Submitted by Dave Lott
April 29, 2014 6:35 a.m.
City’s Pension Plan – Plan Investment Performance (Part 2 of 4)
The first article laid out the structure and governance of the City’s two pension plans – the Police/Fire and the General Employees plans. In this second of the four-part series, we will look at the investment performance of the plans and their financial impact on the City’s overall budgetary process.
The investment earnings goal of both programs is presently set at 8.0%, a rate has been the standard goal rate for pension plans for quite some time based on the fact that the average return of large stocks in the market over the last 50 years has been 9.2%. There have been some years where the plans have provided returns in excess of that level, but there have also had some really bad years where the returns were in the negative range. Pension plan reform advocates cite the 8.0% as being unreasonably high. The State’s pension program (Florida Retirement System or FRS) now has an investment goal of 7.75%. During the period from 1995 – 2013, the Police/Fire and General Employee plans have an average net return of 6.81% and 7.18% respectively.
The actuary uses a standard 4-year “smoothing” process intended to temper the wide swings that might occur in the investment market. Based on the latest annual actuarial report, the 4-year smooth earnings rate was 8.13% for the Police/Fire plan and 8.09% for the General Employee plan. While during the economic recession in 2008 – 09, the actual earnings rate was substantially below the target earnings rate of 8.0% the chart below shows how the market’s strong rebound over the last two years has significantly improved the four-year average of the Police/Fire and General Employees plans.
This change also demonstrates that even the 4-year smoothing process doesn’t always prevent major shifts in the overall performance averages.
When the plan doesn’t achieve its investment return threshold, the City must make a greater contribution in order to keep the fund balance at a fiscally sound level and able to meet its payout obligations. The program funding level is calculated annually by the actuary firm hired by each of the pension boards. This firm does a detailed analysis down to the individual member level and using a variety of statistics comes up with the total dollar value necessary to fully fund the program at that point in time. Some of the most important actuarial assumptions include the anticipated rate of payroll growth, plan participant entry and departure levels, projections of how long retirees will live (i.e., the mortality rate) and therefore receive retirement benefits, and the assumed investment returns on pension assets. It is important to note that the City has met 100% of its calculated contribution amount at least as far back as 2004.
The percentage of the actual value of the investments versus the required fund value is the funding percentage. The inverse amount is the “unfunded liability” percentage. Plans that are “100%” or “fully” funded have enough assets to cover the present value of all of their pension liabilities, discounted by the assumed investment earnings percentage goal (8.0%). Plans that are less than fully funded have a level of financial risk in not being able to fully meet the payments promised to the members should the shortfall not be corrected over the long term. Ideally a plan should be funded 100%; but a funding level above 80% and less than 120% is generally considered fiscally acceptable. Unfunded liability levels in excess of 20% may have a negative impact on the bond rating of the government making it more expensive for the government to borrow money through the issuance of bonds. Additionally, the unfunded amount is incorporated in the calculated in the annual required contribution (ARC) under a 30-year amortization schedule.
Under Governmental Accounting Standards Board (GASB) requirements, effective in June 2014, all governments with defined benefit pension programs are required to disclose a “net pension liability” on their balance sheets. That liability equals the difference between the total pension liability and the value of assets set aside in a pension plan to pay benefits. This change will be reflected in the City’s upcoming 2014-15 budget reports.
As of the last annual pension plan reports which ran through September 30th, 2013, the unfunded liability for the Police-Fire fund was $9.9 million (37.4%) and $9.8 million (40.5%) for the General Employee fund for a total unfunded liability amount of $19.7 million. This places the City at combined funding level of only 61.1% for both plans, or stating the inverse, an unfunded percentage of 38.9%.
The Leroy Collins institute, an independent, non-partisan organization that researches major public and private issues facing governments in FL, conducted a study of defined benefit pension programs of the hundred largest cities in Florida. While Fernandina Beach was not included in the study due to its small size, the study gave any program with a funding level of less than 60% a failing grade. Of the cities in the study, only 15% fell into that category and Fernandina Beach has just barely pulled out of that category.
This critical position for the City’s plans is due to a number of short- and long-term factors. The primary short-term factor was the poor performance of the stock market during the 2008 – 2011 timeframe. While fund values have now surpassed their pre-recession levels, the gap between actual earnings from the 8.0% goal rate over a number of poor performance years in the last couple of decades has led to this large shortfall. Unfunded liability amounts impact the annual budget as the calculated shortfall is spread over 30 years in determining the City’s annual contribution. As an example, in the two year period from October 1, 2007 to October 1, 2009 (the worst of the economic collapse), the General Employees’ Plan unfunded liability increased from $4.4 million to $8.0 million—an increase of $3.6 million or 82%. In 2008, the General Employee’s plan had an unfunded liability percentage of 34.2% and the Police/Fire plan’s unfunded liability was 32.1%.
While the unfunded liability percentage has been decreasing, the actual amount of dollars contributed by the City has increased substantially and remains a significant budget item. For the 2007-08 plan period, the City’s contribution for both plans totaled approximately $740,000 but the contribution for the 2012-13 plans is $2.4 million. This annualized increase of 46% comes not from increased benefits nor large salary increases for employees, but is primarily due to a number of factors including the number of plan participants and the afore mentioned earnings shortfalls in earlier years.
Editor’s Note: Dave Lott has been a management consultant specializing in consumer banking and payment systems for 30+ years. As a former 11 year resident of the City, Dave has served on numerous City advisory committees. Dave served as Interim City Manager. He currently resides in Atlanta, Georgia.