06NOV2008

Pension Fund FAQs

We know many of you have questions about the Police/Fire pension fund shortall, and the 1-cent sales tax that City Manager Greg Burris has proposed to City Council to address the problem. Here's a list of frequently-asked questions we believe are important, or have heard from citizens and even City employees. Have more questions? Send them to us and we'll post the answers here.

The following questions were posted on Jan. 21, 2009:

Instead of proposing a sales tax, why doesn’t the City cut its budget to address the issue?

The City has indeed cut its budget in order to put more money into the pension fund, but cuts alone simply will not be enough to address the issue. For the current budget year, the City cut $5.2 million in order to pay the full, recommended amount of $12.5 million; for the 2009-10 fiscal year, the recommended amount will be more than $13 million.

The overall liability on the pension fund is about $198 million. The City’s General Fund – the source from which this money comes – is about $73 million,with more than 50 percent of that funding public-safety services (police and fire). Even if the City could do away with all General Fund services and personnel for two full years, it still would not be enough to cover the liability. The bottom line is the City cannot just budget cut its way to a solvent pension fund.

Where did the money go in the four years the City’s portion wasn’t fully funded?

During this period, the City continued the same level of contribution as previous years. The recommended contribution, however, grew substantially faster and exceeded the amounts available in the City’s budget to make the recommended contribution in those four years. The funds were not available without cutting the budget to meet the obligation, just as we did for our current year’s budget when $5.2 million was cut to make the full contribution.

It was during this time the City began making other changes, such as creating the Tier II plan and other steps, to address the issue. These changes have shown positive results, but they alone are not enough to solve the problem.

If approved, how will the city sales tax compare to surrounding communities?

At 6.85 percent, Springfield currently has the lowest overall tax rate (combined city, county and state) among a number of surrounding communities. With the 1-cent increase, Springfield would move into the upper third of that list, but would remain competitive given that the difference in overall rates would be no more than about six tenths of a percent. Springfield’s overall rate would be 7.85 percent. Compare that to: Marshfield at 8.058 percent; Republic, Ozark and Joplin at 7.725 percent; Branson at 7.6 percent; Willard, Rogersville and Bolivar at 7.475 percent; Nixa and Lebanon at 7.225 percent. Kansas City’s sales tax rate is 7.975 percent, while St. Louis’ rate is 8.241 percent.

Springfield’s current city tax rate of 1.375 percent (of the 6.85 percent overall) breaks down as follows: 1 cent General Sales Tax, which provides the basis of the General Fund; 1/4-cent sales tax for capital improvements; and 1/8-cent sales tax for transportation. Sales taxes for other services such as E911 and Parks are countywide taxes included in the 1.25-cent county sales tax rate. The state collects 4.225 percent to round out the current 6.85 combined rate.

What is the cost to businesses and residents?

The 1-cent increase would equal $1 on every $100 in taxable purchases over the period of five years or until the pension fund becomes fully funded, whichever occurs first. It is worth noting that visitors to Springfield pay an estimated 50 percent of our sales tax revenue. This includes anyone who lives outside of city limits, but who works and shops in Springfield, as well as tourists and visitors who come to the city. People who live outside of Springfield benefit from many public services while they are in the city.

Is this tax proposal specific?

Yes. The state legislation that allows Missouri cities to propose this type of referendum is very specific about how it can be used and how the ballot language can be worded. The state allows cities to seek up to a 1-cent sales tax increase specifically for public-safety needs. Our ballot language specifies that the revenue can only be used for the Police/Fire pension fund and that it will sunset in five years or when the system is fully funded, whichever comes first.

When any Missouri municipality has taxes approved for specified uses, a separate deposit account is created and the state deposits the money directly into that account.

The ballot language reads as follows:

“Shall the City of Springfield impose a sales tax at a rate of 1 percent solely for the purpose of providing revenues for the Springfield Police and Firefighters Pension System with said tax to sunset upon the earlier of A) Five (5) years from the date of commencement of collection of this tax or B) the Pension System fund reaching a fully funded (100%) status as determined by an independent actuarial study conducted for the Pension System Board of Trustees?”

What else has been done combat the problem besides the sales tax proposal?

The city has taken many steps to tackle this problem. They include: increasing the City contribution rate; withholding two pay increases for police and fire employees so that money would go to the plan; reducing benefits for employees hired after July 1, 2006, including the return of contribution and changing the multiplier, the minimum years of service, the COLA, and disability benefits; and leave accumulation was capped. The Pension Board has been restructured and now has greater investment flexibility and has lowered investment fees by 30 percent. The City increased its contribution rate to 50 percent of Police/Fire salaries for fiscal year 2008-09 (resulting in a $5.2 million budget cut). The City also contributed an additional $500,000 of funds realized from an earlier telecommunications settlement.

Why don’t Police and Firefighters pay into Social Security?

In 1946, Springfield citizens voted to create a self-funded pension plan for its police officers and firefighters. It was common then, and remains so today, for certain types of public employees such as police officers, firefighters and teachers to have these types of plans rather than Social Security. The plan replaces Social Security and disability payments for these employees. Under the City Charter, pension benefits earned cannot be reduced and pension benefits promised but not yet earned cannot be changed without a public vote.

One of the reasons municipalities chose pension plans in lieu of Social Security is that public-safety employees don’t continue “street duty” to the age at which they would be eligible for Social Security. So, they would experience a long gap in benefits between the normal retirement age for their professions and the eligibility age for Social Security.

Why is the police and firefighters’ retirement plan based on defined benefits rather than defined contributions?

This again goes back to the way the pension plan was set up by a public vote in 1946. At the time, defined-benefit plans were much more common, whereas today defined contribution plans, such as 401(k)s, are often used in the private sector. Defined-benefit plans are still the national norm for police and fire personnel, and changing this aspect of the plan would negatively affect recruitment for these positions. The philosophy is that fire and police personnel are taking the risk with their lives and health with the understanding that their pension is guaranteed. Injury is quite likely in these professions; therefore, knowing that an income is guaranteed (again, they receive no Social Security disability) if permanently disabled is an important consideration when applying and working in these careers.

There have been circumstances in which employees have sustained disabling injuries early in their careers. Under a defined-contribution plan, a young employee may walk away with $2,000 for a career-ending disability.

Would Pension Obligation Bonds solve the problem?

Pension Obligation Bonds, or POBs, are a strategy some plans use to prop up their underfunding. Bonds are issued and the funds then invested. The bonds are then repaid with the investment income. In effect, the system could come out ahead by using the spread between the interest paid on the bonds and the return of the investments. The pension board determined this was not a sound practice for three reasons. First, POBs are taxable, unlike other City-issued bonds, driving up costs and making the spread relatively small. Second, this adds risk to the portfolio, as many of those using POBs have found, and could increase the shortfall rather than improve it. Third, the bond market was very tight and many were going unsold, which increased the cost of this strategy.

Isn’t City Council authorized to levy a property tax without a public vote?

The pension ordinance approved by voters in 1958 authorized the City to levy a property tax up to 1.5 mills. This is not currently collected, and was proposed to City Council for consideration. This would not solve the issue without another significant funding source. The Council did not take action on the proposal. The general consensus was that, although they had the authority to make the change, it would not be prudent to re-establish it without a public vote. Property taxes are paid only by city property owners. Non-residents, who use public safety and other services while in Springfield, would not share in the cost.

Why not a ¼ cent or ½ cent sales tax instead of 1 cent?

The Pension Board looked at all of these rates, taking into account a variety of investment return rates and scenarios. The Board very carefully evaluated these and concluded that the plan must be at least 90 percent funded to be self-sustaining. It found that less than a ½-cent sales tax will not ensure 90 percent funding. The 1 percent sales tax level was the least sensitive to poor market returns and took the least amount of time to roll the tax back. The Board’s actuary recommended a large infusion of funds as quickly as possible for the highest probability of success in restoring a healthy funded ratio.

How have other communities dealt with this issue?

Many communities across the country are dealing with very similar issues for their public employee pension systems. The City of St. Louis recently faced a court order to address its pension shortfall; in February 2008, voters there approved a sales tax increase for public safety needs, including its pension system. The City of Vallejo, Calif., recently declared bankruptcy over a failing pension system.  Springfield’s Police and Fire Chiefs cite examples of other cities being in denial; they continue to recruit police and firefighters with promises of pensions that are also in underfunded plans. Several larger cities have even suggested public pension plans be included in the Federal financial rescue package.

By addressing this issue now, we believe Springfield will be at a competitive advantage over cities that are not proactively addressing similarly serious problems.

Did the city make bad investments that lost money?

The City did not make bad financial investments, but a relatively conservative asset portfolio mix prevented investments from achieving maximum possible returns during boom times had the asset allocation been different. However, taking on more risk to achieve the greater returns could have also worked against the fund and made today's scenario even worse. The fund has lost a considerable amount of money since June 30 due to the market downturn. The Pension Board made some changes to the asset allocation two years ago and as a result, we have been told by our investment counselors that our losses since June would have been even greater had we not made these changes.

Was pension money stolen?

There has never been any money stolen from the pension fund. The fund is independently audited every year. Accounting methods for the fund's assets are subject to audit and are maintained under strict standards and rules.

If the City is, in effect, losing $39,000 a day because of the pension shortfall, why wait until July 1 to put the sales tax into effect if voters approve it Feb. 3?

State laws outline when a new sales tax becomes effective. A new tax takes effect the first day of the second quarter following the passage of the tax. In this case that timeline means July 1, 2009 is the earliest the tax could begin. The waiting period is designed to allow businesses to be notified and the Department of Revenue to make necessary changes in its office.

The following questions were posted on Nov. 6, 2008:

Why is the pension underfunded?

The current underfunding has a number of causes and occurred over a long period of time. The main reasons can be boiled down to the following issues:

• The adjustment of actuarial assumptions several years ago created a more realistic assessment of lifespan predictions, anticipated years of retirement, market returns and other variables. As a result of those actuarial changes, the future funding liability increased significantly.
• Poor investment returns. As a relatively small, self-funded plan, the City's self-funded pension plan had less flexibility to weather the market downturn following the technology bubble burst and the Sept. 11, 2001 tragedy.
• During four fiscal years in this decade, the City did not contribute its full recommended level of funding. This equates to about $10 million in today’s dollars for the total of those four years.
• The fund was operating with a relatively conservative investment strategy and, therefore, didn’t fully capitalize on the boom times in the stock market in the 1990s.

How big is the problem?

As of June 30, 2008, the fund had $128 million in assets. The future funding liability is estimated at $295 million, leaving a shortfall of $167 million. The fund itself has lost about $10 million more in value since June 30 during the recent period of turmoil in world financial markets.

Why a sales tax?

The actuarial firm hired by the Pension Board, Milliman, Inc., an international consulting and actuarial firm, told the Pension Board that the best way to address the shortfall would be to infuse the Pension Fund with as much revenue as possible, as quickly as possible. The proposed 1-cent sales tax could generate about $40 million a year, based on past performance of our sales tax revenue in Springfield. If the system takes in this amount of revenue for several years, along with the ongoing contributions by employees and the City, it is in a better position to sustain itself over the long term by generating investment returns to maintain a healthy funding level.

Why now?

Everyone working on this issue realizes the challenges that the current economic climate poses for this issue. We believe that is offset, however, by the necessity of addressing the issue because the pension fund is, in effect, losing the equivalent of $33,000 a day.  That represents the amount of investment returns that the fund would generate if fully funded rather than the current funded level.

When does the tax go into effect, if approved?

If approved in February 2009, the tax would go into effect as of July 1, 2009.

What do the police and firefighters think about this?

Officers for the Police and Fire employee groups have been involved in developing the proposal presented on Oct. 23. The Springfield Firefighters association has endorsed this proposal. The Springfield Police Officers Association has not yet held a full membership meeting to consider it.

What if this tax doesn’t get approved?

City staff will begin working before the end of 2008 to develop several scenarios for the 2009-10 annual budget. Budget scenarios will include passage or failure of the sales tax referendum. That outcome also will affect the contribution rate recommended by the actuary firm. All of that information will be used to determine the level of budget cuts that will be necessary to make. In the 2008-09 budget, the City cut an additional $5.2 million from the budget to make the full, recommended contribution to the Police/Fire Pension Fund. City Manager Greg Burris has stated that he does not believe these cuts are sustainable over multiple years without initiating programmatic cuts.

Why wasn’t this problem tackled five or 10 years ago?

The worst period for the pension fund has been since 2002. After it became clear through the post 9/11 market drop and the technology stocks drop that market returns were not achieving expectations, the Pension Board and the City began addressing the issues. A number of changes were made, including the Tier II pension plan for new employees hired after July 1, 2006. Other changes that have been made include revising the actuarial assumptions; reducing investment fees by 30 percent; and changing the investment allocation policy. So, actually there have been a number of changes made through the years. It became obvious fairly quickly, however, that those changes would not be enough by themselves to turn the fund around and restore it to a healthy funding level.

Where did the money go in the years the City’s portion wasn’t fully funded?

The City has not made the contribution recommended by the actuary for the four years prior to the current fiscal year. The total difference between the recommended contribution and the actual amount the City did contribute to the Plan is about $10 million in today's dollars over those four fiscal years. During this period, this General Fund revenue was used to fund other important needs in the City. For example, six new positions were funded to staff new Fire Station No. 12 and new positions were funded for Emergency Communications prior to the passage of a dedicated sales tax for 911. Money also was put toward pay-plan improvements for City employees.

Why is the City still spending money on things like the Square?

The Park Central Square renovation is funded primarily by federal grant money. There is some City match funding in it that was allocated from the ¼-cent sales tax for capital improvements.

This is NOT General Fund money that could be used for the Pension Fund. Capital Improvements Sales Tax revenue cannot legally be moved into the General Fund for the Police/Fire Pension Fund or any other use other than what voters approved.

In the General Fund, there were no budget priorities approved for the 2008-09 budget year.

What about the buildings the City sold at a loss downtown?

The City believes the long-term return on the development of those properties by Missouri State University will more than offset the difference between the City’s purchase price for those properties and the sales price to Missouri State. Development of the Jordan Valley Innovation Center/Brick City/IDEA Commons center is creating new jobs, investment by new companies in our community and entrepreneurial opportunities for businesses and services serving the additional population.

From a practical standpoint, the costs the City would have incurred to either raze portions of those properties or secure the facilities to prevent further decay would likely have cost about the difference in the purchase and selling prices.

The sales proceeds do not go into the General Fund, so the revenue could not be applied toward the Police/Fire pension fund.

What about this Commercial Street tax? Are you asking for two taxes?

The proposed Commercial Street Community Improvement District is for a self-imposed sales tax that property and business owners will vote on whether to levy within a specified area on Commercial Street. This will not be on a public election ballot and will only affect a specified area to pay for improvements within that area.

Will there be a legal obligation going forward to keep the fund solvent?

The City has a legal obligation to pay all benefits earned by employees. Under the City Charter, City Council cannot bind future City Councils; however, the pension obligation has traditionally been treated as a debt obligation by the City and therefore receives funding priority similar to other debt obligations.

Can’t the City sell some properties, like the Ice Park, to pay for this?

If the City chose to sell assets to raise revenue for the Police/Fire Pension Fund, any debt remaining on those assets would have to be paid before any net revenue would be realized. In the case of Mediacom Ice Park, that facility is only seven years old, so it still has a debt obligation and wouldn’t realize much net revenue from a sale. That would be presuming that there are interested buyers. We also believe that the Ice Park is an important community recreation asset and like other community amenities, it is publically owned so that prices can remain reasonable enough for everyone to participate. If a private investor bought it to operate at a profit, prices to participate in Ice Park activities would likely increase.

The City Council recently approved offering a City-owned parcel of property in southwest Springfield for sale because it has potential development interest and is no longer needed for a public purpose. This property, however, is an asset of the Sanitary Services Enterprise Fund so any sales proceeds will stay with this fund.

The City is in the process of reviewing its overall inventory of City properties. If there were others with similar potential, the City Council could consider additional sales. But there are certainly not enough of those types of assets available to sell to make any significant dent in the Police/Fire pension underfunding. The General Fund does not hold very many property parcels that could be sold with revenue returning to the General Fund.

What about selling City Utilities to private investors?

This is another area where we believe it is not in the long-term best interests of our citizens to privatize our municipal utility to solve this problem. A private owner would likely have to raise rates in order to make a profit after paying the operating costs of the utility and repaying the investment. Over the long term that would be much more costly to citizens than a temporary sales tax increase that is proposed to sunset after five years.

The following questions were posted earlier, but we are adding them again in an effort to keep a complete, rolling FAQ.

What is the formula to calculate the pensions?

The calculation for a normal service retirement is equal to the years of service times the multiplier times the average final salary. The current multiplier is 2.8 percent per year of service. The final average salary is the highest three years out of the last 10. The maximum amount the retiree can recieve is 70 percent of his or her final average salary. This is for the Tier 1 part of the system that covers the majority of the current employees and the retirees.

Are any current employees  allowed to use sick days or vacation days in the calculation for their pensions?

Sick leave is not used in any pension calculations. Vacation time is included due to a court case the Pension System lost in 1978 (Fraker, et al, vs. City of Springfield, et al).

Is a paid actuary involved in determining the future returns and solvency of the pension plan?

Yes, the City currently uses Milliman, Inc., an international actuarial and consulting firm based in Seattle, as the actuary for the Police/Fire Pension System. You can learn more about the firm at www.milliman.com.

Why try a 1 percent increase now, when all pensions, 401(k)s, IRA's are down due to the market, as opposed to a 1/4 or 1/2 percent increase that was mentioned previously? Based upon the fluctuations of the market, there will be a surplus or deficit at different times.

The actuary did projections based on a number of models, including the 1/4- and ½-cent sales tax rates. Either of those would take the fund significantly longer to reach a healthy funding level. The ½-cent model could take up to 20 years, for instance. That length of time creates an additional level of uncertainty, particularly regarding the stock market’s performance. That, in turn, makes it more difficult to project the fund’s performance and ability to get to a level that is both healthy and sustainable. He said the quickest way to improve the fund would be to infuse it with as much revenue as possible over the shortest time possible so that it would be in a better position to reach a sustainable, healthy funding level. We also believed that a sunset provision would be a very important factor for voters in considering the ballot measure. With the 1-cent rate, we have more confidence that the healthy funding level can be achieved in 5 years, rather than trying to project an accurate sunset period for a lesser amount of sales tax with a range of 10 to 20 years for a ½-cent level and even higher for a ¼-cent level.

posted by Mike Brothers, Public Information

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