pension plans do not earn that rate of return, then the plan assets will not increase at the rate expected and the unfunded liability will increase as a result.

Given the low market returns of the last decade, notwithstanding the recent positive rebound last year, it may be very difficult for plan trustees to earn the required 7.25% rate of return, so the plans’ unfunded accrued liability will most likely increase over the coming years.

City Council’s Pension “Giveaway”

The City has taken steps to reduce the $8 million budget gap to put it in a position to aid the pension plans, but there is a current resolution before the Board of Aldermen that raises concerns.

Despite the City’s financial condition, the City may sweeten its municipal employees’ pensions. In an alleged effort to recruit new workers from out of state, a proposal is before the aldermen that would allow city workers to boost their pension benefits.

Under the proposal, municipal employees would be able to purchase up to ten years worth of extra pension credits by paying the required employee contribution portion of the pension credits. The City would then pay for the increased pension benefits through higher future contribution rates. This could certainly affect the City’s finances adversely in the future.

The police and fire pension plans are not eligible for the out-of-state service credits, but roughly half of the City’s department heads would qualify. Tim Schoolmaster, a trustee of the city’s police pension plan, said the proposal would amount to a giveaway to top-level city workers.

Under a typical defined benefit plan, the City and employee make contributions over the career of the employee.

These contributions earn an investment return over the twenty-plus years of the employee’s career which helps then fund the employee’s pension in retirement. However, if an employee is able to purchase ten years worth of credit and retire shortly thereafter, then the City must bear a disproportionate amount of that pension liability.

The City will have to pay for its portion of the contributions to the plan and then it also must pay for all of the lost return that would have accrued over the ten years of service.

This proposal is especially interesting given Illinois Constitution Article 13, Section 5: “Membership in any pension or retirement system of the State, any unit of local government or school district, or any agency or instrumentality thereof, shall be an enforceable contractual relationship, the benefits of which shall not be diminished or impaired.”

The duty to provide for pensions through proper funding is the equivalent of the obligation of paying on the bonds the City has issued.

We certainly have learned through our work in Springfield, Missouri, and from the task force report we reviewed in Omaha, Nebraska, that the bond rating agencies may be the ultimate force to get cities to fund pensions properly. Failure to do so may be catastrophic to a city’s bond rating, which will dramatically increase the cost of future debt obligations that the City issues.

Our Assessment of the Evanston Pension Sweetener

The Board of Alderman should not approve this measure without fully assessing its costs and benefits.

According to Alderman Coleen Burrus, 9th Ward, the City already attracts workers from other states, so there is no need to provide further incentive. Furthermore, the current unemployment rates as of January 2010 for the United States and the City of Chicago were 10.6% and 11.7%, respectively, so there is clearly no shortage of potential job applicants nationally or locally.

Though municipal employees are not as vulnerable as the general public to layoffs, there should be a large number of qualified persons available without a pension “giveaway.”

Most importantly, this measure will also cause a financial strain on the City when it is required to make higher future contributions to pay for the pension sweetener. During a financial crisis, honoring existing obligations is more important than creating new benefits, even though this may seem positive or attractive to some.

Failure to do so would be disgraceful and a slap in the face to the uniformed officers and firefighters who protect Evanston’s citizens on a daily basis.

Even though the City is looking to make deep budget cuts and to remove personnel positions, it is also contemplating sweetening pensions for roughly half of the City’s department heads. What is wrong with this picture?

The Board of Alderman’s approval of this resolution would indicate that the City has learned nothing from the past few years or this financial crisis.

The residents of Evanston should require the City to take real action to correct the financial issues plaguing the City’s budget and the police and fire pension plans. Police officers and firefighters, who put their lives on the line for the residents of Evanston, are not covered by Social Security. They are totally dependent on their pensions.

If the citizens of Evanston want to both honor their constitutionally guaranteed pension obligations to the police officers and firefighters, and have a “pension giveaway” to attract high level City employees, then the citizens need to increase their taxes dramatically.

As noted previously, the conservative residents of Springfield, Missouri increased the city’s sales tax by 0.75% in the midst of the Great Recession. Some form of tax increase is probably necessary in any event to help solve Evanston’s problems.

We recognize the difficulty that this places on the residents of Evanston. Property taxes are already perceived to be high. The business community is almost never supportive of tax increases, but when things become desperate enough, business people often are willing to face the realities.

In Springfield, Missouri, we were pleasantly surprised when key members of the Chamber of Commerce supported a ¾ cent sales tax increase to fund police and firefighter pensions. The Chamber membership was certainly divided on the issue, but leadership was determined and the tax passed in early November 2009, in the middle of a severe recession, when unemployment was even higher than it is now.

Difficult problems can be solved over time, but ultimately, funding problems require money. That is an inescapable fact.

The City of Evanston: A Perspective on Police and Fire Pension Underfunding (Part 3 of 5)

By admin

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.