Dallas Pension Crisis Prompts Another Credit Rating Downgrade and Ban on DROP Withdrawals

The Dallas Police & Fire Pension System (DPFP) has made headlines recently due to its massive unfunded liabilities, a virtual “run” on the system since August—with an estimated $500 million in withdrawals—and its unsustainable deferred retirement option plan (DROP). The situation continues to unfold quickly, and we plan to cover the Dallas public pension crisis in more detail here on the blog.

Two recent developments stand out.

First, Dallas Mayor Mike Rawlings recently filed a lawsuit to temporarily stop lump-sum cash withdrawals from the fund’s DROP accounts and restrain run on the money. The lawsuit prompted the DPFP board to subsequently approve an indefinite moratorium on DROP withdrawals, stopping an additional $154 million in withdrawals from occurring the next day.

For a pension fund where DROP balances account for roughly 56% of plan assets—and where members can withdraw all of their DROP balances in lump-sums if they wish—the “run on the fund” situation naturally imposes a direct threat to the solvency of the entire system. According to one estimate, the DROP withdrawals have already reduced the plan’s funded ratio from 45% to 36% since January.

Another reason why fund managers, retirees, and taxpayers should worry is the fact that even though DROP members are taking some of the liability under the pension system with them when emptying their accounts, the fund currently holds approximately 68.4% in illiquid assets (i.e. alternatives and real estate). This suggests that DPFP could simply run out of cash to continue paying out the DROP lump-sums, let alone the promised retirement benefits.

Among the underlying issues at play with DROP (which will be explored in more detail in the upcoming posts):

1. DPFP’s DROP accounts are in essence high-yield savings accounts, which should have been treated under different asset and liability classes for actuarial purposes. The system currently aggregates these liabilities under a single category.
2. If one considers DROP as a complementary benefit similar to COLA, then there should have been a mechanism of prefunding the 8%-10% guaranteed returns (e.g. forming a separate fund or at least factoring into the normal cost like a pre-paid COLA). These return assumptions also proved to be much higher than DPFP’s ten-year average market return of 1.79%.
3. DPFP’s governance structure allows agents without liabilities (labor leaders) to capture the decision-making process away from agents with liabilities (taxpayers). Under Texas law, DPFP members are allowed to unilaterally increase their own benefits without any approval of the City Council or taxpayers.

In other major news, Moody’s recently downgraded Dallas’ general obligation bond rating for the second time this year, citing pension-related factors that include the run on DROP accounts this fall, the potential impacts of a decades old back pay lawsuit, and statements by city officials—including Mayor Mike Rawlings—warning of a potential bankruptcy scenario if conditions continue to deteriorate. According to The New York Times, Moody’s has recently reported that “Dallas was struggling with more pension debt, relative to its resources, than any major American city except Chicago.”

Stay tuned for more updates on the Dallas public safety pension crisis in the coming weeks and months.