Unfunded Municipal Liabilities

1. Unfunded Municipal Liabilities MMAAA Andrew Bagley & Carolyn Ryan November 7, 2013

2. Municipalities Face Enormous Unfunded Retiree Liabilities Notes: The Teachers Pension category excludes the liability for Boston Teachers which is included in the Municipal Pension category. However, the state and not Boston is responsible for that liability. Local pension systems have a wide range of fully funded dates. One system—Minuteman Regional—is fully funded while Leominster plans to achieve full funding in 2016. On the other hand, 75 systems do not plan to fund their pensions fully until 2030 or later, including six systems which will not be funded until 2040.

3. Pensions

4. Despite Billions in Contributions, Little Progress in Funding Pensions • In 2012, the state’s 99 local pension systems had approximately $14.7 billion in unfunded liabilities, compared to $13.5 billion in 2000. • Municipal pensions were just 57 percent funded in 2012, compared to 59 percent in 2000. Of the 99 systems, 97 are below 80 percent funded and 26 are less than 50 percent funded. • The lack of progress can be attributed to several factors: • Benefit enhancements • Weak investment return • Extending funding schedules • Minimal savings from 2011 pension reform

5. Pension Enhancements • The state has granted municipalities the option of providing early retirement incentives as a way of controlling operating budgets, but these also add millions to unfunded liabilities. • In 2002, the Legislature approved a local option early retirement program giving certain municipal employees five years of additional credit towards years of service or age – the program was in effect for two years. • In 2010, the Legislature made the program a permanent local option for municipalities. • As part of the Municipal Relief Act of 2010, municipalities may exercise a local option to increase the $12,000 COLA base.

6. State and Municipalities Paying the Price of Weak Investment Returns • State and municipal pension plans, suffering a near 30 percent collapse in the market value of their pension funds from the 2008 financial crisis, faced enormous increases in annual contributions. To avoid a budget crisis, funding schedules were extended. • Although many systems have slightly reduced their assumed rates of return, there is serious concern that 7.5 to 8 percent annual growth rates may be unachievable over the next 30 years. • To achieve 8 percent return today, given historically low interest rates, pension asset allocations are far riskier than 20 years ago, making them more susceptible to market volatility.

7. Extending Funding Schedules Adds Billions of Dollars in Costs • Municipalities have extended their funding schedules to limit short-term growth in contributions: in 2000, all systems planned to have their pensions fully funded by 2028, but now, 75 local systems have extended their funding schedules to 2030 or later. • These extensions will cost cities and towns substantially more in foregone interest than savings from pension reforms.

8. 2011 Pension Reforms Apply Only toNew Hires; Provide Minimal Savings • Pension reforms (in present value terms) will save municipalities only $500 million out of a total liability of $35 billion, or roughly 1.5 percent. • Savings are small because the pension reforms apply only to new hires as of April 2012: • Raises the minimum retirement age from 55 to 60 and the full retirement age from 65 to 67 for most employees. • Lengthens the period for calculating the pension benefit from three years to five years. • Reduces the incentive to retire early by adjusting the benefit scale so that it mirrors Social Security’s benefit neutrality.

9. GASB Statement 67 Introduces Blended Discount Rate • Last year, GASB introduced major changes to pension reporting in financial statements. Among other requirements, in fiscal 2015 governments must report the total unfunded liability—based on a blended discount rate—on their balance sheets. • As a result, Massachusetts state and municipal governments will report much larger pension liabilities in their annual financial statements. • Expect similar statements regarding OPEB reporting in coming years.

10. OPEB

11. The Retiree Health Care Challenge • Cities and towns spend an estimated $800 million per year on retiree health care benefits which, without change, will grow to $1.5 billion in 10 years. • Even with this major investment, municipalities have $30 billion in retiree health care liabilities, with 99 percent of that unfunded.

12. Reform Proposal Falls Short • The Governor proposed some positive reforms based on the OPEB Commission’s recommendations: • Changes eligibility for most employees from age 55 with 10 years of service to age 60 with 20 years of service. • Pro-rates benefits based on years of service, starting at 50 percent of premium for those with 20 years of service up to the maximum benefit at 30 years of service. • However, the proposal does little to help municipalities control costs. • The reform would lower the unfunded municipal retiree health care liability from $30 billion to approximately $25 billion—still more than $10 billion greater than the unfunded pension liability. • Furthermore, municipalities would see little relief in the short term because most of the savings from the reforms would not be realized for at least another 10 years.

13. Reform Erodes Municipal Authority • In a major step backward, the reform strips municipalities of the authority to adjust premium contributions for existing retirees, the most important tool for controlling costs for communities. • The reform fails to require that benefits for municipal part-time employees be pro-rated. In most cases, they will still be eligible for the same benefits as full-time employees after just 10 years of part-time service.

14. Options Under Existing Law • Nevertheless, municipalities have important options under current law to help control costs and reduce long-term liabilities. The options fall into four categories: • Tighten eligibility requirements • Adjust premium shares • Control health care costs • Strengthen analysis and public awareness

15. Tighten Eligibility Requirements • Implement a continuous service policy that requires employees to retire directly from the municipality in order to receive retiree health care benefits. • In calculating years of service for eligibility, change local regulations so that part-time service is pro-rated based on a full-time schedule.

16. Reduce Municipal Share of Premiums • Under current law, communities can reduce their share of premium contributions to 50 percent. This adjustment can be made for both current and future retirees. • For every percentage point that a municipality reduces its contribution, it can expect roughly a one percent decrease in the unfunded liability.

17. Reduce Costs: Implement Municipal Health Reform • More than 200 municipalities and regional school districts have adopted modest changes in health plans to achieve savings of $205 million in the first year, double the initial estimate. • Municipal health reform will realize even greater savings over the long term by slowing the rate of growth of health costs. While important, these savings alone will not make retiree health care affordable.

18. Reduce Costs: Anticipate the Cadillac Tax • Federal health reform includes a tax on especially rich health plans—those with premiums of $27,500 for family coverage or $10,200 for individuals will be subject to a 40 percent tax in 2018. • Some municipal plans offered to both pre-65 retirees and active employees already surpass that threshold. • Communities should begin to eliminate these high premium plans and estimate the impact of the tax.

19. Improve Analysis and Public Awareness • Create a separate line item in the municipal budget for retiree health care expenses to measure annual spending and year-to-year growth in costs. • Additional metrics may include percentage of operating budget, share of total health care costs, annual growth in retiree health care vs. annual growth in property tax revenues, and the cost per resident to meet the liability. • Raise awareness of the issue for residents by publishing analysis and valuations through selectmen/council meetings, local newspapers, etc.