Underfunded Police Pensions Strain U.S. Cities
By Mark Johnson, Ph.D., J.D.
The financial burdens presented by police pension plans are drawing national attention. Municipal retirement funds for police and firefighters have set aside only a median 71 cents for every dollar needed to cover future liabilities, according to a recent Wall Street Journal article titled “Police Pensions Put Cities in Bind.” Nationwide, police pension plans are reportedly underfunded by more than $80 billion.
Public pension plans generally, including city plans covering the police force and other employees, are not governed by the Employee Retirement Income Security Act of 1974 (ERISA), which applies to private industry plans. Nor are municipal plans covered by the Pension Benefit Guaranty Corporation (PBGC), the federal agency responsible to protect private sector pension plans.
In recent years, data has revealed an ever-increasing gap between state pension fund assets and net pension liabilities, or the money and benefits owed to public employees. According to The Pew Charitable Trust, the deficit for pension systems throughout America reached $1.1 trillion in 2015, growing by $157 billion from 2014. The current state of police pension funds reflects the larger issue of significantly underfunded state pensions plaguing municipalities and local governments across the U.S.
Municipal governments are responsible for police pensions, which were the first retirement programs in the U.S. that extended beyond military forces.Law enforcement officers are widely respected for their role in protecting society, making it politically difficult for cities to cut pensions or benefits.
Historically, when municipal budgets were tight, cities would expand pension promises rather than provide raises. This was a way to keep the peace with police unions while avoiding an immediate increase in spending.
In the decades leading up to the Great Recession, a strong economy and high investment returns made municipal pension promises look attainable. According to the Public Plans Database, major police and firefighter plans were funded at a median of 101% in 2001.
This changed with the stock market declines of 2008, which wiped out pension plan earnings while simultaneously placing stress on municipal budgets. Many cities responded by contributing less to the plans than was needed to maintain adequate funding levels. Other municipalitiescontinued to usehigh interest rates of returns from the 1990’s when calculating annual pension contributions. Since high interest rates allow lower funding levels, police pension plans were left in an underfunded status when high rates were not achieved.
The rate of return assumed in calculating future pension obligations plays a critical role in determining current taxpayer liabilities, even though the longer-term commitments remain fixed. As the assumed rate of return increases, current funding requirements decrease. Conversely, a lower assumed rate of return requires a higher current funding level in order to meet future obligations. By one industry estimate, each one-point reduction in the assumption rate means 10 percent more in current contributions.
According to the Public Plans Data published by the Center for Retirement Research at Boston College, the average rate of return assumption for public pension plans overall has decreased from 8% in 2001 to 7.6% in 2015. During the same time period, the average funded ratio dropped significantly from 99% in 2001 to 74% in 2015.
At the same time that rates of return are declining, an annual increase of 5.5% in liabilities for public pension funds from 2001 to 2015 significantly exceeded the average asset growth rate of 3.2% annually.
Many municipal governments responded by cutting pension plans. San Jose was one of the first cities to decrease pension costs. Struggling to afford public services like road repair and libraries, voters approved police pension cuts.
Cities Seek Balance between Pension Benefits and Crime Fighting
The ramifications were significant and hundreds of police officers left the San Jose police force. Currently, the city has the lowest ratio of officers to residents among the nation’s largest 35 cities. Additionally, the Journal article reports that police response times for emergencies has dropped, and violent crime in the city has increased. The shortage of San Jose police officers is often cited as a key factor in these crime statistics.
Labor-union litigation, coupled with the city’s need to retain and recruit police, forced San Jose to restore previous retirement ages and cost-of-living increases for existing police officers. San Jose gave police officers a 10 percent increase earlier this year, with additional pay hikes scheduled for 2018 and 2019. Police academy enrollment is currently on the rise.
In 2014, the city of Memphis, TN voted to end pensions for municipal workers, including police officers, who had been working for seven and a half years or less. The pensions would be replaced by a hybrid 401(k) and pension benefits package. Many officers left the force after the move, and violent crime rates increased. The police union is now working to restore certain benefits in court.
Police pension issues have also dominated headlines in Dallas, Texas, the funding level for police and firefighter pension plans has fallen to just 36 percent according to news reports. Many of the financial difficulties date back more than 25 years to a time when the city sweetened benefits in lieu of salary increases. The city promised rates of return and benefit levels that ultimately could not be sustained.
The Texas state legislature took action in May, when it approved additional contributions of $25 to $40 million annually tothe pension plan while also cutting benefits. The plan will remain at less than 50 percent funded, however, even with the increased funding.
Police Pension Plan Litigation
The severity of police pension plan funding levels in many American cities is an example of the broader challenges facing municipal and government pension funds on the whole. Police pension deficits,coupled with the importance of maintaining adequate police forces to fight crime, makes a difficult combination both politically and financially.
Many municipalities will struggle to fund police pension plans in the years to come. Litigation is likely to result as both sides seek to protect their positions.
Police pension expert Mark Johnson is available to discuss litigation matters with plaintiff or defense attorneys involved in pension disputes.
ABOUT THE AUTHOR: Mark Johnson, J.D., Ph.D. Mark Johnson, Ph.D., J.D., is a highly experienced ERISA expert. As a former ERISA Plan Managing Director and plan fiduciary for a Fortune 500 company, Dr. Johnson has practical knowledge of plan documents as well as an in-depth understanding of ERISA obligations. He works as an expert consultant and witness on 401(k), ESOP and pension fiduciary liability; retiree medical benefit coverage; third party administrator disputes; individual benefit claims; pension benefits in bankruptcy; long term disability benefits; and cash conversion balances.
ERISA Benefits Consulting, Inc. by Mark Johnson provides benefit consulting and advisory services and does not engage in the practice of law.
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