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As you have probably seen in media accounts, the Legislature has passed a bill making very substantial changes to the City of Houston’s pension systems. The bill as passed was 260 pages and mind-numbingly complex. When added to the existing statutory language, the Houston pension statutes will now run over 90,000 words, which in and of itself is absurd.
The bill follows the general outline of what Turner proposed last October, but as the result of lobbying by the business community and grass roots activists, the Legislature made significant changes to Turner’s original proposal. This is the first time that groups representing the taxpayers showed up in Austin to be heard on pension legislation. In the past, local elected officials and the employee groups would make a deal and the Legislature would rubber stamp it. That is not what happened this time.
Let me begin by emphasizing that while the final bill moves us in the direction of solving the City’s pension problems it is far from a permanent solution. Many of the City’s claims about the virtues, like it will allow the City to pay off the pension debt in 30 years or it will save a million dollars a day, are patently false. And other than the $1 billion in borrowed money, the bill actually allows the City put less money in the plans over the next 5-6 years. Hardly a way to reduce the debt.
So, the City will face another pension crisis. The timing of that crisis depends in large measure on how the investments in the pension plans perform over the next few years. If they continue to perform as they have in recent years (10-year average = 5.6%), that crisis will be sooner rather than later.
A detailed review of the bill is impossible here. For those of you who want to take a deep dive, you can review the bill [here]. But here is the Cliff Notes version:
1. Pension Cost Reductions for Infusion of Bond Proceeds – The only part of the new legislation that is likely to make any real difference in the City’s pension costs and debt are benefit reductions and increases to the employee contribution in the amount of about 15% or $2.6 billion. It is important to emphasize that this reduction in pension liabilities is estimated because the actual amount of the savings is dependent on factors in the future, like interest rates. Nonetheless, the savings are substantial and will bend the cost curve down in the future.
The benefits reductions fall into two categories.
The police and municipal plans agreed to about $1.7 billion in cuts in exchange for the City’s agreement to infuse $1 billion from the issuance of pension bonds. Some of you will recall that in the last mayoral campaign this was one of the scenarios I suggested as a tool to reduce the unfunded liability. At the time, Turner was adamantly opposed, arguing, “You can’t solve debt with more debt.” Fortunately, Turner changed his view.
There are also benefit cuts and contribution increases totaling about $900 million for the fire fighters pension plan. I have long criticized the fire fighters for being slow to accept that their benefit structure was unsustainable, but the changes to the fire fighter plan are deeply troubling to me. Unlike the police and municipal plans, the fire fighters did not agree to the cuts in their benefits and will not get any bond money.
Also, the cuts to the fire fighters’ benefits were dramatically more severe than those agreed to by the police and municipal plans. The average benefit cut per member to the fire fighter benefits under Turner’s plan is about $150,000 compared to about $90,000 for police and $28,000 for municipal.
There is no question that the benefits for fire fighters are the most generous benefits of the three plans and were badly in need of reform. However, this plan does something that every candidate for mayor in 2015, including Turner, promised to never do – take away benefits that had been previously earned by our employees. How many times did you hear all of us who ran for mayor declare “a deal is a deal” and promise that earned benefits would never, absent an agreement, be cut. We, as a City, have now done just that and in doing so have clearly broken our word to the current and retired fire fighters. That is not something that should be taken lightly or celebrated.
2. Voter Approval of Pension Bonds. One reform that was won by the business community and grass roots groups was the requirement that any new pension bonds must be approved by voters. When the Legislature allowed cities to issue pension bonds in 2003, the legislation was silent on whether voter approval was required. The Attorney General’s office has interpreted that silence (incorrectly I believe) to mean that voter approval is not required. As a result, the City has already issued about $600 million in pension bonds without getting voter approval.
That will no longer be the case. The bill now requires the City to obtain voter approval before issuing any new bonds. I have long said that pension bonds can be a tool to help manage our pension problems. But like any tool, they can be used properly or they can be misused. Voter approval is an important check to make sure any future pension bonds are not misused.
You may recall that when taxpayer groups first insisted on a voting requirement on bonds, Turner declared it was a poison bill that would kill the bill. But apparently after Turner saw polling that nearly 80% of Houstonians thought they should vote on any new bonds, the provision became less toxic.
3. The “Corridor.” The third major component of the bill is a complex mechanism that is intended to limit the amount that the City will contribute to the pension plans in the future as a percentage of payroll, which has come to be known as the “corridor.” As nearly as I have been able to determine, no other entity, public or private, anywhere in the country, has ever implemented anything like the corridor. It is a completely untested and experimental model.
It is also hideously complex and the provisions are ambiguous and in some cases internally inconsistent. That, in my experience is a recipe for litigation and I suspect you will see plenty of that in the future. You will also see the administrative costs for the plans, which are already too high, rise even more.
The real flaw in the corridor mechanism however, assuming it is actually enforced, is that it primarily relies on future increases to employee contributions if the City’s contribution rises above the limit. It is highly likely this will occur because the plans are unlikely to achieve the 7% investment target over the long run. And a small miss on the investment return equates to very large increases in the employees’ contribution. These increases will be so large at some point in the future it will not be feasible to enforce the corridor. That is the event that will likely precipitate Houston’s next pension crisis.
4. Phasing out Defined Benefit Plans. The biggest disappointment with the bill is that there is no immediate phasing out of the defined benefit model. The bill does include a safety net of sorts that provides that if any of the plans fall below a 65% funded level, they must move all new employees to a cash balance plan. Cash balance plans have some elements of both defined benefit and defined contribution plans. Unfortunately, the bill also includes extraordinarily long grace periods (four years for police and fire and ten years for municipal) which will likely make the provisions meaningless for all practical purposes. In all likelihood, the City will see its next pension crisis long before the expiration of those grace periods.
Nonetheless, the inclusion of this safety net is an important symbolic victory, because it is a concession that phasing out defined benefit plans is the real solution to the City’s pension problems.
5. The Constitutional Question. There is one issue outstanding that may make this entire effort for naught. There is a provision in the Texas Constitution that grants the right to set actuarial assumptions to the pension boards. Of course, the entire point of the corridor is to force the pension boards to share that power with the City and the bill establishes certain limitations on the pension boards’ discretion in setting the assumptions. While there is certainly an argument to be made that the pension boards should not be exclusively vested with the power to set assumptions, that seems to be what the State Constitution provides. The fire fighter pension board has already filed suit to declare the legislation unconstitutional.
The other boards currently have no plans to sue, but may find they are forced to do so to avoid liability from their members. Also, it is possible that any member of the plans could bring such a suit. Of course, that litigation will take time to resolve. If the City implements the plan and then it is declared unconstitutional several years from now, we will have a real mess on our hands.
Notwithstanding Turner’s public confidence that the City will prevail in this litigation, the City legal staff was manic during the negotiations to get the fire fighter board to agree not to sue. I make no prediction about the outcome on the merits, but certainly on its face, the legislation appears to violate the constitution.
There is also another practical effect of the fire fighters’ lawsuit. The Texas Attorney General must approve the issuance of any bonds by local governmental entities. Generally, their policy is to not sign off on any bonds when there is any pending litigation. Whether the Attorney General’s office would find this litigation affects the issuance of the pension bonds is an open question. But generally, that office has been pretty conservative in making such determinations.
6. Conclusion. Shortly after Bill White was elected in 2003, he received the bombshell that the pension plans were underfunded by over $2 billion. White undertook a series of reforms that reduced benefits and he issued pension bonds to shore up the plans. But he left the defined benefit model in place. A dozen years later, our pension debt had tripled.
White’s reforms unquestionably reduced the future costs of the pension plans, but ultimately his incremental approach proved not to be a permanent solution. Such is the case with this plan. It too reduces the pension costs immediately, but instead of biting the bullet and beginning the phase-out of defined benefit plans, it relies on an untested and what will be proven to be unworkable mechanism to do what moving to defined contribution plans would have accomplished without the cost, complexity, litigation and uncertainty of this plan. And as a result, Houston taxpayers and employees will suffer in the long run.
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