According to a recent CNN survey, 96% of private sector employees have a defined contribution pension plan. The private sector phased out defined benefit plans over the last several decades because it is impossible to predict what their ultimate cost will be. They have proven to be particularly problematic in the public sector where elected officials, unions and pension boards have an incentive to understate the costs by jiggering the numbers – like assuming an 8.5% rate of return on pension assets.
Predictably, that kind of chicanery eventually catches up with the pension plans and the entities sponsoring them. One city after another that has played this game has found itself driven into insolvency and without sufficient revenues to provide basic municipal services. Which, of course, is where Houston finds itself today.
Turner has proposed a mechanism, the so-called “corridor”, to cap the growth of the City’s exposure to rising pension costs. No other entity has ever adopted such a measure. It is completely untested and experimental. It is also hideously complex. Complexity leads to ambiguity, which in turns leads to parties gaming the system and litigation.
Of course, you might want to ask yourself, if this is such a great plan, how come no one else has ever used it? You would have to believe that the same financial geniuses that got Houston into this mess have suddenly become so brilliant that they have devised a solution no one else in the country has been smart enough to think of. Excuse me if I am skeptical of that unlikely scenario.
But the truth is that no one knows how well it will work, or if it will work at all. I have previously expressed my doubts and reservations. Others, like the Arnold Foundation’s Josh McGee, have a more favorable view of its potential benefits. But I have not heard anyone, other than Turner and his surrogates, claim it is a permanent fix to our pension problems, because it clearly is not.
If our goal is to limit, to define the taxpayers’ exposure to pension liabilities, we know how to do that. We know how to do that because the private sector has already shown us the way — phasing out defined benefit plans in favor of defined contribution plans. By the way, in addition to the private sector, other public sector organizations in our area, such as the Port of Houston and Metro, have already done this.
The easiest, the fairest, and the least painful way to start the transition is stop offering new employees defined benefit plans. It will take years to work out of the problem, but at least, we know there is an end someday.
So, the question I have been asking for the last few weeks is this: Why not add phasing out the City’s defined benefit pension system in favor of defined contribution plans for new employees to Turner’s plan. There is nothing that prevents us from doing both. What is wrong with a belt and suspenders.
The only answer I ever get is that the employees will not agree to that. Huh? Let me get this straight, 20,000 employees, over half of which do not live in the City, are dictating what kind of pension plan the other 2 million of us are going to offer to new employees!! Are you kidding me?
I completely support someone who came to work for the City being promised a defined benefit pension to demand they receive what they were promised. But the employees have no right to veto taxpayers deciding to move new employees to defined contribution plans, something they favor by more than a 2-to-1 margin.
So why would our elected officials bow to such an outlandish demand? Well, as they say, follow the money. The employee groups, along with the vendors that are feeding at the pension trough ($50 million last year), make very generous campaign contributions. In the last City election, the “Workers’ Voice PAC”, which has a Washington, D.C. address, doled out over $300,000 alone.
Of course, the ultimate irony is that a continuation of defined benefit plans is just as bad, if not worse, for the current employees as the taxpayers. If Turner’s plan is implemented and really enforced, contributions from police officers and fire fighters are almost certain to rise to nearly 20% in a few years. And COLAs, well, you can forget about those altogether. What kind of luck do you think the City is going to have trying to hire new police officers when they tell recruits they have to contribute 20% of their salary to a pension that does not have a COLA?
But, of course, it is the taxpayers who will, at the end of the day, be left holding the bag. It is time for Houston taxpayers to take a stand and say, “NO MORE!” If Turner wants to put his “corridor” in place, so be it. But Houston taxpayers are entitled to a backstop in case the rosy promises we are hearing now end up being like the ones we heard about how the drainage fee was going to solve our flooding problem.
We know that phasing out the defined benefit pension by switching new employees to defined contribution plans will absolutely make this problem go away, eventually. So again, I ask the question, “Why not?”
A few days ago, I received an unmarked envelope. Inside the envelope was a copy of the draft bill that the Turner administration is proposing to amend the police pension plan.
Because of the secrecy in which this process is shrouded, I am not certain that I have the most recent version. The mere fact this process is being carried on in this cloak-and-dagger fashion is shameful and, of course, very telling about the proponents’ confidence in this plan. Of course, we still do not have any of the financial data that backs up Turner’s claims about the plan.
You can review the police pension statute as it would be amended by this bill by clicking Article 6243g-4 – Police (w proposed changes). The comments in the margin are mine. Also, you can read my detailed analysis of the bill by clicking WEK Bill Summary.
But here are the highlights:
Not a Permanent Solution – At the outset, everyone should understand that Turner’s proposal is not a permanent solution to the City’s pension woes. It does, however (1) represents about a 14% cut in the City’s costs of the pension plans and (2) establishes a hideously complex mechanism that, if enforced in good faith, would limit the percentage of payroll the City must contribute to the pension. These improvements are not trivial, but neither are they an ultimate solution to our pension woes. As I have said many times, there is no pathway to real pension reform that does not entail phasing out our defined benefit plans.
However, if defined contribution plans for new employees were added to this plan and the “corridor” mechanism were tightened to be both effective and enforceable, especially restricting the issue of pension bonds, we would be much closer to a real solution.
Pension Debt Not Paid in 30 Years – Notwithstanding the Turner administration’s repeated promises that the plan would retire all of the City’s pension debt in 30 years, that is clearly not true. Any year in which the pension plans do not make the 7% investment goal – as they have not in three of the last five years – the losses for that year are added as an additional layer of debt that is amortized over thirty years from that loss. For example, if the plans miss their investment goal in 2037, 20 years from now, that ensuing debt would not be paid off until 2067!
No Vote or Restriction on Issuing Pension Bonds – Part of the Turner plan is to issue $1 billion of new pension bonds without voter approval. But worse, this bill imposes no restrictions on future pension bonds nor does it require voter approval. The bill has provisions that may require additional bonds to be taken into account when calculating the City contribution, but it also appears to allow the City to borrow its annual contribution each year.
Future COLAs (Cost of Living Adjustment) Tied to Investment Returns – This may be the most surprising, and potentially most impactful provision of the plan, both to taxpayers and retirees. In the term sheets, future COLAs were frozen for some retirees for three years and then tied to Social Security’s COLA adjustment. But in this bill the COLA is set to 5% below the pension plans’ investment return. Over the last ten years the plans have averaged about 5.5%. If that trend continues, this provision would virtually wipe out COLA adjustments for all retirees. While the current COLA provisions are unrealistic and need to reworked, this provision would dramatically impact older retirees, especially those who retired prior to the big run-up in pension benefits at the end of the Lee Brown administration.
Pension Debt will go Up, not Down – As we suspected from the term sheets, the bill adopts a repayment schedule that negatively amortizes the pension debt. If the City’s contribution hits the maximum allowed by the bill, which just about every expert predicts it will, the pension debt will go up an additional $1 billion. In addition, because of other factors (e.g. lag times, asset-smoothing, etc.), it is a virtual certainty that the pension debt will rise for the next decade or so, at least. We could easily wake up 10 years from now with several billion dollars more in pension debt than we have today.
No Consequences if “Corridor” is not Enforced – This may be the most serious concern I have about this bill. There is no consequence to the City if it elects not to enforce the corridor mechanism. The bill requires the pension plans to reduce benefits if the corridor maximum is reached. But the bill does not specify what happens if they refuse. The only remedy would be for the City to sue. First, do we really have confidence that an administration and City Council that accepts hundreds of thousands of dollars in campaign contributions from employee groups would really initiate such litigation? And even if they did, the complexity of the plan and the glacial pace at which our courts move would keep enforcement action in limbo for years. I think we have been in litigation over the drainage fee for seven years now and it still is not over.
Huge Loopholes in Bill – As you will see if you review my bill analysis, there are huge loopholes in the bill’s corridor mechanism. Whether these are intentional or just oversights, I cannot say. But if we are to go forward with the corridor mechanism, these problems in the draft bill must be addressed.
Conclusion – There are very significant issues with the changes to the City’s pension system that are proposed in this draft bill. But, if it were amended to address some of these issues, it would represent a real improvement in the current situation. The two most important changes to the plan are the addition of defined contribution plans for new employees and giving voters the right to approve pension bonds, and these points should be non-negotiable. Anyone not prepared to support these common-sense ideas is not serious about pension reform and certainly not a fiscal conservative.
1. Turner has claimed that there will be $2.5 billion in savings from the plan from benefit reductions and increases in employee contributions. However, the City has refused to release the calculations from which these proposed savings were derived, notwithstanding the repeated requests to do so by third parties attempting to vet the plan. From the limited information we have, most of those familiar with the plans have been unable to generate a number anywhere close to $2.5 billion. Craig Mason, the City’s chief pension officer under Bill White, has flatly said the changes to the plan will not generate $2.5 billion in savings.
2. No drafts of the proposed legislation have been made public. A secret draft of the legislation for the police has been circulated to some select organizations but not made available to the public. Apparently some Houston residents are more important than others. This week the City refused to release the draft of the police bill claiming it was exempt from the Open Records Act. Of course, the mere fact that a “secret” draft is being circulated tells you all you really need to know about this process. How can any organization or individual endorse the “plan” without the actual legislation being released to the public?
3. The only potentially redeeming feature of the plan is the so-called “corridor” which would limit the City’s contribution to 37% (as absurd as that level is). According to the term sheets, once the contribution goes above 37% of payroll, the pension plans would either reduce benefits or increase employee contributions. The problem is that the enforcement mechanism for even this minimal protection for the City has never been defined. What exactly happens if the pension systems do not make the specified changes is anybody’s guess. That kind of vagueness and the inherent complexity of such a mechanism virtually guarantees that the pension systems and the City will be in litigation for decades.
4. The plan uses a repayment schedule that negatively amortizes the pension debt for about the first six years. Conveniently, the payments begin to dramatically ramp-up after the current administration will be out of office. At the end of the 30-year period, the annual pension payments would be over $1 billion.
The City and your pension plans’ management are leading you down a path that will seriously impact your pensions for years to come.
Defined benefit pension plans are a broken financial model. They were originally put in place in a time that most people only lived a few years after retirement and financial markets were much more stable. Neither of those conditions exist today. As a result, the costs of defined benefit plans have inexorably risen over the last several decades causing the private sector to almost completely abandon them.
Every new employee added to this broken model makes your pension plan weaker and your pension less secure.
This is not an opinion. It is just math.
The latest data from the City (which is still unrealistically optimistic) shows that the City would have to contribute over $8 billion just to pay the benefits that you have earned so far.
The proposed plan represents an average 12% cut in the benefits you thought you were going to get. Of course, this comes after City leaders repeatedly promised you they would honor all pension commitments. And trust me, these cuts will not be the last you see. In fact, this is just the beginning.
Automatic Future Benefit Cuts or Increased Contributions
The term sheets agreed to by your pension boards include automatic additional cuts if the City’s costs exceed the “corridor”. The term sheets specifically say that once the corridor is exceeded that the pensions will further cut the cost-of-living adjustments (COLA), extend retirement ages, and/or increase contributions.
Of course, no one can predict the future, but it is highly likely that the corridor limits will be exceeded sooner rather than later, as was suggested by Tuesday’s Houston Chronicle story. Many investment professionals question whether the new 7% return assumption is reasonable. Warren Buffet has said that pension plans should not be using anything above 6%. His company’s plan is based on 4.5%. Over the last two years your plans have averaged returns of less than 3%. Both the police and fire plans lost money last year.
You have been told that this plan provides certainty about your future benefits, when the exact opposite is true. And the plan is so complex it will undoubtedly result in years of litigation over how it is to be interpreted, if it ever passes.
Forget about Future Raises or Increasing Staff
The proposed plan sets the target contribution for the City at 32% of payroll. The upper limit is about 37%. How can the City possibly afford to hire new employees and pay them a decent salary when it must put up an additional 37% in a pension plan? And what do you think are the chances of existing employees getting any kind of respectable pay raises with a 37% add-on for pensions?
Practically speaking, you can also forget about there ever being two officers in a patrol car, the City ever building any new fire stations, or hiring enough building inspectors, or addressing any of the other hundreds of critical needs Houston is facing.
The Causes and The Cure
There are two reasons that the City is in this mess. The first is that the increases to pension benefits during the Lee Brown administration turned out to cost vastly more than was understood at the time. This is what is frequently referred to as the “legacy costs” and we must come up with a plan to deal with those costs.
But an equally important driver of the out-of-control costs is the City’s blind commitment to indefinitely continue defined benefit pension plans. The notion that we can hire people today and promise them a benefit based on their salary thirty years from now and have any idea what that is going to cost is absurd. If the City continues to cling to defined benefit pension plans, the City’s – and your pension plans’ – finances will continue to deteriorate.
The Right to Opt Out
In addition to other needed reforms, you should have the right to opt out of the existing pension plans and to put your money in your own retirement savings account. That may not be for everyone, but if you want out of the interminable controversy that has been and will be the history of these plans, you should have the right to do so and to take control of your future.
Property Tax Cap Will Not be Repealed
Many of your leaders are assuring you that some of the financial pressure on the City will be relieved if voters repeal the property tax cap that was passed in 2004. It is a fantasy. It is not going to happen. This issue has been polled extensively and over 70% of Houston voters oppose repealing the cap on property taxes. And with tax bills already skyrocketing, can you blame them?
I am not predicting an imminent crisis or financial collapse of either the City or your pension plans. But if we do not reform the City’s finances and begin providing reliable services at reasonable tax rates, the City will suffer a long, slow decline, or hollowing out, like other great American cities that failed to tame this problem. And there will be a tipping point at which this becomes a crisis, just as it has in Dallas. That should concern you because your benefits are paid over the long term as well. If the City suffers financially, so will your pension plans.
We don’t know what all will be required to put the pension system on a sound footing and probably will not know for some years. But the most obvious change that should be made immediately is to convert new employees to defined contribution plans. This will not, by itself, solve the pension problems. But as the old saying goes, when you are in a hole stop digging.
Every city employee and retiree should not only be supporting defined contribution plans for new employees; they should be demanding it.
Many of you have been upset with me for the last several years because I kept raising the alarm about the condition of your plans. But I think if you look back at what I said and predicted about the City’s pensions, everything I told you or predicted was true or has come true. In contrast, all the assurances you repeatedly got from your pensions’ management and the City, that there were not any problems, has proved completely wrong.
And please do not ever lose track of the fact that there is a whole cottage industry of pension executives, Wall Street bankers, lobbyists, accountants, actuaries and others that make a very nice living off your pension. For example, why don’t you inquire about what the executive director of your pension plan is paid and compare that to your salary?
Last year, your plans paid $50 million in expenses. That is $50 million that could have gone to shore up your pension funds, but instead went into the pockets of bankers, pension bureaucrats and lobbyists, to name a few. They are petrified that their gravy train might end someday, which switching new employees to defined contribution plans would eventually do that. So, they will continue to spread misinformation about your plans, just like they have been doing for the last 20 years.
I, on the other hand, have zero financial interest in this issue one way or the other. My only interest is seeing that the City I love so dearly does not go the way of Detroit.
So, before you blindly follow your leadership and the City into yet another plan that is going to kick this can down the road until the current elected officials are out of office and your current leadership is retired, perhaps you should consider what is best for you. And believe me, that is not the continuation of defined benefit plans for new employees.
Any hopes that Houston’s sales tax decline was about to ease were dashed yesterday when the Texas Comptroller reported that the City’s sales tax receipts for December were down by 7.5% from last December. In the last ten years, Houston has only seen a 7% or greater decline in monthly sales tax nine times. Three of those have been in 2016.
The report is based on October sales and completes the first six months of the City’s fiscal year. Year-to-date collections are now off by 4.4%, which is the worst start for sales tax collections since 2013. Year-over-year collections have now declined for 16 consecutive months.
The last time the City saw a year-over-year increase was August, 2015. The trend line on collections has been in decline since October, 2012. This the longest period of depressed sales tax collection for as far back as I can find records.
It is time for the City to stop whistling past the graveyard and realize that it is in both cyclical and structural deficit and take action accordingly. It is certainly no time to be committing 50% of our property taxes for the next 30 years to pension contributions.
- There will be no transition, in the long or short term, to defined contribution plans. A transition to defined contribution plans for new employees is favored by 70% of Houstonians. Turner took it off the table because the employees would not agree to it. Exactly why our employees, most of whom do not live in the City, should have a say in what kind of retirement plan we, as taxpayers, offer to our new employees is beyond me.
- The plan will commit the City to spend $20-26 billion on pensions over the next 30 years.
- The City’s assumptions are based on the plans’ assets earning a return of 7% for the next 30 years, down from the old assumption of 8.5%. But in 2015, the plans earned less than 3%. They have not released their returns of this year. Rumor has it that they were less than 2015. The firefighters’ plan’s numbers were so bad this year it did not release the draft of the actuary report that was prepared.
- The employee groups’ leadership have tentatively agreed to about $2.5 billion of benefit cuts. This is about a 12% reduction. Various actuary groups are grinding away on whether the cuts actually add up to $2.5 billion, but my guess is that will be pretty close. It is less clear whether the rank and file in the employee groups are on board with their leadership’s agreement with Turner on these cuts.
- In exchange for these benefit cuts, the City will issue $1 billion of pension bonds and give that money directly to the pensions. This will be the largest general obligation bond issuance in the City’s history and there will be no voter approval of these bonds.
- The target contribution for the City is approximately 32-33% of payroll. That is, of course, a staggering number compared to private industry. But the plan will allow that level to rise to 37-38%, which is supposed to be the maximum the City will ever have to contribute. But the details of how that limitation would work have not been disclosed or apparently even worked out with the employee groups.
- The repayment of the pension debt is back-end loaded so that the real fiscal pain is conveniently delayed for about eight years. I am sure that is just a coincidence.