Stock market bust, early retirements hit city -- and taxpayers
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Pensions: why should you care?
A major reason why city taxes are going up while departments such as the police are taking personnel cuts is rising pension costs. One of every six dollars of Mayor R.T. Rybak's proposed 2003 tax increase will pay for higher-than-expected pension costs.
The stock market tanked, requiring the city pay $11 million more to the Minneapolis Police Relief Association in 2003. That's more than the Minneapolis Park and Recreation Board will spend on forestry next year. It's more than the police department will spend on its emergency communications center.
It gets worse. Because the system also encourages early retirements, the city will have to increase its payments to another fund, Minneapolis Employees Retirement Fund (MERF) by $18 million in 2003 -- more than the mayor proposes to spend on park improvements in the next 5 years.
That brings the total shortfall to $29 million.
If taxpayers paid the full $29 million next year, Rybak's proposed $12-million tax increase would triple, or result in more dramatic service cuts. Instead, for the first time, city leaders want to borrow for pensions, paying $2 million to $2.5 million a year for the next 20 years -- just to cover 2003 pension costs.
Next year's $2-million pension loan payment equals the proposed "two percent reduction strategy" in the 2003 police budget. That plan leaves 24 sworn officer positions vacant all year, with more losses through attrition.
The city's pension hit has some budget-watchers questioning how well some pension funds are managed. They also ask how city early-retirement and overtime policies have pushed pension costs up.
The pension funds' impact is not limited to 2003. In the next five years, Minneapolis will need to borrow roughly $123 million to cover MERF's costs alone, city figures show.
$123 million is roughly as much as the city plans to spend on the new downtown public library or nearly as much as the next 10 years of the Neighborhood Revitalization Program.
Future police fund costs are unknown -- and depend on how well the fund's investments do in the stock and bond market, said Patrick Born, the city's finance director.
Ongoing pension costs are a major reason why Rybak and the council were forced to come up with a 10-year plan that raises taxes 8 percent a year while cutting services.
Born said pension costs put pressure on other city services. "The causes of the pressures are certainly poor performance in the stock market, people retiring sooner and -- in the police's case, until recently -- the lack of professional management," he said.
Gerald Bridgeman, president of the police fund, said the city shouldn't make the police fund out to be "the boogie man." He said that former mayors Don Fraser and Sharon Sayles Belton were able to keep taxes down because good investment returns.
"Unfortunately for Rybak, he took office at a time when the markets fell," Bridgeman said.
How is your tax bill affected by the stock market and early retirements? Here is a primer on the Minneapolis pension problem.
1. This problem goes way back.
Today's city taxpayers are paying for past leaders' failure to budget. Taxpayers have been paying for many decades, in higher state and local taxes.
It is Minneapolis' version of the Social Security problem.
The police fund and the Minneapolis Firefighters' Relief Association started before 1900; MERF started in 1919. They were pay-as-you-go systems, according to those familiar with their history. The city collected what it needed to pay benefits -- but it wasn't saving for workers who would eventually retire.
By the late 1970s, the funds had amassed huge "unfunded liabilities" -- $400 million that the city should have had in the bank, but didn't.
Al Hofstede, Minneapolis mayor1974-75 and 1978-1979, said the pension fund shortages threatened the city's top bond rating. Double-digit inflation in the late 1970s boosted pension costs because of built-in escalators. The fire department had more retirees than people working.
The city faced other troubles; industry was leaving and the tax base eroding, Hofstede said. Minneapolis -- and many other municipalities with the same problem -- went to the legislature for help.
As part of a state bailout, the city closed MERF to new members in 1978. New city employees went into the state-run Public Employees Retirement Association (PERA).
The city's police and firefighter funds would close to new members two years later.
In 1980, the state required all public pension funds to be fully funded by 2010. The city had what amounted to a 30-year mortgage to eliminate its pension debt. The state also agreed to provide aid so all obligations would be met.
2. When police and fire fund investments perform poorly, city taxpayers make up the difference.
The three pension funds have hundreds of millions of dollars invested in stocks and bonds, waiting to pay off future pension costs. In 2001, MERF had $1.5 billion, the police fund had $349 million and the fire fund had $304 million.
How these investments perform affects how much extra money the city and state must contribute to assure that retirees get promised benefits.
When the state bailed out the pension funds in 1978 and 1980, it structured the investment risks differently, said Judy Johnson, MERF's executive director.
For police and fire, the state promised to make fixed contributions -- the city had to make up any difference so pensions were fully funded in 2010.
In 1984, the city levied more than $19 million for the police and fire funds -- 20 percent of the city's property tax bill, said Brian Rice, general counsel for the police and fire funds.
The city benefited from the bull market that followed, he said. Robust investment returns put the city ahead of projected payments. The tax bite trended downward starting in the late 1980s.
The city's police and fire fund payments dropped to as low as $311,000 in 2001, according to city numbers.
Each year the levy dropped, it freed up money for other city projects, Rice said. The city treasury "water-skied behind the police and fire funds," he said.
The fire fund reached full funding in 1998 and stayed there through 2001. The police fund peaked in 1999, when it had more than 95 percent of the money to pay future benefits. Its shortfall had dropped to $20 million, according to city figures.
Fortunes changed with the market.
By 2001, the police shortfall grew to $116 million. The fund was 75 percent funded. The markets have not recovered in 2002.
The city levied $2.9 million for the police fund in 2002, but projects a $13.7 million levy in 2003 -- a $10.8 million one-year budget boost.
Bridgeman said the city could have set money aside during the good years as a "rainy day fund," hedging against the eventual market drop. Instead, it levied the minimum required by the payment schedule.
Born said the city had acted responsibly.
"Should we have overtaxed in case the market goes down?" Born asked. "Brian (Rice) is almost making it sound like the city got a windfall. That is not how I would characterize this."
3. From the city taxpayer's perspective, stocks don't affect MERF payments as much as earlier retirements do.
The state covers MERF's investment risks. However, the city takes a big hit when MERF members retire earlier.
Unlike the police and fire funds, MERF has separate accounts for its active members and its retirees, Johnson said.
When an employee retires, the city must transfer several hundred thousand dollars into that person's retirement account to fully cover their future pension costs (as estimated by actuaries).
A nurse in MERF retired this year after working 29 years and two months. The city transferred $489,000 to fully fund her retirement account. A city attorney retired after 32 years and the city had to transfer $814,000.
During those careers, the city and employee have put money aside for retirement, each contributing 9.75 percent of payroll per paycheck. But prior to 1980, the city never saved enough for MERF. The funding gap has closed over the past two decades -- the state alone contributed more than $180 million -- but the city did not close the gap quickly enough.
MERF employees can retire at full benefits after working 29 years and one day. The boom economy and city incentives have encouraged people to leave shortly after qualifying for full benefits -- instead of leaving at age 62 or 63 as they have in the past. Many MERF employees have retired in their mid-50s.
The city's reserves to cover retirements hit zero earlier this year; now, it is $4 million in the red and dropping, triggering the need for tax dollars. The total by 2003 will reach $18 million.
Johnson had seen the early retirement trend coming for several years and had sent memos to the past city administration, alerting it to the looming pension problem, she said, but "I didn't get a response back."
Born and Johnson said that the slowing economy and high health-care costs for seniors may slow the early retirement trend, potentially reducing rising pension costs.
4. Fraud has hurt all funds, and different investment strategies vary returns.
The Legislative Commission on Pensions and Retirement analyzed pension fund returns and compared them to the State Board of Investment, which manages more than $30 billion invested for state employees' retirement benefits.
From 1994 to 2001, the city's police fund would have had $97 million more in the bank -- nearing full funding this year -- had it invested with the State Board, Burek said.
MERF would have had $76.2 million more had it tracked the State Board's investments during that period.
The fire fund outperformed the State Board.
Some of the investment differences happened because of fraud and deception. Some have to do with pension-fund management decisions -- the mix of stocks and bonds, of high-risk and low-risk investments.
The three city funds have all had losses due to shady activity.
MERF investments suffered under the leadership of John Chenoweth, its executive director from 1979 to 1990, reports said.
The State Board of Investment used to invest MERF's money, Johnson said. Chenoweth, a former state senator, convinced the legislature to let the MERF board invest its own money.
"He [Chenoweth] ended up investing in junk bonds, venture capital, high risk things," Johnson said. "He didn't consider risk control. He lied to the board."
If MERF had competent investment advice during Chenoweth's investment slide, it could have had $60 million to $130 million more by the early 1990s, said a report from the Legislative Commission on Pensions and Retirement.
The losses were so bad that in the early 1990s the state extended MERF's timetable to fully fund the pension, giving it an extra 10 years, Johnson said.
In 1996, the police and fire funds invested in a venture capital project called Technimar, which never got off the ground.
The fire relief association lost $5 million and passed a resolution to never to invest in venture projects again.
The police relief association lost $14 million -- the $5 million it thought it invested in Technimar and another $9 million that Rice and Bridgeman said an investment manager invested without the board's knowledge or approval. (Some fund members sued the board, saying it failed to do its job in reviewing the investment.)
The 1990s Technimar loss contributes to city taxpayers' 2003 tax hit.
Bridgeman called the $14 million loss "tremendous," but said, "When you look at the overall picture of the pension fund through its history, it is a small blip."
MERF took another hit this year when one of its investment managers, Advanced Investment Management, failed to follow MERF guidelines and lost $27 million, Johnson said. He added that the loss is borne more by reduced pension payments than by taxpayers.
The various pension funds have also had different investment strategies.
Johnson and Rice say the State Board of Investment has the second most aggressive investment strategy of any public pension fund, trailing only one fund in New York.
During the high-flying 1990s, its stock-heavy portfolio paid off, and the State Board outperformed other funds, they said. During the recent market crash, the State Board has taken heavier losses.
Bridgeman said the police fund had allocated a higher portion of its portfolio to less-risky bonds during the 1990s, "because we were more concerned about not losing," he said.
Reacting to criticism that its investments were lagging the State Board's, the police fund increased its investment in stocks in the late 1990s.
That was just before stock market tanked.
Why has the fire fund done so well? Rice said it is because the board only invests in American companies.
Most portfolio managers will diversify -- including into international investments, he said. Foreign funds have not performed well in the last decade.
5. Retiree and government benefits go up when investments perform well, even if overall the fund is underfunded.
The police and fire funds and MERF predate Social Security. Unless fund members worked outside jobs, they don't get Social Security; their city pension is their only retirement check.
The police and fire fund benefits differ significantly from MERF.
All police and fire fund members pay the same amount into the pension system: 8 percent of the salary of a first-grade top patrol officer or fire fighter. Upon retirement, all get the same pension -- regardless of their rank at retirement -- based on a first-grade top officer's or firefighter's salary.
In 2001, firefighters on full pension got $3,040 a month and police officers got $3,265 a month.
The funds have had several benefit increases above the standard raises based on salaries.
In 1989, the police and fire funds got legislation to pay an extra benefit based on investment returns referred to as "the 13th check."
If investments performed well -- two percentage points better than the scheduled pension increase -- fund members got a bonus check. Legislation capped the 13th check at the prior year's monthly payment.
Today, that pension deal draws a questioning eye from some in City Hall. It allowed bonus payments before the police and fire funds were fully funded.
Born takes exception to Rice's contention that the city budget "water-skied" behind police- and fire-fund gains.
"He is not talking about how benefits increased," Born said. "We wouldn't have to put in as much money if the 13th checks weren't issued."
At the time, City Hall agreed to the 13th check. Former City Councilmember Steve Cramer helped negotiate the deal and today calls it a good compromise.
Powerful north Minneapolis state legislators such as Jim Rice, Carl Kroening and John Sarna backed the 13th-check plan, Cramer said.
It might have been better to do nothing from a financial standpoint, but the city could not ignore the political realities, Cramer said: "We ought not pretend that things don't get mushed together."
Brian Rice said Minneapolis benefited from the 13th check legislation. It allowed the city to assume the police and fire funds would get higher rates of return -- reducing its required annual payments by assuming investments would do better than previous estimates. (If the higher rates didn't materialize, though, the city was still on the hook for any shortfall.)
In 1994, the police and fire funds unilaterally changed how they calculated benefits. Instead of using the base salary of the top patrol officer or firefighter, they added overtime pay and clothing allowance.
"We determined that anything with a taxable nature is salary," said Walter Schirmer, the fire fund's executive secretary.
That year, the fire fund pension benefit jumped by 23 percent to $2,271 a month. The police fund pension increased 15 percent to $2,224 a month.
In 1997, the police and fire funds got legislation for another bonus check if the fund reached 102 percent of full funding, a way to share the wealth of the bull market gains, proponents said.
The fire fund members got the bonus checks four years running, starting in 1998. The 1999 bonus check -- $10,195 -- equaled nearly a third of their annual pension. The smallest bonus check was $7,612.
"Some of the people who are in their 70s should get a benefit from the performance of the fund," Schirmer said. "If you keep it and build it up in a big pool, those people are going to die and they are not going to get the benefit of the investment return."
The police fund never did well enough to pay the "102 percent" bonus check.
6. At MERF, overtime costs increase future pension costs.
MERF members receive pensions based on their top five salaried years, Johnson said. The average MERF pension in 2001 was $2,090 a month, according to its annual report. Some workers got less than $250 a month. More than 150 retirees get more than $5,000 a month.
MERF retirees get increases if investments do well. If investments tank, retirees only get a Consumer Price Index increase. This year, the pensions will increase only .7 percent, Johnson said.
Another way pensions have increased is when staff nearing retirement work overtime. Overtime increases their salary in their last five years, and therefore increases their future pensions.
"We were seeing more and more overtime on wages, which was bumping pensions," Johnson said. "That can be difficult. Because when you have the overtime, under union contract, the most senior people get it, which means MERF members get it."
She gave a "John Doe" example.
John Doe is 55 and retires after 30 years of service. He worked no overtime and made an average of $50,000 a year for his last five years, putting his pension at $2,916. The city would have to transfer $494,000 to his retirement account when he retires.
If John Doe worked four hours of overtime a week during his last five years, his monthly pension would increase to $3,208 a month, or a nearly $300 monthly increase.
To cover that cost, the city would have to transfer $543,000 into his retirement account -- $50,000 more than if he had not worked the four weekly overtime hours. (See graph below.)
7. The retirees control the pension fund boards, even though city taxpayers pay for some decisions.
The majority of board members on the police and fire funds and MERF are retirees.
Born said he has confidence in MERF's Johnson -- a former state budget director and general counsel for the Minnesota State Auditor's Office. He has concerns about management of the police and fire funds, saying in some cases they have not met the City Council's professional management standards.
Born has sent a memo to the City Council's Inter-Governmental Relations Committee seeking review.
"They (the police and fire funds) are not conducting the investment management work in a way that gives me confidence," Born said. "They are not hiring people in a competitive way to advise them. In fire's case, they do not have an independent investment consultant, who advises them on selection of outside managers.
Born's memo said that if council members agree with his analysis, the administration would support legislation transferring police and fire fund investments to the State Board of Investment.
Schirmer, a firefighter and fund executive secretary since 1995, said his general reaction to Born's memo was "insult."
Born never talked to him, he said. The city should be more concerned with results than credentials. Noting that the fire fund had outperformed MERF, the police fund and the State Board since 1994, he said, "Why would you give your money to someone who is getting less of a return?"
The dispute boils down to a difference of opinion over whose money is in the pension funds.
Born said that when employers (in this case, the city) must maintain assets to meet future pension costs, the employer should control those assets.
"The city ultimately has responsibility to see these funds are fully funded and by law is compelled to do so -- but we have virtually no control over how the money is invested."
Bridgeman disagrees: "We believe that once the monies go into the fund, they belong to the retirees and the retirees should have a major say in it.
"The city has two members on this board who are full voting members. I don't think they have voted against any of the investment policies we have. For many years, they didn't even send anybody to the meetings," he said.
Rebecca Law, one of the city's two appointees to the police fund board, said three closed funds could save costs if jointly administered.
She said investment practices have improved at the police fund, but she was concerned that executive director Renee Tessier was hired in May without a competitive process.
Tessier, who has worked for the police fund for 15 years, does not have a college degree, Bridgeman said. However, the police fund had used the city's hiring process in the past, but directors with degrees would only stay for a year or two, he said.
Tessier handles pension payments and is not involved with investments, he said. Rice reviews investments on a quarterly basis. An investment advisor reviews the portfolio more frequently, he said.
Another police fund issue: high legal costs that rose from $75,000 in 1996 to more than $800,000 in 1999, according to Law's figures. In 2001, legal costs topped $500,000.
By comparison, MERF's legal fees in 2001 were under $20,000.
Bridgeman said the legal costs reflected Technimar-related litigation, which is winding down. Legal payments also reflected Rice's investment reviews -- a post-Technimar safeguard -- and legislative lobbying, he said.
"We think we have the best attorney in the pension business," Bridgeman said.
The pension issue will be aired before the City Council's Inter-Governmental Relations Committee Tuesday, Sept. 10.