Predicting who retires when not an exact science

The upcoming city budget will be the toughest balancing act since the 1986 oil bust.

Fixed expenses will jump $156 million, but revenues are expected to climb only about $43 million. Like many cities, Houston faces steep increases in employee health insurance premiums - $26 million more next year. We’ll also pay $51 million more for contractural HPD raises.

Sales tax revenue (about 25% of the general fund budget) is finally beginning to inch up again after dropping or staying flat for two years. The recession even slowed property tax collections, which account for about 45% of the budget.

Then there’s the pension fund shortfall you may have read about. That will account for almost $58 million of the increase ($40 million for civilian employees, $17.8 million for HPD).

The pension fund crisis isn’t just an esoteric issue affecting only city employees. It could affect the level of city services and has certainly precipitated a crisis in public confidence. Everywhere I go astonished voters ask how this happened and what the city’s going to do about it.

May 15 election

Houston voters will be asked May 15 to opt out of proposition 15, the recently approved state constitutional amendment which prohibits cities from reducing or impairing any pension benefit already earned by someone vested in a municipal pension.

Public and private entities all across the country face staggering pension problems, mostly due to the drop in the stock market and the recession. The City of El Paso’s pension fund faces a $440 million gap while Dallas is $2 billion short. As of last year, the Teacher Retirement System of Texas faced a $10.1 billion gap. Many private pension plans have already asked for a federal bailout or have sought bankruptcy.

City pension plans

Municipal Employees – The Houston Municipal Employees Pension System has two plans that cover almost all civilian employees. Department heads have their own plan.

Plan A has caused the most controversy. After 25 years of service, Plan A pays 90% of salary upon retirement and includes 4% annual cost-of-living increases. Employees contribute 4% of their salaries. Municipal employees can retire when they’ve accumulated 70 points (age plus years of service).

Under Plan B, employees contribute nothing, but only receive about 51% after 25 years.

And there’s an expensive catch: Plan B employees can switch to Plan A if they pay back their years of service contribution plus 6% interest. Towers-Perrin, the pension board’s actuarial firm, underestimated the number of employees who would switch plans, thus contributing to the rapid and unexpected increase in pension liability.

HPD and Firefighters Relief Fund – Both the Houston Police Officers Pension System and the Firefighters Relief Fund pay classified employees 65% of salary upon retirement after 25 years of service.

The police pension includes 4% annual cost- of-living increases. Firefighters get 3% raises. Both police and firefighters pay in 9% of their annual salaries because they are not required to pay Social Security taxes.

How it happened

Since city employees make about one-third less than their private sector counterparts and are lucky to get a raise every three or fours years, both the city and state have tried to compensate by offering better pensions.

The Texas Legislature controls pension benefits for cities. In 2001, the legislature dramatically increased Plan A benefits by raising the 25-year pension from 80% to 90% of salaries.

Like previous pension changes, these occurred in Austin. City Council did not vote to increase pension benefits. We did, of course, know about the legislation.

In 2001, Towers Perrin, estimated that 14% of the city’s annual payroll would be needed to cover pension obligations. We thought we could afford the more generous pension benefits being discussed in Austin.

In 2003, a new Towers Perrin report predicted pension obligations would eat up more than 40% of the city’s annual payroll. What happened between 2001 and 2003? Many of you with mutual funds and 401k’s know. The stock market tanked.

The last state legislature also gave the city the right to negotiate changes to municipal pension plan benefits through the meet and confer process. In return for meet and confer, City Council had to give up its two appointees to the pension board. This was done to eliminate a potential conflict of interest. Because Council must vote on any agreement reached through meet and confer, it was suggested it would be unfair for them to also have representatives on the other side.

Yes, we’ve got a serious problem. But it’s the result of the age and demographics of the municipal workforce converging with changes on Wall Street and in Austin.

The dilemma is complicated by the fact that we’re trying to predict what may or may not happen two or three decades down the road. No one knows for sure at what age an employee will retire or what kind of returns we can expect from our investments in 2020. It’s all imaginary numbers.

The way out

Change the actuary period. This would have a huge impact. The current estimates are based on a fixed actuary period that will expire in 18 years. A rolling 30-year actuary period would allow us to spread out the unfunded liability.

Issue pension obligation bonds. This would be like taking out a home equity loan to pay current bills. It’s not a good idea, but we may have to consider it.

Change pension benefits. Employee payroll contributions likely will be increased. New hires and employees who are not yet vested may well be offered an entirely different plan. We need to consider a defined contribution plan instead of the current defined benefit plan. A defined contribution plan is similar to a 401k. Each year the city would contribute a specific amount of money on an employee’s behalf. The employee would also contribute. Upon retirement, the employee would receive only the money in the account as opposed to a specified percentage of salary.

Give the Controller a seat on the pension board. It’s a perfect fit with the controller’s responsibility as the city’s financial watchdog and a way to bring some independent oversight to the pension fund’s investing policies. There would be no conflict of interest because I have no vote at the Council table. Either the controller or a designee could serve.

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My Municipal Channel TV Show, Money Matters, can be seen every Monday on the Municipal Channel (Warner Cable 16)  at 2 and 8 a.m. and 2 and 8 p.m. If you’d like to receive my newsletter, send an email to controllers@cityofhouston.net . The Controller’s website is www.ci.houston.tx.us/citygovt/controller/


Senior Citizen

        City Pension Plans

   Municipal Employees
     Pensions begin at 70
         (years of service
         plus age)
    

    Plan A
     25 years of service =
         90% of salary
            upon retirement
         4% cost-of-living
            increases
       Employees
         contribute 4%

    Plan B
      25 years of service =
         51.25% of salary
            upon retirement
         4% cost-of-living
            increases
       No employee
         contribution
       Option of buying
         into Plan A

     Police Officers
    
 25 years of service=
          65% of salary
          upon retirement
        4% cost of living
           increases
       Employees
          contribute 9%


    Firefighters Relief Fund
     
25 years of service=
        65% of salary
       3% cost of living
           increases
       Employees
           contribute 9%