Pension Debt: The Billion Dollar Problem Still Threatening Omaha

Policy Study

Pension Debt: The Billion Dollar Problem Still Threatening Omaha

Since 2007, Omaha’s pension plans have been assuming that investment returns on the assets of pension fund members would earn an average return of 8% a year.  In 2015, however, the plans earned a return of just 0.2% for the Police and Fire Retirement System (PFRS) and 3.1% for the Employees’ Retirement System (ERS), and the actuary for the plans reported that 2016 would need to see a return of 13% in order to put them on their expected 8% rate of return pace. Strong evidence suggests that the actual return for 2016 will be considerably lower than that, and almost certainly will be less than the expected 8% again. And in the process, taxpayers will see millions of dollars of unfunded liability added to the city’s two defined benefit plans.

While one or two years of investment returns should never be the singular focus when analyzing a pension plan, the past two years are representative of both the historic underperforming trend for Omaha’s pension plans, as well as the forecasted future of lower expected returns for pension funds than even the past. The unfortunate reality is that despite changes made to Omaha’s retirement systems in 2015, growing pension debt remains a considerable threat in the coming years absent further reform.

This conclusion is based on analysis of PFRS and ERS that we have recently co-published in a new policy study with Nebraska’s Platte Institute. The study outlines the problems facing Omaha, provides a quantitative forecast for what unfunded liabilities will look like in the coming years if there are no changes to the pension plans, and details a series of solutions that can address these challenges.

Read the full report here.

The good news for Omaha is that things could be worse. In 2015, Mayor Jean Stothert signed a collective bargaining agreement with civilian labor unions that, in part, created a new “cash balance” retirement plan for new members of ERS. This cash balance plan guarantees a 4% rate of return on contributions to member’s retirement accounts and shares 75% of investment returns above 7% with plan members. Thus, every member hired after March 1, 2015, when this cash balance plan was adopted, is an employee whose pension liabilities are not exposed to the actuarial assumptions of the civilian defined benefit plan.

While the data is not yet final, general market returns during the 2016 fiscal year suggest that Omaha will certainly see market rates of return less than the assumed 8% return target. As such, we can safely assume that unfunded liabilities are going to be lower in 2017 — if even by a small amount — than if the cash balance plan had not been implemented.

That is the extent of the good news for Omaha, though, as we outline in this report. PFRS saw its unfunded liabilities grow by $40.7 million during fiscal year 2015, and it remains exposed to even further pension debt growth. Changes made to benefits in 2010 and 2013 slightly reduced the growth of unfunded liabilities, but they did not fundamentally change the underlying funding policy factors that have been the drivers of unfunded liabilities. Plus, while the adoption of a cash balance plan for new civilian hires in 2015 was a positive step toward meaningful pension reform, the funding policy for the existing plan must be adjusted in order to prevent the existing liabilities from experiencing continued underfunding. Thus, there are several other steps that should be taken in order to protect Omaha’s taxpayers from seeing their tax dollars consumed by unfunded liability amortization payments.

In 2014, we highlighted several problematic trends associated with Omaha’s billion-dollar problem with a policy study co-published with Platte Institute. This new policy study follows up on that work and identifies three underlying causes for the pension debt that continues to weigh down Omaha:

  1. Not Paying the Full Actuarially Determined Employer Contribution
    • Omaha has a history of not always contributing 100% of this actuarially calculated contribution rate. Collectively, since 1994, the city has paid only 73% of the ADEC for PFRS’s, and 62% of ERS’s total ADEC.
  2. Underperforming Investment Returns
    • Omaha’s plans have averaged returns of between 4.5% and 4.8% over the past 10 and 15 year time periods, respectively, all while assuming 8% rates of return. Even a 20-year average for ERS at 6% is well below what the plans have been assuming. And based on the asset allocation of PFRS and ERS, it is a virtual certainty that the plans will continue to have average returns underperform long-term expectations without a meaningful change to funding policy.
  3. Undervalued Liabilities
    • Unfortunately, even if investments were performing as expected over the long run, Omaha may still have seen unfunded liability amortization payments grow over the past few years. This is because the plan is undervaluing the amount of all promised future benefits in today’s dollars. If Omaha were to use a “discount rate” that more accurately prices accrued liabilities, the combined reported unfunded liability would be more than double the existing recognized amount to near $2 billion and the total funded ratio would fall to only 29%.

Our conclusion is that the cash balance plan for ERS was a good first step toward improved solvency, but the existing liabilities of the defined benefit plan in that system are still exposed to the risk of underperforming the plan’s assumed rate of return. The same risks exist for the liabilities of the PFRS defined benefit plan. So despite efforts to address pension issues over the past decade in one form or another, unfunded liabilities are still likely to continue growing and harm city finances — just as leaving toxic waste alone without cleaning it up is likely to lead to increased environmental damage.

See the full report for our actuarial forecasting of PFRS and ERS, as well as details on the policy solutions we recommend Omaha consider to solve its problems.

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