Reform plan is a good try, but it misses the core problem

KUDOS to Mayor Sylvester Turner for stepping up to the plate to address the city’s pension problem. Unfortunately, I think he swung and missed.

His plan has some bright spot — assume invest-ment return will be more realistic and the city's an- nual contribution to the pension plans will be capped. But, ultimately, the proposal fails to fix the core of the problem, which, quite simply, is this: The city cannot afford the costs of the generous pension benefits for its employees that are embodied in state law.

These generous benefits are epitomized by the benefits received by career firefighters who retired in 2015 and received, on average, an increase in pay upon retirement. Even when considering the risky public-safety work firefighters are called to do, the retirement benefits are extraordinarily lucrative. For instance, the average net annual income of a career firefighter (one with 30-plus years experience) is around $56,000. After retirement, that figure typically rises by a few thousand dollars annually and is supplemented by a very large lump sum payment upon retirement, often approaching $1 million. Numerous knowledgeable out- side objective municipal finance analysts, including The Arnold Foundation and The Greater Houston Partnership, have warned that continuing to support this level of benefits has the city on a path to imminent fiscal disaster.

The city isn’t so far down the hole so as to be hopeless, but any solution must embrace this fiscal truth: Benefits drive the costs of a pension plan. So, any solution to the city’s pension problem must focus primarily on a reduction in future benefits. At a minimum, this must include the provision for automatically increasing benefits after retirement without regard to cost and the costly provision known as DROP (Deferred Retirement Option Plans), which allows retirees to essentially accrue pension benefits while continuing to work. The DROP provision is the source of the lucrative lump sum firefighters typically receive at retirement and has provided longservice police officers with lump sum values at retirement ranging from $1 million to $1.5 million in recent years. These lump sum amounts are in addition to the lifetime annual incomes with guaranteed future annual increases.

Even though one of the mayor’s stated objectives is to reduce the city’s current and future pension costs, Turner’s proposed plan does virtually nothing to satisfy that

objective. While it’s not likely that firefighters would have entertained opening the door to a pension-fix conversation if the reduction in benefits I described above had been on the table, they must understand in no uncertain terms that under Turner’s strategy, these benefits are not sustainable and their future is thus in jeopardy.

While the mayor mentioned some unspecified changes in benefits, he describes his proposed plan as being “budget neutral” or “cost neutral.” To the informed ear, this indicates that there would be no reduction in the city’s pension costs or reduction in taxpayer burden. In the absence of a meaningful reduction of the city’s current and future projected pension costs, the mayor’s plan will fail to solve the city’s pension problem.

There is a bright spot, however. One positive feature of the mayor’s plan is the requirement that the city’s pension funding obligations be determined on a more conservative and realistic actuarial basis. This is accomplished by having the actuaries lower the assumed rate of interest to be earned on pension fund assets to 7 percent per year (down from 8 percent and 8.5 percent), amortizing the “unfunded accrued liability” portion of the pension cost calculation over a fixed 30-year period (as opposed to resetting the amortization period to a new 30-year period every year,) and requiring the city to pay the full actuarially determined annual contributions calculated on this basis every year.

Another potentially positive feature of the mayor’s plan is the introduction of a cap on the annual city contribution rate. While again he was not specific on what the capped rate would be, in order to have a positive effect on solving the pension problem, the limit on the city contribution rate should be set at no more than 20 percent of payroll, significantly less than the current unsustainable projected annual city contribution rate of well over 30 percent of payroll.

The mayor’s plan also includes the issuance of $1.8 billion in pension obligation bonds as a means to reduce the actuarial unfunded accrued liability of the pension funds. This is a very risky transaction as it converts $1.8 billion of the city’s pension liability from a “soft” debt payable to the pension funds to a “hard” debt payable to the bondholders without an appreciable reduction in the city’s overall pension liability burden. It’s somewhat of a shell game, and city taxpayers stand to lose.

Acutely absent from Turner’s plan is any attempt to increase city authority of the pension plans. Currently, the ultimate authority to determine the pension benefits payable to the city’s employees rests with the state Legislature. This is a significant structural flaw, and it’s easy to see why: Most of these lawmakers are not accountable in Houston, even as their action (or inaction) on this issue directly affects Houston taxpayers, and they are unduly influenced by a small group of self-interested plan beneficiaries with an inherent incentive to seek maximum reward for themselves while shifting maximum financial risk to the city.

In the end, the mayor’s plan may get us to first base, but it fails to deliver the homerun city taxpayers need.