November Deadline Looms for Municipalities to Submit Reports on Underfunded Pensions

While Rhode Island has attracted national attention for implementing pension reforms at the state level that address unfunded liabilities, the story is much different at the local level, where retirement plans that have reached “critical status” have not yet been recalibrated. Although the issue has been quiet, come November, local officials are required to submit reports to the state general treasurer’s office that describe how they intend to ensure the long-term viability of plans that are now underfunded.

In February, the Rhode Island Center for Freedom and Prosperity put together a national task force to assess the funding status of local pension plans. That task force included Eileen Norcross of the Mercatus Center, Rich Danker of American Principles Project, Bob Williams of State Budget Solutions, and Mike Stenhouse, the Center’s president. The end result was a study published through the Mercatus Center at George Mason University that examined the 36 Rhode Island cities with their own pension plans.

Norcross and her Mercatus Center colleague Benjamin VanMetre used private-sector valuations, as opposed to assumed investment returns, to calculate liabilities. They found that the total amount of liabilities for municipal pensions is $6 billion as opposed to the $2.4 billion figure that was previously reported. The same private sector valuations also found that every local pension plan is funded below 60 percent of what is needed to cover retirement expenses, according to the study.

Before local officials can get serious about reform, they must first acknowledge that their current accounting methods skew to the point where they greatly understate financial challenges, Stenhouse noted.

“Everyone has heard of Enron, and how financial scandals flow from dishonest accounting,” he said. “We are calling on our local elected officials to be upfront and transparent with their numbers.  That’s the first step, you can’t tackle a problem until it is properly defined.”

Robert Cushman, a former Democratic councilman in Warwick, anticipates that his municipality’s pension system could implode within the next few years unless elected officials act now to alleviate expanding liabilities.

“What I see now is a lot of window dressing,” Cushman said. “Yes, Warwick is meeting annual obligations, but the  mayor and the council are not looking at long-term trends. The truth is that majority of our tax dollars are now going to fund a pension system that is unsustainable. Given the path that we are now on, taxpayers can expect their contributions to the pension plans rise dramatically.”

Since 2004, about 45 cents out of every dollar raised in taxes in the city has been going to pension and  other post-employment benefits (OPEB) costs,  Cushman explained.  Moreover, once existing employee salaries, sick pay, and health care costs are factored in, 92 cents of every $1 in taxes is consumed by these costs, which means very little is left over other city services.

“The question that never gets asked is what effect this pension situation has not just on the city budget, but also on the school budget,” Cushman observed. “When you look the trends moving forward, it means we are looking at tax increases to meet obligations associated with legacy costs [for current retirees], and when you look at four out of five of the last school budgets, they were underfunded. That tells us we have a serious problem that calls out for fundamental reforms. That means looking at existing benefits for current employees and for existing retirees.”

Cushman favors dropping the rate of return (ROR) for the Warwick pensions so that the unfunded liabilities will become more evident up front and more difficult for elected officials to “kick the can down the road.”

“That’s what they did at the state level,” he said. “The unfunded liabilities just exploded when they lowered the rate of return, so they really had no choice but to go ahead with reforms.”

Cushman credits State Treasurer Gina Raimondo for taking decisive action aimed at closing the gap between assets and liabilities within the Rhode Island pension system. The new law enacted this past November suspends cost-of-living adjustments (COLAs) for retirees until the pension system is funded at 80 percent. Raimondo’s reforms shift most of the current employees into hybrid pension plan that blends a guaranteed benefit with a 401(k) style plan. The changes went into effect on July 1st.

Raimondo has been the subject of favorable press coverage that cite her reform package as an example of what other states should be doing.

“She’s a superstar across the country, and she did show some real leadership here,” Cushman said. But she dropped the ball when it came to Warwick. She gave everyone the impression that Warwick was taking the right steps when in reality our local government is doing to address unfunded liabilities.”

Raimondo dropped the ROR from 8.25 percent to 7.5 percent for the state. Cushman said a similar change should be made in Warwick.

The Ocean State Current made multiple phone calls to Raimondo’s office seeking comment but did not receive a response.

Justin Katz, the head researcher for the Center and managing editor of the Current has dissenting view toward the state-level reforms.

“The discount rate (or anticipated return on investment) is way too high,” he argues. “It’s 7.5 percent, but the returns have been 2.28 percent. The treasurer sparked the crisis by lowering the number 0.75 percentage points, and the structure of the legislation appears designed to favor the unions when even that proves too little.”

Moreover, even if all of the assumptions are accurate, the defined-contribution portion of the “hybrid” plan actually makes it more expensive, as a result of the one percent-of-payroll contribution that the state will be making to it on top of the defined benefit portion, Katz explained.

“The hybrid plan only makes sense if the returns come back well below expectations,” he continued. “In fact, the hybrid doesn’t save any money unless the return comes in less than 5 percent. But at that point, the 0.75-reduction crisis will look like a cloudy day before a hurricane.”

There is another problem that Raimondo’s reforms overlook, Katz said. Most of the 8.75 percent of employee contributions going toward pensions will now be of table for any future reforms on the defined benefit side, since 5 percent of that amount is now going to the defined contribution plan, he points out. Furthermore, teachers are contributing a total of only 8.75 percent, where before they were contributing 9.5 percent of payroll.

“When the whole scheme falls apart, the authority for devising a fix of the system will fall on the Retirement Board, seven of the 15 members of which are directly accountable to the unions,” Katz said. “The board will have the authority, at that time, to hand the General Assembly two choices and say, ‘pick one.’ And one of the options has to have no effect on employee benefits.  Naturally, that’s the one that goes into effect if the General Assembly opts not to choose.”

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