Freeze & 40: A Plan for Pension Reform in Jacksonville

Part 5 – Freeze & 40: Piecing Together a Joint Pension Reform Solution
 
In our opinion, the City and the Jacksonville Police and Fire Pension Fund have severely underperformed both politically and financially in managing and overseeing the Fund, placing a $1.7 billion liability at the feet of citizens to address.  The need for comprehensive reform is evident and urgently needed.

We have aligned the following reform proposals with six guiding principles in mind:

1.)  a 50-50 joint responsibility for the $1.7 billion unfunded liability between taxpayers and all fund members;
2.)  no new taxes of any kind;
3.)  preserve retiree peace of mind;
4.)  continue to attract and retain top quality public safety talent;
5.)  provide clear transparency of retiree benefits to all citizens; and
6.)  guarantee  that another pension financial calamity will never happen again


 
The reform plan is called “Freeze & 40,” and contains two sister components related to the Fund’s investment management fees and annual pension cost of living adjustments, titled “Fee Chopper” and “Diet COLA,” respectively.

The net financial effect of the plan is to reduce the PFPF’s unfunded liability to a point where taxpayers contribute $56 million of “annual amortized cost” per year towards the unfunded liability, plus fund management expenses. (Today, taxpayers pay 100% of the cost, about $112 million).

After a change to the retirement structure of current employees, the city will save $56 million per year, which equates to around 1.25 mills of property taxes. We advocate returning at least 0.5 mills back to Jacksonville taxpayers through a property tax cut. This would reduce the millage rate to 10.94 mills, which approximates the tax rates of the late 1990s of the Delaney mayoral administration.

While this is a reduction over the current millage rate of 11.44, it is still 29% higher than the 8.48 millage rate levied in 2008 and 2009. Property taxes would be effectively reset to the period prior to the 2001 pension agreement that began our pension problem and before the real estate bubble that temporarily distorted city revenues and spending.

There will be $25 to $30 million in remaining savings from the Freeze & 40 plan, which can be re- allocated by the City Council to core strategic priorities.  We recommend a comprehensive strategic review of present public safety spending and that the top priority of remaining savings be the strengthening of public safety through the addition of new officers and fire stations.

Core Reform Proposal: Freeze & 40

As described across this proposal, the complexity, unpredictability, and opaqueness of defined benefit pensions has been harmful to the City of Jacksonville, resulting in a $1.7 billion undefined benefit that threatens the financial health of our city government and Jacksonville’s quality of life.  Jacksonville is not alone in facing this problem.  Across the nation, hundreds of states and cities face trillions of dollars of unfunded liabilities, as they have been unable to successfully manage their respective pension funds.

As a result, we advocate that the city get out of the business of funding long-term defined benefit pensions to employees - replacing complexity, unpredictability and opacity with a modern structure of benefits that is simple, reliable and 100% transparent.

We propose the following reform component, named “Freeze & 40.”

First, all defined pension benefits earned by current employees will be frozen at present earned levels. An officer, for example, who has served 15 years would still be eligible to receive a pension at 45% of their last two year’s average salary upon retirement after 20 years.  The employee has earned the core value of the defined benefit pension.

Replacing the defined benefit pension, employees will receive a defined contribution via a modern, cutting edge 401k that is designed for the special risk profile of employment as a police officer or firefighter.  The city will fund $40 million of defined contributions in year 1. The normal annual taxpayer cost of current pension benefits is presently calculated to be approximately $36 million. In exchange for switching from a defined benefit pension, the new 401k benefit will be robust, portable and immediately vesting.

The city 401k will provide a 12-to-1 match on the first 2% of all employee contributions.  With the average employee in the PFPF making  an average salary of $60,000, he would contribute $1,200 to his own 401k and receive a city match of $14,400. Presently, there are between 2,700-2,800 total PFPF- qualifying employees across the police and fire departments. Allocating $40 million in defined contributions equally among them is approximately $14,300 to $14,800 per employee.  Senior employees will receive a larger match in tandem with the higher salaries they earn.  In addition:

• The employee contribution to their 401k to receive a 12-to-1 match is 2%. This is a reduction from the mandatory employee contribution of 7% paid into the PFPF towards a future pension. As a result, employees will be able to keep more of their paycheck. Based on their personal circumstances, an employee has the freedom to put more into their 401k or divert the freed up funds for other personal needs.
• The vesting of defined contributions is immediate (versus 5 years, at present).
• Employees will own their 401k, 100%. It is portable to other jobs, can be borrowed against if needed, and willed to heirs.
We consider this component of our plan to be a win-win for both employees and taxpayers, as it aligns with several guiding principles.


• The 401k benefit is robust, just as the current defined benefit pension is robust. Some may argue that the 401k benefit is too rich, but Jacksonville must be certain it remains able to attract and retain top talent in our police and fire departments. This benefit will be especially attractive to new officers, given the immediate vesting of the 401k.
• This modern 401k benefit provides clear transparency of retiree benefits to all citizens.  The benefit is simple, 100% predictable, and understandable to all, as numerous Jacksonville citizens have retirement benefits invested in a 401k.
• This structure allows taxpayers to easily monitor and quickly comprehend any potential changes to retirement benefits.  Citizens will not need to rely on an actuary’s assumptions in projecting the cost of pension benefit changes – assumptions that can be later changed at significant cost to the taxpayer. Instead, a taxpayer can measure and assess any potential changes on their own with pencil and paper.
• The vesting of defined contributions is immediate (versus 5 years, at present).
• Lastly, the shift to a modern 401k will guarantee  to taxpayers that another pension fiscal calamity will never be experienced again in Jacksonville. Taxpayers will never again find themselves on the hook for a billion dollars because of retroactive benefit enhancements or undervalued pension liabilities.

The shift to a modern 401k will reduce the unfunded liability to taxpayers as the DROP (Deferred Retirement Option Program) program for retirees will be abolished.  In DROP, after 20 years, an employee can elect to continue to work in the police or fire department, receive their current salary, defer their pension, and receive a guaranteed  8.4% return on deferred pension dollars.  DROP, in effect, allows retirement-eligible employees a “triple dip” that is prohibitively expensive to taxpayers.  Going forward, police and fire department leadership will need to optimally manage human resources to ensure their departments have appropriate succession plans in place for key leaders and employees, and not instead rely on the expensive “triple dipping” of DROP as a crutch.

Reform Component #2: Fee Chopper

In order to pay for future pension benefits, the PFPF has over $1.1 billion invested in various securities. The PFPF can save over $6 million per year and reduce the $1.7 billion unfunded liability by shifting its current investments from high-cost, high-fee, money management  firms to low-cost index funds that closely replicate broader stock and bond indexes.  According to an analysis provided to the Jacksonville Pension Reform Task Force, the Fund’s investment strategies are skewed towards active management, with 83% of equity funds actively managed by firms that charge significant fees to the Fund – and by extension, to taxpayers.  Despite this strategy, the most recent 10-year investment return of the PFPF underperformed a comparative set of examined pension funds.  The Fund paid 74 basis points in fees (0.74% of assets) in 2012 and 78 points in 2013. By comparison, the State of Florida Retirement System paid just 30 points in fees in 2011. Across $1.1 billion in investments, 78 basis points results in $8.6 million in annual management  fees.  If the Fund replicated the State of Florida’s fees, only $3.3 million in fees would be realized.

We believe that the Fund can shift its investments to reputable index funds which closely replicate the Fund’s portfolio strategy for less than 25 basis points.   As a result, the Fund can save over $6 million per year which can be used to pay down the unfunded liability, with no impact on investment returns. These reforms can be enacted and the proceeds realized in a matter of weeks.

Reform Component #3 – Diet COLA

A large portion of the estimated $1.7 billion unfunded liability is a result of the 3% fixed, compounded cost-of-living adjustments (COLAs) to retiree pension payments.  Prior to the 2001 pension agreement, no COLAs were enacted in the first five years of a pension.  After 5 years, the COLA was the lesser of inflation or 3%. The current practice of 3% annual COLAs is, in our opinion, financially unsustainable and destructive to Jacksonville taxpayers.  In contrast, U.S. Military pensioners receive a COLA of “Inflation minus 1%” on their pensions until they reach the age of 62, and then receive a COLA equal to the rate of inflation.

The financial unsustainability of 3% fixed COLAs is especially true for larger pensions in excess of $60,000, where retirees are guaranteed  to receive an annual raise of $2,000 or more, per year, every year, for the rest of their lives. In the past 10 years, there were several instances where inflation was less than 2% - yet retirees received their 3% increase to their benefit.  This is effectively a raise to retirees, paid by taxpayers.  In the long-term, these raises come at the expense of higher tax rates or reduced public services offered by the city.

Later this decade, due to the compounding effect of 3% fixed COLAs, we estimated that the average PFPF retiree will earn more from their pension than the average front-line employee in the police and fire department will earn in salary for performing their job.  As a result, we believe that the 3% fixed annual COLA needs to go on a diet.

Adjustments to COLAs are aligned with guiding principles #1 and #3. In order to share the burden of the $1.7 billion unfunded liability equally between taxpayers and all pension fund members, fixed COLAs need to be adjusted downward in a fair manner.  However, we must also make sure to preserve retiree peace of mind in the adjustment process.

After taking into account reductions to the unfunded liability as a result of the first two components of our reforms, the balance of the reduction will come from adjustments to COLAs.  We propose the maximum COLA offered to retirees going forward be the rate of inflation.  Depending on the age of the retiree and the size of the retiree’s benefit, COLAs should be varied.  Older retirees with a smaller pension benefit should receive the maximum COLA available.  Retirees with a pension in excess of $80,000 per year should receive the smallest annual COLA.  The youngest retirees retire in their 40s and 50s and possess who have 10-20+ working years available in their careers should also receive small COLAs.

The below Chart 2 illustrates a range of potential COLAs based on the retiree’s age and the size of their pension benefit.  After tabulating the impact of the first two components of our reforms, actuaries can calculate the range of COLA adjustments needed to provide a 50-50 shared responsibility between taxpayers and fund members for the unfunded liability.



A “lowest” COLA, for example, might be the annual prevailing inflation rate minus a fixed percentage of 1.5% or 2%. As a result of these proposed reforms, the aggregate sum of benefits collected by a retiree with a large pension may not approach the $5 million range in lifetime benefits as described in Chart 1. However, the retiree will still certainly retain financial peace of mind in their retirement.