Coming Pension Meltdown: The 10 Most Troubled City Systems

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Monday, 11 Nov 2013 04:21 PM

By Jennifer G. Hickey

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Voters in Cincinnati last week soundly defeated a ballot initiative which would have overhauled the pension system for public workers, leaving the city without a plan to deal with $872 million in unfunded liabilities.

Cincinnati is not alone.

Across the nation, cities and states are finding funding for basic services being crowded out of their budgets by the rising cost of retirees' pensions and healthcare.

The Cincinnati initiative would have turned the public pension system into a 401(k) style-plan and require the city to pay off its unfunded liabilities in 10 years.

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It failed 78 percent to 22 percent, an example of the opposition that cities face when trying to tackle the politically sensitive issue of funding retirees' benefits.

More and more cities, counties, and even some states will face the harsh reality of having to fix their pension systems or deal with a Detroit-style bankruptcy.

"This is happening in too many cities and towns across America, where social services, because they can be cut, are cut. Because pensions and bonds constitutionally cannot be cut, they're the protected class," Wall Street financial analyst Meredith Whitney told CNBC.

"I think you're going to see a real issue of neighbor against neighbor on these very issues," said Whitney, who recently co-founded Kenbelle Capital LP, a New York hedge fund.

Whitney argues in her recently released book, "Fate of the States: The New Geography of American Prosperity," that cities and states which delay addressing the crisis will witness a continued decline in growth.

A study by the Pew Center earlier this year looked at 61 cities — those with populations over 500,000 plus the largest city in each state — and found a total gap of $217 billion between pension and retiree healthcare obligations and the funding saved to pay those costs.

According to Pew, those cities had a total pension liability of $385 billion, with 74 percent funded, leaving a $99 billion shortfall.

The situation regarding retiree healthcare benefits in those cities is far worse, with a total of $126.2 billion of liabilities that are only 6 percent funded.

But here’s the real rub: experts are warning that many pension systems, those claiming they are well funded and those who say they aren’t, have all been using rosy projections about future investment returns.

In a recent editorial in Barron’s, Thomas Donlan writes that pension funds have “hidden the results with dubious financial reporting.”

He cites as just one example Detroit, which claimed as late as 2011 that their pension funds were 80 percent fully funded. New auditors found a $3.5 billion shortfall, a hole that pushed the city into bankruptcy.

Detroit, he says, was using the standard 8 percent return on assets, widely used by other funds. Donlan argues that is foolhardy to claim an 8 percent rate of return.

Consider that since January 1, 2001, the Dow Jones has appreciated, on average, a paltry 2.2 percent, with the S&P growing just 1.36 percent.

Instead, Donlan suggests pension funds use a 4 percent rate, the blended rate for no-risk Treasuries or a 5.5 percent rate, consistent with current corporate bond payouts. But if pension funds were to be honest and use such numbers, real unfunded liabilities would jump by a third or more.

Here are the top 10 cities with the lowest percentage of funding for pension liabilities
City Total Liability % Funded
Charleston, W. Va. $270 million 24
Omaha, Neb. $1.43 billion 43
Portland, Ore. $5.46 billion 50
Chicago, Ill. 24.97 billion 52
Little Rock, Ark. $498 million 59
Wilmington, Del. $364 million 59
Boston, Mass. $2.54 billion 60
Atlanta, Ga. $3.17 billion 60
Manchester, N.H. $436 million 60
New Orleans, La. $1.99 billion 61

The Pew Charitable Trusts study further identified nine cities that underperformed on two pension indicators, levels of funding along with the annual contribution percentage: Charleston; Chicago; Fargo, N.D.; Jackson, Miss.; Little Rock; New Orleans; Omaha; Philadelphia, and Portland.

Equally startling, Pew found numerous cities were woefully unprepared to finance healthcare benefit obligations.

"Only Los Angeles, Calif., and Denver, Colo., had even half of the money needed to fulfill their promises to employees. Thirty-three cities had set aside nothing to pay for this bill coming due," the research noted. Cincinnati was not among the cities ranked.

Many localities are seeing their operating budgets squeezed to pay for pension and healthcare retirement benefits.

The country's 250 largest cities saw spending for pensions increase to 10 percent of their general budgets in 2012, an increase of 7.75 percent since 2007, according to The Wall Street Journal.

The situation is no better for the states, which are also facing high burdens associated with worker's retirement costs.

The Chicago Sun-Times reported that an analysis of pension reform scenarios under consideration by the Illinois legislature "make clear that no matter what legislators do, including major pension cutting, a significant portion of the state's budget for the next 20 to 25 years will go toward paying pension bills, consuming 16 to 24 percent of the state’s general revenue fund annually."

Reform: No Easy Solutions

Steven Stanek of the Heartland Institute says there are no easy solutions when you get into situations that are as bad as states like Illinois, which has saved just 43 cents to cover every dollar of what it needs to pay 350,000 retirees and 500,000 current workers who are counting on pension checks.

"Enacting reform is made even harder because all policy is politics ultimately," Stanek tells Newsmax.

Stanek said that while rankings may differ depending on who is doing the number crunching and which data they survey, some states are present on all rankings.

"I would say from what I have seen the worst are Illinois, California, West Virginia, Oklahoma, New Hampshire, Louisiana, Alaska, Connecticut — all make the list," said Stanek.

A September report by the think tank State Budget Solutions said that state public employee retirement promises are underfunded by $4.1 trillion nationally. In addition, the report concluded that when combined, state public pension plans are just 39 percent funded.

The study found the five most poorly funded states are Illinois (24%), Connecticut (25%), Kentucky (27%), and Kansas (29%), along with Mississippi, New Hampshire, and Alaska tied at 30% funded.

State Budget Solution's Cory Eucalitto said in the report that for years the methodology used to rate public pension systems in the states has been too generous, allowing states to spin a rosier picture than reality truly reflected.

The generosity of the standards resulted in decisions this year by the Governmental Accounting Standards Board and by Moody's Investors Services to change the way they calculate state burdens.

"GASB and Moody's have joined a chorus of financial economists and other observers warning that pension funding practices are dangerous for both taxpayers and public employees alike," he writes.

Pension reform not only is causing a strain on local governments, but also on long-held political alliances.

California: The Future Has Arrived

Reform efforts advocated by Democratic mayors in Chicago and Detroit have both been vocally opposed by teacher and labor unions. The fissures have also arisen in San Francisco, where pension reform was one of several issues which resulted in Bay Area Transit Authority (BART) workers striking.

San Jose Mayor Chuck Reed announced in early October he would support a ballot measure for November 2014 that would amend California's Constitution to allow local governments to reduce pension expenses associated with their current employees. The proposal would not affect retiree benefits, but could allow modifications to future beneficiary plans.

With other cities in the state laboring under the weighty costs of pension obligations and retiree benefits, San Bernardino Mayor Pat Morris and Santa Ana Mayor Miguel Pulido joined Reed in submitting the ballot initiative to the state Attorney General.

"Typically, reform is being led by Democratic mayors. It's being resisted by leaders of public employee unions, who are also Democrats. California state legislators tend to side with the unions over the mayors, preferring the status quo — and the campaign contributions from unions — to an intramural fight," says Carl Cannon of RealClearPolitics.

Richard Dreyfuss, senior fellow at the Manhattan Institute, suggests several reforms are needed to avoid going off the fiscal cliff, including prohibiting issuing new bonds to refinance existing liabilities.

Dreyfuss also advocates for comprehensive reform that will combine a transition to defined-contribution plans, such as a 401(k), with reforms to how pensions are funded. He believes the new pension plans should be funded as they are earned, to avoid burdening future employees and beneficiaries.

Dreyfuss is clear in stating that any reform is going to be politically unpalatable.

"The necessity for real reform is problematic for policymakers, who must deal with a workforce resistant to the loss of guaranteed monthly pension benefits; and for political constituencies, including government workers and their allies, whose support for defined-benefit pensions in the public sector stems as much from ideology as from financial self-interest," he wrote.

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