A proposed pension fix holds promise
Mayor Sylvester Turner has had a busy first 10 months. It started with fixing potholes, then he tackled the city budget and now he is pushing forward on pension reform, an issue of great concern to the Greater Houston Partnership. As the region’s leading business organization, we work directly with a wide range of stakeholders and they all agree: We need a long-term pension solution in order to protect employees, put the city on solid financial footing and, ultimately, improve services. After two years of study, the Partnership developed and shared six principles meant to guide any comprehensive effort to reform the city’s pension plans. Based on what we know to date, the mayor’s plan is largely consistent with those principles.
Principle 1: Fully funded plans
The mayor’s proposal will ensure that the plans are well-funded in two ways. First, the proposed “corridor” mechanism will make pension debt payments a statutory requirement — thereby forcing the city to stay on schedule. Second, a closed amortization schedule will place the pension debt on a real path to elimination over no longer than 30 years.
Principle 2: Investment assumptions must be realistic
Right now, the city’s plans have some of the highest rate-of-return assumptions in the country — as high as 8.5 percent. These will be reduced to no more than 7 percent going forward, which will allow for a more accurate accounting of the magnitude of the city’s pension debt. After lowering the discount rate and reflecting recent investment performance, the city’s unfunded liability increased to almost $8 billion, in line with Partnership’s and other expert estimates.
Principle 3: City employees should be in savings-based plans
In the pension reform process, a common approach is to place new employees into a defined contribution plan, a savings-based approach broadly adopted in the private sector and in many cities that have achieved comprehensive pension reform.
Mayor Turner’s proposal does not include a defined contribution option. Instead, the mayor’s plan takes a new approach: It creates a target range for the city’s pension contributions. If the city’s pension payments stay within the range, employees will continue to contribute at the same rate. If, however, the city’s contributions go too high, employees may be required to contribute more or benefits may be adjusted.
This range of city contributions, which is being referred to as the “thermostat” or a fiscal “corridor,” is a key part of the mayor’s plan because it will force the city to constantly manage its pension payments and it will cap the city’s contributions each year. This feature will reduce the city’s risk relative to almost any other municipal defined benefit plan in the country.
Principle 4: Benefits for current employees must be addressed
At the mayor’s direction, all three pension systems formulated their own benefit reductions affecting current employees, which will reduce the city’s pension debt by approximately $2.5 billion in total. This step was absolutely essential to comprehensive reform. Many of these benefit reductions will deal directly with the changes made in 2000 and 2001 that increased costs dramatically.
Principle 5: Complete transparency
Reaching this agreement required an unprecedented level of cooperation between the city and the pension systems. Actuaries on both sides of the bargaining table agreed that the proposed changes would have the intended effects. The agreements stipulate a similar degree of data sharing going forward.
Principle 6: Good governance
Good governance is the final step in any reform plan. This essentially means creating a sustainable structure that will protect taxpayers and public workers in the future. The “corridor” mechanism addresses some of these concerns, but we need to learn more here. For example: Will there be independent oversight of investment returns? Have we eliminated conflict of interest fears?
Obviously, there’s still work to be done, but the mayor has made great progress. It’s a new idea with great potential to solve a 15-year old problem in Houston. And, if the “corridor” mechanism is airtight and works as intended, it could become a case study for cities across the country.