Dallas Pension System Crisis: Could It Be Repeated in California?

Despite a strong national economy and rallying stock market, the city of Dallas faces a pension funding crisis that has triggered fears of a municipal bankruptcy. Can something similar happen in California?

Dallas’ Police and Fire Pension System (DPFP) was already teetering at the beginning of 2016, when its actuarial valuation report showed a funded ratio of just 45% (which means that DPFP’s pension assets are sufficient to pay less than half of future anticipated benefits). Further, the value of fund assets declined by more than 12% in 2015 because managers invested in such non-traditional vehicles as “Hawaiian villas, Uruguayan timber and undeveloped land in Arizona.”

DPFP was especially vulnerable because it offered employees a Deferred Retirement Option Program (DROP). This program allows veteran police officer and firefighters to take a lump-sum payment equal to the estimated present value of their lifetime benefits. They could then invest the lump-sum payment in a separate account earning 8% interest.

When city officials began to discuss benefit cuts in August, more officers started taking advantage of the DROP alternative, producing a run on Dallas’ retirement bank. By early December, employees had claimed more than $500 million in DROP payments, representing about a quarter of system assets.

Dallas suffered multiple rating agency downgrades as the city considered an emergency cash infusion into the hobbled pension system. On December 8, the city unilaterally suspended DROP withdrawals.

Given Texas’ reputation for economic strength and fiscal conservatism, it may be surprising to see a pension crisis in the Lone Star State.  But it is not the first time: last year, Houston suffered rating downgrades due to pension underfunding.

So if Texas is vulnerable to such emergencies, can California be far behind? One way to answer that question is to scan California pension systems for the presence of DROP options, since it was the lump-sum withdrawals that caused Dallas’ pension problems to reach crisis proportions.

Our state’s two biggest systems, CalPERS and CalSTRS do not offer DROPs. Legislators have made several attempts to add DROPs for CalPERS public safety employees but all of their bills have either died in the legislative process or were vetoed. The most recent bill, proposed by Charles Calderon (D-Pasadena) in 2009, was supposed to be cost neutral. But as Ed Mendell reported at the time, a CalPERS trustee concluded “it’s almost impossible to certify or state from the beginning that such a program is cost neutral. You are guessing at people’s behavior.”

Several single-employer California systems do offer DROPs. According to State Controller reports, the following systems provide at least some employees the lump-sum option (we have included 2015 funded ratios gathered from the system’s actuarial reports or financial statements)::

System Funded Ratio
City of Fresno Employees’ Retirement System 109.2%
City of Fresno Fire and Police Retirement System 119.6%
City of Los Angeles Fire and Police Pension System 91.5%
Los Angeles County Transportation Authority AFSCME Employees’ Retirement Income Plan 79.3%
Los Angeles County Transportation Authority Maintenance Employees’ Retirement System 66.2%
Los Angeles County Transportation Authority Non-Contract Employees’ Retirement System 73.4%
Los Angeles County Transportation Authority Transportation Communication – Union Employees’ Retirement System 69.3%
Los Angeles County Transportation Authority United Transportation Union Employees’ Retirement System 69.4%
San Diego City Employees’ Retirement System 75.6%
San Francisco City and County Employees’ Retirement System 85.6%
San Luis Obispo County Pension Trust 76.7%

A more comprehensive review of individual retirement system web sites would likely turn up others.

None of the systems listed here face challenges as dire as those confronting DPFP. That said, the various LA Metro plans, San Diego City ERS and San Luis Obispo County all permit DROP withdrawals and are less than 80% funded. While all pension systems should be fully funded, these more vulnerable systems warrant special attention.

Aside from its severe underfunding. DPFP was also especially vulnerable to a crisis because of the unique provisions of its DROP plan:  it is unusual for participants to be able to reinvest their lump-sum payments at an interest rate of 8% and then withdraw them at will. If plan managers cannot revoke DROP provisions entirely, they would be wise to review and possibly tighten up the rules under which participants can take these payments.

6 replies
  1. Redfaced actuary
    Redfaced actuary says:

    The real question is, How long until it arrives in California? DROP programs aren’t the root issue although they certainly helped.The root issues are the benefits and the calculation of their liability.

    The benefits are simply too big. Why should a school district pay $100,000 for 20-30 years to someone who isn’t teaching? Sure it’s good for the teacher but how are the taxpayers and students served? There is an easy solution to this one, eliminate deferred pay. Raise teacher base pay by 10% and eliminate the plans altogether.

    Secondly, the liabilities reported for the benefits are far too small and masked the problem. Had a proper (risk-free) discount rate been used all along, and accurate liabilities known every step of the way, contributions would have been much higher through the years.To take it a step further, it is safe to conclude that if these true contribution requirements had been measured and considered when the plan as was first adopted, or at during various times along the way when they were improved, the plan benefits would not be as rich as they are.

    Sadly, the plans are now nothing more than loans gone bad. Lenders/pensioners will be forced to suffer haircuts. There is no other way. Any state or federal bailout is impossible as those institutions are equally insolvent, in part for the same reason.

    Reply
    • Tough Love
      Tough Love says:

      THIS commentator is giving the CORRECT picture. The ROOT CAUSE of the pension mess in CA and almost all other places offering “final Average Salary”-style DB Plans is grossly excessive pension “generosity”.

      The Elected Officials, their Unions, (and to a lesser extent the workers, the Plans Administrators, and the Plan Consultants making high fees) are to blame, with the latter (the Unions) BUYING the favorable votes of the former (the Elected Officials) with BRIBES disguised as campaign contributions and election support.

      These parties (an well as the workers) like to cite the lack of full funding as the CAUSE of the pension mess, conveniently ignoring the fact that the annual contribution amount necessary to achieve and maintain “full funding” moves in lock-step with the generosity of the Plan, and VERY generous plans are VERY costly, and hence VERY difficult to fully fund.

      The lack of full funding is not the CAUSE of the pension mess, bu the CONSEQUENCE of the true ROOT CAUSE ….. grossly excessive pension “generosity”.

      Reply
  2. michael
    michael says:

    The more relevant question here is exactly how accurate are the fund ratio projections. These ratios are only as good as their underlying assumptions. My guess is that these ratios are significantly flawed. Once the business cycle ends, the tide will go out and I believe we will see the exact same issue with Dallas.

    Reply
    • Tough Love
      Tough Love says:

      Published “official” funding ratios would typically drop by about 1/3 if the Plans were valued under the identical assumptions and methodology that the US Gov’t REQUIRES in the actuarial valuation of Private Sector pension Plans.

      Reply
      • Redfaced actuary
        Redfaced actuary says:

        A drop of a third is a reasonable rule of thumb. So a plan shown at 60% funded would fall to 40% if valued properly.

        That said, I would be careful citing ERISA (the US Gov’t requirements you allude to) as proper in this regard since that law allows for bogus fantasy discount rates, e.g. based in part on 25-year average interest rates. Those plans making contributions on that basis are being systemically underfunded too.

        Reply
        • Tough Love
          Tough Love says:

          True, and the Gov’t should never have allowed the increase from 7 to the 25 year smoothing period.

          But at least PRIVATE Sector Plans have a shutoff mechanism wherein no further accruals are allowed when the funding ratio (using the MUCH more conservative Private sector assumptions & methodology) drops below 60%.

          If PUBLIC Sector Plans had to operate under the same rule ….. no further accruals are allowed when the funding ratio (using the MUCH more conservative Private sector assumptions & methodology) drops below 60% ………. well over 50% of ALL Public Sector Plans would NOT be crediting any further accruals. Think about that …. as a indicator of the ripoff of Taxpayers who the Public Sector workers/Unions are counting on to pay for the current and growing shortfalls.

          ALL of these Public Sector DB Plans need to be frozen, and for it to be financially meaningful, for the future service of all CURRENT (not just new) workers.

          Reply

Leave a Reply

Want to join the discussion?
Feel free to contribute!

Leave a Reply

Your email address will not be published. Required fields are marked *