Freeze & 40: A Plan for Pension Reform in Jacksonville

Part 4 – Finding The Source of the $1.7 Billion Unfunded Liability

Since we now understand how pensions are calculated and how much a retiree can expect to receive in benefits, we are in a position to assess how the $1.7 billion unfunded liability came about.  We make three claims, backed by evidence, that point towards the root causes of the liability.

1.   Lifetime pension benefits for retirees are set at financially unsustainable levels, far above what is needed to attract and retain a quality public safety workforce.
2.   The estimated cost for providing enhanced pension benefits in 2001 was severely miscalculated and misrepresented to taxpayers over multiple years. The PFPF was consistently underfunded as a result of underestimated retiree life expectancies and deeply flawed discount rates for valuing pension liabilities.
3.   Reporting on the Fund’s performance and long-term viability is proactively infrequent, opaque, and inaccessible to citizens, preventing regular external oversight.

Let’s address each claim in turn.

Claim #1: Lifetime pension benefits for retirees were set at financially unsustainable levels, far above what is needed to attract and retain a quality public safety workforce.

The most recent changes to pension benefits occurred in 2001. The 2001 changes impacted the size and growth of a retiree’s pension for current employees.  These changes were also made on a retroactive basis for those already retired.

In effect, retirees received a large raise.  For those retiring after 20 years, the first pension payment increased from 56% of an officer’s final salary to 60%. Annual cost of living adjustments (COLAs) were previously zero for the first five years of a pension, then directly tied to the rate of inflation.  While inflation has averaged in the 2.0 to 2.5% range over the past decade, pension COLAs are fixed at 3%. This arrangement is prohibitively expensive to taxpayers when compounded over decades of a retirement.  In 2013, inflation was only 1.5%. But PFPF retirees will still receive a 3% increase to their pension, which is in effect a 1.5% raise funded by taxpayers.

Are retiree benefits too high?  That’s a judgment call for citizens and their elected officials to make, based on their assessment.  We believe the answer is “yes” and offer two pieces of evidence.

Chart 1 of this report is our first piece of evidence.  A standard police officer retiring after 20 years and his survivor can expect to collect over $3.4 million in pension benefits during their lifetimes, starting at age 43. This is over three times the $1.1 million in total salary the officer earned during his 20 years on the force. In total, the officer will receive a combined $4.5 million of salary and pension for 20 years of service, over $220,000 per year.  A senior leader in the department making $100,000 will collect nearly $5 million in pension benefits, in addition to about $2 million in salary while working. Spread across the entire police and fire departments, this sums to billions upon billions of pensions.

Do taxpayers need to fund a multi-million dollar retirement to every member of the police and fire department to attract and retain a high quality workforce?  Our judgment says “No.” But we wanted to make a comparison of Jacksonville police benefits to another profession with a similar risk profile.  As a result, we looked at the pension plan for current members of the U.S. Military.  Similarly, members of the armed forces are able to retire and receive pensions after 20 years.  How do the pension benefits of men and women in the Armed Forces compare?

Chart 2 below compares total estimated pensions and survivor benefits received over a lifetime if both a service member and a Jacksonville policeman or firefighter retired at the same age of 43 with the same ending salary.

Chart 2 - Comparison of the Value of Military vs. PFPF pension benefits with Same Ending Salary


Members of the U.S. Military have a lower base pension benefit, a lower annual COLA, and a lower surviving spouse benefit.  Using our example of a police officer who retires after 20 years with an ending salary of $62,476, he and his survivor would receive a total of $3.4 million of pension benefits over their lifetime.  This is 80%, or about $1.5 million, higher than the $1.9 million in pension benefits that a member of the U.S. Military would receive.  It must be noted that a member of the PFPF does have $80,000 deducted from their salary over the course of 20 years of service, which is invested in their pension benefit.  This does partially reduce the disparity.  But the difference between the estimated total pension benefits of the PFPF versus a U.S. Military retiree still remains expansive.

Thus, we conclude that lifetime pension benefits for PFPF retirees have been set at financially unsustainable levels, far above what is needed to attract and retain a quality public safety workforce.

It is critical to note that in presenting the above examples, we do not wish to diminish the value police and fire department employees provide to Jacksonville. The services we count on every day are essential to Jacksonville’s quality of life. We deeply respect and appreciate the commitment and service of our police officers and firefighters.  However, we believe setting pension compensation at multi- million dollar levels – significantly above the U.S. Military, for whom we also carry a deep respect – is not necessary to attract and retain a high quality public safety workforce. While it is a guiding principle that retirees should have a pension that provides a base peace of mind, a multi-million dollar benefit is not what we had in mind.  This level of benefits is unsustainable and comes at the long-term citizen expense of uncompetitive tax rates or shrinking city services.

Claim #2: The estimated cost for providing enhanced pension benefits in 2001 was severely miscalculated and misrepresented to taxpayers over multiple years.  The PFPF was consistently underfunded as a result of underestimated retiree life expectancies and deeply flawed discount rates for valuing pension liabilities.

As noted earlier, the city elected to significantly enhance future pension benefits for employees and also retroactively boost pension to then-current retirees in 2001. How could such a financial decision have been justified, given the additional millions of dollars involved?

There are two items in the claim. First, retiree life expectancies were underestimated by the Fund and later updated.  How does this affect the Fund and its liability?  Once again, take the example of our officer.   If he and his spouse live for two more years versus what we modeled in our example, taxpayers would pay out an additional $250,000 in pension benefits.  Across 5,000 employees and retirees, that’s an extra $1.25 billion of pension benefits to be funded!   The 3% COLA on pensions makes any upward adjustments to retiree life expectancy very, very expensive.

At present, the Fund is using the “RP-2000 Combined Healthy Mortality Table” to estimate the life expectancies of employees and the duration they and their spouse will receive retirement benefits.  We do not proclaim to be experts on mortality tables, but it does give us pause that billions of dollars of liabilities are being estimated off of forecasts created over 10 years ago. Is the $1.7 billion unfunded liability even higher today because most current life expectancies are not incorporated in pension liability estimates?

The second item in the claim relates to deeply flawed discount rates for valuing pension liabilities.  Let’s illustrate this with an example.  Suppose you bought a house with a unique mortgage.  You pay nothing up front, but simply owe the bank $200,000 in exactly 20 years for the house.  If you do not come up with the $200,000 in 20 years, your home will be foreclosed.

If you are to pay the bank $200,000 in 20 years, how should you value the liability on your personal balance sheet today?  $200,000?  Something else?  Based on the accounting of the PFPF from the 2000s, the PFPF would have valued the liability today at only $39,123. Why $39,123?  Because the PFPF assumed that its investments would grow by 8.5% per year. So, they could take $39,000 of taxpayer and employee contributions to the PFPF, invest it in a portfolio of stocks and bonds, assume they will earn 8.5% per year and then have the $200,000 to pay the bank in 20 years.  According to the PFPF, the above scenario would be in perfect balance, by assuming that the $39,000 will grow by 8.5% per year for 20 years.

That’s a very liberal way to value a major liability like a mortgage – or a retiree pension.  What if the 8.5% rate is not reached every year?  What would happen then?  Today, the assumed rate of return has been reduced to a more conservative rate of 7%. The same $200,000 liability in 20 years would now instead be valued at just under $52,000. As a result, the homeowner would need to fund an additional
$13,000 – or an additional 33% over the original estimate – for his assets and liabilities to be “balanced.”

If the homeowner did not fund the difference immediately, it would be booked as an unfunded liability. It is adjustments like these, applied over billions of dollars of pension liabilities, which have added hundreds upon hundreds of millions of dollars to the PFPF’s unfunded pension liability.

According to the PFPF, the current value of all future pension liabilities is $2.8 billion. The $2.8 billion is the result after discounting all projected liabilities at a 7% rate, which is the present anticipated (but not guaranteed) rate of return on the Fund’s investments.  But is discounting liabilities by 7% the right amount?  Most financial experts would say that 7% is still too aggressive and should be reduced further, which would further increase the unfunded liability and the threat to Jacksonville’s long-term finances. Overall, there is general consensus among the financial community that the appropriate rate for valuing pension liabilities is separate  from the question of what pension funds are hoping to earn on their investments.

The City of Jacksonville and the PFPF have been systematically miscalculating and misrepresenting the value of pension benefit liabilities. Pension liabilities had been incorrectly valued for numerous years. Later upward adjustments to the value of liabilities have in turn added to the PFPF’s unfunded liability. Pension liabilities arguably are still undervalued today with a 7% discount rate on liabilities and potentially outdated life expectancy assumptions for retirees.

This has led to consistently insufficient funding policies and the gravely erroneous belief that benefits can be greater, city services can be greater, or taxes lower while still funding benefits securely.  As a result, 13 years after pension benefits were enhanced, we are now faced with a $1.7 billion unfunded liability to address.

But couldn’t citizens have uncovered this problem sooner and enacted reforms before the problem became so large?  This leads us to claim #3.

Claim #3: Reporting on the Fund’s performance and long-term viability is proactively infrequent, opaque, and inaccessible to citizens, preventing regular external oversight.

In preparing this analysis, we were surprised at the dearth of publicly available information on the PFPF. With such a large liability looming over the taxpayers of Jacksonville, we consider it an absolute must to have online access to the Fund’s two most critical documents:  its comprehensive annual financial report (CAFR) and its actuarial valuation report.   Neither is presently available online.  In addition, given the billions of dollars involved in the PFPF, we are surprised the Fund would order an actuarial valuation report only every three years.  Three years is an eternity in finance.  No reputable financial advisor would recommend going three years without reviewing one’s personal savings and plan.  Yet that has been the practice of the PFPF.  In every released actuarial valuation report in the past decade, the size of the PFPF’s unfunded liability was calculated to markedly increase by hundreds of millions of dollars.
 
At present, we must be certain that all benefit assumptions are current and stakeholders have the latest information on the viability of the Fund, including any potential changes (good or bad) in assets and unfunded liabilities.  So why does the PFPF fail to place its actuarial valuation and detailed annual report online for review and inspection?  Why does the PFPF not mandate an actuarial review annually?  We can only speculate on the reason, but the consistent lack of transparency has been a contributor to the growth of the $1.7 billion unfunded liability, as citizen oversight has been restricted.