Budget Maneuvers: City Pension Woes Keep Mounting

Going on two years ago, the City of Knoxville's Pension Board concluded that the 8 percent annual investment return on which its pension funding had been predicated was too high—contributing to a $127 million unfunded liability. That's the amount by which its $595 million in pension liability as of June 30, 2011 exceeded its $468 million in assets, which is tantamount to debt.

With the remarkable run-ups approaching 30 percent over the past year in both U.S. and global stock markets in which the majority of pension assets are invested, one might suppose a big improvement. Indeed, for the 12 months that ended March 31, the pension fund's 10-year annualized rate of return rose to 9.21 percent from just 5.53 percent the year before.

Yet even with this big improvement, the value of the pension fund's assets has only risen slightly from $468 million at the end of fiscal year 2011 to $493 million as of March 31 this year. Over the same span of time, liabilities have grown from $595 million to $673 million. So the unfunded liability that must be paid off over 25 years like a mortgage has risen from $127 million to $160 million.

How can the results have been so poor in such good times? A big part of the answer lies in the fact that pension benefits to retirees are running about $40 million a year on their way up to a projected $50 million over the next decade. These payouts are applied directly against investment returns. So it would take an annual 8 percent return on a rounded $500 million in assets just to keep them from declining. In fact, pension assets have never recovered from the 2008-09 market crash that drove them down from a peak of $548 million in 2007—this despite the fact that the stock markets globally have subsequently risen to record highs and other pension investment returns have kept pace.

Making matters worse, pension liabilities (which are actuarially determined) have been growing at the rate of about $17 million a year and will continue to do so. These increases mainly reflect the fact that every year city employees covered by its pension plan gain another year of service, which adds to their pension entitlement. There's been very little turnover in the ranks of city workers, which might mitigate this increase, and when they retire their benefits continue to go up by a minimum 3 percent a year cost of living adjustment. The actuarial calculation of liabilities takes these into account, as well as the 2.5 percent annual pay raises to which all city workers are entitled under the city's charter, and increases in life expectancy also enter in.

The combination of growing benefit outlays and prospective liabilities is almost certain to keep driving up the unfunded liability that must be amortized for as far as the eye can see. And the Pension Board spiked it even more so a year ago when it reduced the assumed annual investment return from 8 percent to 7.375 percent. The lowering of that rate, which is also used actuarially in discounting assumed future benefits to present value, produced a $61 million one-time increase in liabilities. This spike, in turn, was the biggest single factor in causing the city's required contribution to the pension plan to leap from $12.2 million in fiscal year 2012 to $21.9 million in the fiscal year ahead.

Looking further ahead, the perverse combination of benefit and liability increases makes amortization of the unfunded liability almost a chasing-the-tail exercise. Hence, annual city contributions over the next decade are expected to soar to well in excess of $30 million before they begin to taper off. (Employee contributions of a little under $4 million a year are unaffected by the gyrations.)

Mayor Madeline Rogero's biggest achievement of her first year in office was to close the existing pension plan (actually plans) to new entrants and substitute a "hybrid" plan that combines reduced defined benefits for new hires with a 401(k)-like defined contribution component under which they will be entitled to receive only the investment return on what they put in. However, the State Supreme Court has held that an employee's pension benefits can in no way be reduced. So it will be 20 years or more before the closing of the existing plan will begin to make much of a dent in the city pension costs.

I think the world of Madeline Rogero and believe she is proving to be an outstanding mayor. Her administrative skills, her commitment to economic development as well as environmental sustainability are all exemplary. And I particularly commend her budgetary boldness in calling for the city's first new bond issue in 10 years to fund a much-needed new public works complex, enhancements to the Knoxville Zoo, and a start toward transforming the splendid site of the former Lakeshore Mental Health Institute that the city has recently acquired into the crown jewel of the city parks that it deserves to be.

However, I do have a bone to pick with Rogero where her handling of the increases in pension fund contributions is concerned. In her budget for the fiscal year ahead, she opted to mask all but $1.9 million of a $7.9 million increase with an allocation of $6 million from the city's fund balance. This maneuver no doubt averted the need for a tax increase in a year when five incumbent City Council members are up for reelection.

In her budget address, she forewarned that a $6 million increase is projected for the following year. And she has said that means "either a tax increase or a reduction in city services." So the handwriting is on the wall for a non-election year.