A Widening Gap in Cities
Shortfalls in Funding for Pensions and Retiree Health Care
Lessons From the Recession
The Great Recession had a significant impact on local pension plans across the country. Overall, the aggregate funding level of the 61 cities studied declined five percentage points—from 79 percent in fiscal year 2007 to 74 percent in fiscal year 2009. Half of the cities saw drops of eight percentage points or more. But the downturn was not the decisive factor that separated cities with the best-funded pension systems from those with poorly funded ones.
Whether a city was fiscally disciplined made a big difference in how it fared. Cities with pension plans that kept up with their payments—consistently making the “annual recommended contribution” calculated by their actuaries—weathered the financial downturn better than their counterparts.[i] Between 2007 and 2009, 35 cities paid at least 90 percent of each year’s annual recommended sum. The funding level of their pension plans fell at half the rate as those in cities that did not consistently make the bulk of their payments.[ii]
Cities began to reform their public sector retirement systems before 2007, but changes have accelerated rapidly in the wake of the Great Recession. Many of the 61 cities in this analysis—even those with relatively well-funded systems—have made adjustments to address funding shortfalls or unsustainable growth in costs for pensions or retiree health care.
In general, reforms for both pensions and retiree health fall into four categories: (1) plan design; (2) funding; (3) benefits; and (4) organization and management.
The changes most commonly affect new hires but also current retirees and employees in some cases.
[i] This report is the broadest look to date specifically at cities’ retirement liabilities, though it covers a subset of all cities. By comparison, the 50 states faced a gap between assets and liabilities of $1.26 trillion for fiscal year 2009: $660 billion for pensions and $604 billion for retiree health benefits, according to the Pew Center on the States report “The Widening Gap: The Great Recession’s Impact on State Pension and Retiree Health Care Costs,” (April 2011), http://www.pewstates.org/uploadedFiles/PCS_Assets/2011/Pew_pensions_retiree_benefits.pdf. The gap grew to $1.38 trillion in fiscal year 2010: $757 billion for pensions and $627 billion for retiree health care, according to Pew’s, “The Widening Gap Update,” (June 2012), http://www.pewstates.org/uploadedFiles/PCS_Assets/2012/Pew_Pensions_Update.pdf.
[ii] Complete pension data for fiscal year 2010 were available only for 40 of the 61 cities. Pew used the most recent comprehensive annual financial reports available for cities during a final data collection period that began in March 2012 and lasted for several weeks. Even among cities that had issued their financial reports for fiscal year 2011, some reports lacked up-to-date data for one or more of their workers’ pension plans. Pension data often are not as current as other financial information. Moreover, according to Pew’s methodology, even pension valuations dated January 1, 2011, for example, would be counted as fiscal year 2010 data to reflect performance for the just-completed fiscal year.
[iii] This report uses “retiree health care” when referring to Other Post-Employment Benefits, a category that includes other non-pension benefits but in which costs are primarily from retiree health care.
[iv] The funding level for Washington, D.C., represents only liabilities accrued since 1997 in defined benefit pension plans for firefighters, police, and teachers. The federal government in 1997 took over financial responsibility for benefits accrued by those workers up to then, as well as retirement benefits for judges, relieving the city of $4.9 billion in unfunded liabilities that it had inherited from the federal government. The city also contributes to a defined benefit plan (for 2,700 general municipal workers hired before 1987) that is managed by the federal Civil Service Retirement System, but an estimate of the city’s share of those liabilities could not be obtained. This study does not include the costs of pension benefits for general municipal employees hired since October 1987. They are not in a defined benefit pension plan but instead receive benefits through a defined contribution system in which the city deposits money each year into a retirement account for each employee. See Government of the District of Columbia, “Comprehensive Annual Financial Report 2011,” (September 30, 2011), 111–117, http://www.cfo.washingtondc.gov/cfo/frames.asp?doc=/cfo/lib/cfo/cafr/2011/cafr_2011.pdf.
Portland, Oregon, had virtually no assets to offset unfunded liabilities of $2.3 billion in fiscal year 2009 in its pension and disability plan for police and firefighters hired before 2007. Meanwhile, the plan covering the rest of Portland’s employees was estimated at 86 percent funded, with unfunded liabilities of $453 million. Portland funds the retirement costs of police and firefighters hired before 2007 on a pay-as-you-go basis, meaning the city relies on property taxes each year to pay benefits and does not attempt to set aside money for the future to meet those liabilities
[vi] States’ pension funds were 78 percent funded in fiscal year 2009 and 75 percent funded in fiscal year 2010, according to Pew’s “The Widening Gap” and “The Widening Gap Update” reports.
Key Findings: Pensions
[ii] While the target funding level for a pension plan should be 100 percent, funding below 80 percent of actuarial accrued liability is widely recognized as inadequate. An 80 percent benchmark is used by the Pension Protection Act of 2006, a federal law that pertains to private sector pension funds, to determine when stricter funding rules apply. In the context of public sector pensions, 80 percent provides a useful dividing line for comparing pension systems. But there is debate about what funding level short of 100 percent signifies a healthy plan. For a discussion of this issue, see American Academy of Actuaries, “Issue Brief,” (July 2012), http://actuary.org/files/80%_Funding_IB_FINAL071912.pdf); or an explanation by pension experts Keith Brainard and Paul Zorn, (January 2012), http://www.wikipension.com/images/0/0a/80_percent_funding_threshold.pdf.
[iii] Four of these cities actually made all or most of their annual payments for certain pension plans, but still fell short overall because they did not sock away much money for others. For example, Charleston and Portland, Oregon, consistently paid all or most of their annual recommended contributions for their general employees’ pensions but not for those of police and firefighters. Portland does not even attempt to set aside money for the pensions of police and firefighters hired before 2007 but relies on property taxes to cover those pension checks each year, leaving unfunded liabilities on the books.
Over this time period, Little Rock consistently made 100 percent of the annual payments recommended to fully fund its long-term pension promises to police and firefighters hired since 1983. Its payment record overall appears much lower because Pew’s calculation also covers three defined benefit plans closed to employees more than three decades ago. In such situations, a city may pay benefit costs as they arise, an amount often less than 100 percent of what is actuarially recommended. Pew’s calculation does not take into account the city’s annual payments to its defined contribution retirement plan, which has covered non-uniformed city employees since 1981.
In similar fashion, New Orleans made at least 80 percent on average of its annual recommended contributions to three current defined benefit pension plans for workers, while it did not make any contributions to two smaller closed plans for police and firefighters.
[iv] This result tracks trends from other studies, which show funding levels for different groups of public pension plans continued to decline in 2011. At the end of fiscal year 2010, the aggregate funding level for pension systems in the “Public Fund Survey” was 77 percent, down from nearly 80 percent in fiscal year 2009. The “Public Fund Survey” is made up of large state and teachers’ funds, as well as a selection of large local funds. It is maintained by the National Association of State Retirement Administrators. Estimates for fiscal year 2011 funding levels by the Center for Retirement Research at Boston College project a small further decline in that year to 75 percent. It uses the same plans in its calculations as the “Public Fund Survey,” with the addition of the University of California Retirement System.
Key Findings: Retiree Health Care
[i] The total bill for retiree health care benefits was larger than for pension benefits in only two of the 61 cities, as of fiscal year 2009. Boston and Bridgeport each faced more than a dollar in retiree health liabilities for every dollar in pension liabilities. (The unfunded portion of their retiree health liabilities also was larger than it was for pensions.) The reason is that both cities are responsible for retired teachers’ health benefits but not their pension benefits, which are covered by the state. See “Bridgeport Comprehensive Annual Financial Report,” (June 30, 2011), 55, http://www.scribd.com/doc/77057948/Bridgeport-CT-2011-CAFR. For Boston, see “Official Statement of the City of Boston Relating to Bond Offerings,” (2011), A33–A34, http://www.cityofboston.gov/Images_Documents/2011%20GOB_tcm3-25570.pdf.
[ii] The following cities had larger unfunded liabilities for retiree health care than for pensions: Austin; Baltimore; Boston; Bridgeport; Charlotte; Columbia; Detroit; Fort Worth; Honolulu; Houston; Indianapolis; Jersey City; Memphis; Milwaukee; Nashville; New York City; Oklahoma City; Providence; San Antonio; San Francisco; San Jose; and Washington, D.C.
Lessons From the Recession
[i] The annual recommended contribution (ARC) is the amount of money actuaries deem necessary to fund the benefits earned by active employees in any given year (dubbed the “normal cost”) in addition to money to pay down any unfunded liabilities. (The size of the payment also depends on a variety of other factors, such as benefits offered, contributions expected from employees, and the amount of time the city has chosen to achieve full funding.) Accounting standards currently establish the time for an unfunded liability to be paid down as no greater than 30 years, but some entities choose a different period. While some cities must make the total annual contribution because of law or pension system requirements, for others, the contribution often is not a required amount but a suggested amount, leaving cities free to underfund their benefits, thus raising the annual payment in subsequent years. To calculate the ARC, actuaries rely on assumptions for a number of future variables—the investment rate of return, inflation, and retiree life span, for example.
[ii] According to Pew calculations, the funding level of the 35 cities that consistently paid at least 90 percent of their annual recommended contribution declined four percentage points between 2007 and 2009. The funding level for the remaining cities fell nine percentage points.