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)::

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.