Crackdown: municipal retirement shortages

March 27, 2019

 

Bloomfield Township trustees and residents in August 2018, were alerted of a potential looming threat to their way of life: after enjoying decades with a relatively low tax rate and a surfeit of municipal services, there was a possibility they would see a change in both, all due to a law, passed in December 2017,  mandating they fully fund their pensions and retiree benefits, ensuring the promise the township had made to employees and former employees over the decades was fulfilled. Problem was, they had often come up short or paid for the benefits out of current funds – what is known as “pay as you go,” often putting residents and services first over retiree benefits.

 

But the new law, Public Act (PA) 202, also known as the Protecting Local Government Retirement and Benefits Act, now changes that, and requires local municipalities to report and have a collective action plan for each retirement pension benefits and/or retirement health benefits account to the state treasury of each plan's funded ratio by specifying assets and liabilities; the annual required contribution, if it is a retiree health care plan; the actuarial determined contribution required, if it is a retirement pension plan; and the local unit of government's annual governmental fund revenues.

 

For pension plans, the criteria for underfunded status is less than 60 percent funding; and for retiree health systems, less than 40 percent funding. It changes the game for how local governments are viewed by the state, and mandates that they fulfill their promises to their retirees.

 

As of January 1, 2018, municipalities had to develop collective action plans to show how they would get to a minimum of 40 percent funding in the next 30 years if they were determined to be “underfunded.”

 

The irony is, the Charter Township of Bloomfield, a community of over 42,000 residents and one of the most affluent in not just Oakland County but the state of Michigan, was determined by the Michigan Department of Treasury to be not only in “underfunded status,” but as Bloomfield Township Supervisor Leo Savoie noted, one of the bottom communities in the state. 

 

And as Bloomfield Township and its board of trustees wrangle with its upcoming budget, potential tax hikes, service and personnel cuts, it is proving to be not only eye-opening but rancorous as well, as they examine not only where they are but how they got there. And they are not the only community experiencing the “no pain, no gain” fever.

 

Savoie said Bloomfield Township has about $161 million in unfunded liabilities. That means it owes that much to its pension and health care benefit accounts. The liability is primarily on the retiree health care side, with the pensions “96, 97 percent funded. The state constitution mandates 100 percent funding. For the retiree health care benefits, we're up to about 6 percent – we had been at zero. For the last 4 to 5 years we've taking the excesses from various budgets and putting it into pensions and (retiree) health care. (But) to reach 40 percent over the next 30 years means putting aside about $65 million. 

 

“Bloomfield Township has been a pay-as-you-go community,” said Savoie for its retiree health care, which was an accepted practice for many years, but the adoption of PA 202 no longer permits “pay as you go” as the primary means of funding retiree health care benefits –  meaning Bloomfield Township is now considered an unfunded community. “When you look at where Bloomfield Township ranks, we're in the 20 worst communities in the state.”

 

Over the next 30 years, they have to come up with a lot of cash annually to reach the $65 million funding status. “We will have to make payments of $3.7 million to $5 million a year,” Savoie said.

 

Compounded, he said, is the township's involvement with an “archaic pension plan we are involved with Prudential Insurance,” going back to 1961. While over the ensuing years other communities exited similar pension plans, Bloomfield Township remains one of the few in the country saddled in this kind of costly and restrictive plan, Savoie said.

 

The Michigan Constitution of 1963 requires all communities to fully fund their retiree pension funds; it makes no mention of health care benefits, which primarily arose during union negotiations after 1963.

 

While Bloomfield Township is in the midst of resident surveys, community discussions, budget meetings and approvals (the fiscal year 2019-2020 budget was approved on March 11, beginning April 1), town halls and bloodletting to determine how they will change that status and adequately and appropriately fund their retiree pension benefit and Other Postemployment Benefits (OPEB) liabilities, which encompass retiree health care benefits, the reality is it will take biting the bullet by trustees, administrators and residents, and most likely paying more in taxes to receive less in services. A proposal has them shifting their public safety millages to a special assessment district.

 

And they are not the only community to feel the impact of PA 202. It is a law that hits local governments big and small, affluent, middle class and struggling, with almost equal measure, because it is a reflection of how they structured their benefits and retiree health care benefits, rather than a reflection of their financial fitness – although to satisfy the requirements of the act, communities will likely be forced to raise taxes, cut staff and axe services, which could alter their desirability and fiscal security. Across Oakland County, Oak Park is also under review with their status pending, and Berkley, Southfield, Pontiac, Madison Heights, Hazel Park and Holly all were found compliant in February and early March after being under review.

 

According to the Michigan Department of Treasury, a total of 19 local units of government were underfunded statewide, although more were under review and found compliant.

 

Birmingham and Bloomfield Hills each had no issue.

 

“It doesn't mean 'underfunded' in the class emergency manager way. It's a frightening choice of words,” noted Oak Park City Manager Eric Tungate. “It means you're waiting for a waiver.” 

 

Tungate said Oak Park has been approved for their pension collective action plan, but is still waiting on the plan for their retiree health care system. 

 

He said while the state wants pension plans funded to 60 percent, their public safety pension plan is about 55 percent funded, while their general fund retiree plan is about 45 percent funded.

 

“We have a plan we're working toward, and it would have been implemented regardless (of the state treasury approval),” Tungate said. “On our own accord, we've implemented a dump of $1 million into the two pension plans. We had $1 million that was a budget surplus at the end of the year, so we did a one time dump. By doing this, it has put us on a 20-year amortization schedule, and the state has accepted this plan for our pension system.”

 

Tungate emphasized he does not take the budget surplus Oak Park had at the end of last year for granted.

 

“We – with the city council – it was not an easy choice,” he said. “We chose to use it for these long term liabilities.”

 

But he noted that there were other choices that could have benefited the Oak Park community. 

 

“With that money, we could have hired more police officers or added a park,” Tungate said, noting there are good and bad sides to the legislation.

 

“On the good side, it has put communities on notice to be more proactive to bring down these liabilities.

 

“On the negative side,” Tungate continued, “it's also a hard choice to pre-fund long term liabilities versus maybe going out and hiring more staff, people like public safety officers to provide services to residents. We're very frugal and careful, but it's hard to get out from under this liability. With health care, the only one who can help and fix this is the federal government. 

 

“The only way for us as a local government to make it work is to cut costs and to shift benefits elsewhere,” Tungate pointed out. “We have to find more cost effective ways to shift benefits. These are human beings who need health care.”

 

Initially, the city of Rochester was listed as under review, and is now compliant. City Manager Blaine Wing was surprised, as he said the city's pension is currently 69 percent funded, and their OPEB is 95 percent funded, with $11.4 million in the fund.

 

“I'm not concerned at all. We're on the path to go 100 percent (funded),” Wing said regarding the rankings on the Michigan Department of Treasury site. 

 

“We closed our (defined benefits) pension plans several years ago, depending on the unions and when their contracts expired, in 2011 to 2014, and we are on the track to be fully funded in 2033,” he said. “We have also been looking at ways to improve our funding percentage, such as making a 13th payment (an extra monthly payment) and/or paying our payment up front each year, instead of monthly.”

 

Rochester decided several years ago to use ICMA-RC as investment managers along with a governing board, helping to put them on a firm financial foot. 

 

“The policies this (governing) board sets continues to show positive results, and in December of 2018, the board approved a web-based software tool through a company called GovInvest. GovInvest's web-based software will allow staff and the board to run various scenarios, in order to maximize our investments as well as to make smarter choices,” Wing said.

 

Wing said he believes the city of Rochester is the first municipality in the state to use the software.

 

Wolverine Lake Village started a program recently to add extra contributions to its pension funds in order to become fully funded sooner, treasurer Michael Kondak said, working to add an extra $100,000 a year.

 

“We were assured that putting that in over an actuarial period of 10 years, we'll be fully funded,” he said. The addition of $1 million covers 2 union groups, the police and department of public works.

 

“On the health side, we're not so well-funded,” Kondak acknowledged, at only about 12 percent.

 

While the community is small, with a small pool of retirees, Kondak said, “fair is fair, and we're trying to make it right by increasing out contributions to OPEB. But it's not as onerous as someplace much larger, like Bloomfield Township.”

 

Other southeastern Michigan local governments feeling the impact of PA 202 are Grosse Pointe Woods, whose original collective action plan has been disapproved and their revision is pending. Gibraltar is in the same boat, while Grosse Ile Township is under review and pending. Highland Park's plan was disapproved and is non-compliant. Redford Township is under review, but was recently approved and found compliant. Garden City is non-compliant and under review, having never submitted a collective action plan. 

 

Romeo Village President Christine Malzahn acknowledged they have big pension and OPEB liabilities, and have submitted their second plan to the state after having been disapproved and found non-compliant.

 

“The question is how are we going to raise these funds? We are in current union discussions. The current union contracts have 2 years left, and we're looking to close (defined benefits). It takes into account changes to the contribution plans, from defined benefits to 401Ks,” Malzahn said. “There are so many moving parts to it. The second phase is where do we find the money? We have the money and we're looking at revenue sources within the general fund balance, and looking forward 30 years, with inflation, as well as the rate of return with our trust fund.

 

“We've also looked at the possibility of raising taxes of a bond, but at this time we're holding,” she said.

 

Romeo's unfunded liability is just under $11 million, Malzahn, who was elected in November 2018, said. 

 

“At the current time, we have a $110,000 bond that is going to be paid in full in 2020, and that will be recaptured in 2020 and we'll have that additional revenue stream.”

 

She said they need about $110,000 a year plus $60,000 which they have been paying as normal pay-as-you-go costs, plus inflation, which they can access from general fund revenue.

 

“We're making assumptions our newly-created trust fund that we're putting the money into will grow at a rate of 7 percent a year,” she said.

 

The city of Centerline was recently approved after being under review because they did not meet the threshold of PA 202 – while one pension fund, for police and fire retirees, was 64 percent funded,  but for general retirees, the fund was only funded at 49 percent. Their OPEB fund was at 23.4 percent, said Centerline City Manager Dennis Champine.

 

“We have a good plan in place to meet the thresholds by 2028,” he said, where each of the funds are reaching additional funding through 2028, by both making increased contributions and decreasing costs.

 

Champine said the city's deputy treasurer “has saved the city hundreds of thousands of dollars through investment policies. He made structural changes to how we were paying fees to investments, and made numerous changes to our investments – where we're investing and how. He's an expert, and he's saved our general fund. In that way, taxes don't need to be raised. They've been status quo for 3.5 years. Actually, we're anticipating some bonds expiring soon, and not needing to re-up them, so residents will actually pay less in taxes.”

 

Champine said Centerline, which he said has the highest tax rate in Macomb County, is at 14.663 mills. 

 

“We're economically in good shape. When PA 202 came out, we were not happy. We felt the law was punishing communities that were already working and complying,” he said. “We felt the state was adding another unfunded mandate, another level of red tape for cities who were working to comply.”

 

He pointed out that initially over 400 communities were labeled “underfunded.”

 

“Centerline was given a stigma, when we were already working to fund our retirees,” Champine said. “It would be different if we were not funding our benefits at all – but we had a plan in place and we're funding it. At the same time, the state has not been funding us with proper level of revenue sharing under Proposal A. This is a knee jerk reaction to those communities who aren't funding their retirees at all.”

 

PA 202, which was signed into law by former Gov. Rick Snyder on December 20, 2017, did not come out of the ether, but was rather a reaction to very bad behavior from some bad actors – notably the city of Detroit during its bankruptcy, and followed an initiative in the form of a task force by Snyder.

 

“Detroit's bankruptcy was very much about these issues,” said professor Eric Scorsone, an economist at Michigan State University. “Detroit's biggest creditors were the unions and retirees, who didn't have benefits paid into health care or pensions – they had exactly zero paid into them. The city of  Detroit owed them $6 billion.”

 

John Axe, senior counsel at Clark Hill and a member of their education and municipal law practice group, and who has written pension and OPEB legislation, expanded on the problem. “The city (of Detroit) did something that was not too smart – they did not close the pension fund and didn't have all new hires go to a defined contribution fund. They left it in a defined benefit fund. It's the equivalent of running a boat, cutting the hull below the water line, and as it fills with water, running the water real hard,” Axe said. “It's not real smart – and it tells everything. 

 

“It was called the Detroit bankruptcy, but the city had a completely unfunded health care system. They never did anything about it,” he continued. “After the bankruptcy, the health care benefits were wiped out.”

 

Because the pension benefits had not been paid into funds and protected, retirees were left with less than they expected. In May 2014, as part of the “Grand Bargain,” legislation was introduced giving Detroit's retirement systems a $194.8 million lump sum as part of the state's $350 million commitment. With their acceptance, and the unions' agreement to contribute towards a Detroit settlement, there was bipartisan support which saw retirees' cuts at 4.5 percent, rather than 50 percent.

 

“The state is coming down (with PA 202) because they think it's a problem,” Axe said.

 

To clarify, a defined benefit pension plan is a type of pension plan which was very common in which an employer promises a specific pension payment upon retirement that is predetermined by a formula by the employee's earning history, tenure and age, rather than on investment returns. It was a traditional way of compensating government and many large corporate employees for many decades in lieu of increased pay. In contrast, a defined contribution plan is a retirement plan where the employer, or employee or both make contributions on a regular basis, the contributions are invested and upon retirement, the member's account is used to provide retirement benefits. 

 

Worldwide today, defined contribution plans are the dominant form of retirement pension plans, both private and municipal.

 

PA 202, and supporting Public Acts 206 and 207 of 2017, which were initially Senate Bills 686, 694 and 696, sponsored by Sen. Jim Stamas (R-Midland), Sen. Mike Shirkey (R-Hillsdale), Sen. Dave Hildenbrand (R-Grand Rapids), Sen. Philip Pavlov (R-St. Clair Township), Rep. Kathy Crawford (R-Novi) and Rep. Gary Howell (R-Lapeer), among others, created the Protecting Local Government Retirement and Benefits Act, following the creation of a task force by Snyder, looking into responsible retirement reform for local governments, which met from February to May of 2017.

 

“Approximately one-third of the 1,856 general purpose governments in Michigan provide employees with post-retirement benefits – whether in the form of pension benefits or other post-employment benefits (OPEB), which principally include health care benefits, or both,” the task force reported in July 2017. “The total unfunded pension liability for local units in Michigan is estimated at $7.5 billion, and the total unfunded liability for retiree health care is at $10.1 billion.”

 

“The biggest unfunded liability is health care,” Axe pointed out. “What the state didn't mention is, the percentage of the state's unfunded liability is 85 to 90 percent, and they can't issue bonds unless they're voted bonds.

 

“This was not on any former governor's agendas.”

 

The new act changes local government's ability to maintain their underfunded status, because they must submit an annual report to the Department of Treasury, which according to the act means the most recent audited financial statement of the municipality's liability for retirement pension benefits and retirement health benefits, with appropriate actuarial projections, assets and liabilities and inflationary standards.

 

“Even those local governments that do pre-fund retiree health care benefits often have substantial unfunded liabilities mainly (because) they do not make the full annual required payments; system assets do not generate the investment returns assumed; and the cost of health care increases at a rate significantly higher than general inflation,” the act noted as the chief problem it seeks to address.

 

According to the July 2017 report from the task force, in 2015, retiree health care actuarial accrual liabilities for all Michigan cities, townships and villages averaged funding at 19 percent. Michigan counties were on average 34 percent funded.

 

“Sixty-nine percent of our communities who reported for 2017 were not underfunded across the state,” said Rod Taylor, division administrator of the Community Engagement and Finance Division at Michigan Department of Treasury. “The majority of communities are very strongly responsible and have positioned themselves well for responding to this liability that they have. The total of more than $19 billion in pensions and OPEB is good news. On the pension side, 74 percent of communities on average are funded across the state, with the trigger at 60 percent. Most units have been very positively addressing this. OPEB, the retiree health care, that's at a very different level, though. The average funded level is about 25 percent, primarily because pensions are an item that is constitutionally required.”

 

Taylor explained that for many local units of government, including Bloomfield Township, health care has been pay-as-you-go, or PayGo.

 

“Pay-as-you-go will never work for anyone,” Axe stated. “You can never catch up.”

 

“It has not been constitutionally required to make payments,” Taylor explained. “PayGo has been allowed, unless for employees hired after June 30, 2018, who they are required to pay normalized costs – those they must pre-fund the benefit, per the law. 

 

“The focus of the law is transparency and shining a light, so local communities can make the best decisions for themselves, and that has been very effective,” he noted, with employers, retirees and union retirees all able to see and be aware the challenges facing the community. “So they're all in it together. The more people are aware of challenges, the better it is for everyone. For communities who don't meet the criteria, it allows communities to come together and determine the best solution that works for that local community.”

 

Taylor said the bigger risk is in a community not addressing unfunded liabilities, because costs can rise very quickly over the years, “and then locals have to deal with issues of funding services. (By complying with PA 202) locals can honor long term benefits as well as fund critical services like public safety, roads, and other needs.”

 

Axe, who has worked with Oakland County on its pensions and municipal bonding, said it is not by accident that Oakland County is fully funded, with closed plans. 

 

The Michigan Department of Treasury was required to create a Municipal Stability Board, a 3-member board,  within the treasury, an independent board, which monitors compliance of underfunded local communities as well as having to oversee any corrective action plan the local community has to submit and comply with. 

 

Taylor noted that the Municipal Stability Board operates under best practices, and provides troubled communities with guidelines that other communities have used to address their underfunded status. They also have a cap criteria which the board uses to determine if the corrective action plan is likely to be approved, “so it is very clear to the municipality what the expectation is.”

 

As recently as March 8, 2019, Bloomfield Township is under review by the Municipal Stability Board, with their first compliance plan disapproved. A revised plan was resubmitted in February, although finance director Jason Theis told trustees at a meeting on February 11, he anticipated the plan would again be denied by the state, as a full plan was still being updated.

 

“There are some things that still need to be filled out, but we don't have that data ready,” Theis said. “We feel they are pushing us to make a decision that we should take our time on. We will file and expect it to be denied, but we are filing what the state is asking at this time. We had 60 days to respond once we got the denial. We will go back before the board within 60 days to review the updated form, then respond within probably 30 days, and have another 60 days if it's denied. We will probably do this a couple more times as we get into the fall.”

 

Taylor said that the Municipal Stability Board has to act within 45 days of receiving a municipality's action plan, and then has 15 days to respond to a local unit of government if they issue a denial.

 

“If the plan is approved, they are sent a detailed letter as well (as it being posted on the website) outlining next steps,” he said. “They have to start implementing the plan within 180 days. Ultimately, the Municipal Stability Board will monitor them every 2 years to make sure they are complying.

 

“It is an ongoing effort on the part of both the local units of government and the state.”

 

Bloomfield Township's Savoie, finance director Jason Theis and the board of trustees are actively working to find a proper mix and solution to comply with the state, fully fund their pension and health care obligations while finding the right combination of tax increases and cuts to taxpayers and employees.

 

On the pension front, the board has been working since 2013 to help fund the long term Prudential Insurance obligations, selling $80 million in pension obligation bonds in 2014 which was intended to throw off enough interest from an equity account to meet the needs. 

 

“Just then Prudential was demanding a full lump sum annuity amount for actuarial retirement to be taken out of the equity amount (which was managed by Gregory Schwartz and Company – who did a very good job), and put into the fixed rate account,” Savoie said. 

 

He said instead of the $80 million being able to grow to between $110 and $115 million in the equity account, “instead we withdrew about $50 million from the equity account and put it into the fixed rate account with Prudential,” earning between 2 and 3 percent.

 

As the 2016 elections approached, Savoie recalled, “we had been working with the unions, and had them convinced of the ramifications of staying with the Prudential guarantees, when we went into a closed session with (trustee) Dave Buckley (and former treasurer) Dan Devine screaming that it was unconstitutional to get rid of the contracts...Across the country, communities had gotten rid of these contracts in the '70s and '80s. The early '80s were the perfect time to get out of them because of high interest rates, and because people were living longer and mortality tables changed.

 

“So, in 2017 and 2018, we started legal action against Prudential because we don't even have the right to see what we've invested in,” Savoie said. “Bloomfield Township funds are just placed in general funds.”

 

To address its underfunded status and fully fund its pension and OPEB liabilities, Bloomfield Township is looking to go to its residents in August to raise about $1.5 million revenues a year. Savoie said it would be funded all or in part by a public safety special assessment district.

 

“Large townships like Bloomfield are limited to a 10-mill cap on property taxes and must seek alternative funding sources when providing a high level of service,” he said. “In 2010, the residents approved a 10-year general levy of 1.3 mills; over 9 years, 88 percent of the funds raised have gone to public safety and the rest to roads. The millage expires after the 2019 levy. Where there is funding needed for the defined benefit plan or OPEB plan, two-thirds of it will be paid from public safety.”

 

He said they need to raise a total of $6 to $7 million for the 2 benefit funds.

 

And if the residents vote it down?

 

“The likeliest cuts will be in personnel. Everything else is inconsequential,” he said.

 

The greatest irony, to Savoie, is that all of these issues could have been averted.

 

“One of our previous finance managers used to say to me that before Proposal A, we had so much money coming in, we didn't know how to spend it, and I kept warning them they needed to fund these promises, but (former township supervisor) Fred Korzon's goal was to keep the taxes the lowest in the area.” 

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