Knoxville's Rising Pension Costs

The city faces unsustainable but unavoidable increases

Most of the furor hereabouts over the rising cost of local government pension plans has been directed at Knox County's Uniformed Officers Pension Plan (or UOPP), which voters narrowly approved in a 2006 referendum and County Mayor Tim Burchett has said he'd like to close.

Yet projected increases in county contributions needed to fund UOPP pale by comparison with those required to keep the city of Knoxville's employee pension plans on a sound footing over the next decade. The recent report of a Pension Task Force appointed by City Council to evaluate the sustainability of the city's pension system projects that city contributions will need to rise from $11.5 million in the current fiscal year to more than $30 million annually over the next decade.

A big part of the increase reflects the adoption last December by the city's Pension Board of a reduction recommended by its actuarial consultant in the annual rate of return assumed on pension fund assets from 8 percent to 7 3/8 percent. This change in actuarial assumptions alone produced a $7 million boost in projected city contributions to $20 million beginning in the fiscal year that starts July 1, 2013.

By contrast, the actuarial consultant to the Knox County Retirement & Pension Board, which has been using a 7 1/2 percent rate of return assumption, projects county contributions to UOPP rising by $1.4 million over the next two years and then leveling out at around $5.5 million for several years to come. (It needs to be noted that the county's total cost includes an additional $4.4 million in debt service on a $57 million bond issue the county floated in 2007 to fund the benefits for prior service of sheriff's deputies who enrolled in the plan that year.)

But while the county's failure to cover the cost of UOPP with a tax increase that was implied in the ballot proposition by which voters approved it remains the subject of debate, the county has managed to absorb this cost for five years now and isn't nearly as fiscally challenged by increases as the city looking ahead.

The city's Pension Task Force concluded in its final report that the "Knoxville Pension System is not ‘sustainable' under the current actuarial assumed rate of 7.375 percent," but punted when it came to what to do about it. "The Pension Task Force is without the resources to make specific recommendations about the changes that should be made to the pension plans and the resultant projected savings which might result," the report stated, and could only recommend that the city "employ the appropriate experts" to do so.

In fact, there's very little, if anything, the city can do to avert the big jump to $20 million next year and thence to $30 million in its projected annual pension contributions. These largely reflect the cost of benefits to which present employees and retirees are entitled in the city's two main defined benefit plans (one for the police and fire departments, and the other for general government workers).

The State Supreme Court has long since ruled that a public employer may not "adversely affect an employee who has complied with all the conditions necessary to be eligible for a retirement income." This means the city can't raise employee contributions or retirement age, lower a very generous cost of living adjustment, or otherwise reduce pension benefits—at least not for employees who've served the five years necessary to become vested in the plan. While more recent hires might be excluded with a return of their contribution, hardly anyone believes they would; and even if they were, city officials say it would be many years before a significant reduction in the city's untouchable "vested and accrued" benefits would result.

While other factors enter in, the biggest part of the reason for the escalation in city contributions is that investment returns averaging 5.6 percent over the past 20 years haven't kept pace with actuarial assumptions. This shortfall has left the $468 million value of the city's pension plan assets as of last June 30 far short of its $650 million in liabilities, which is the present value of those accrued benefits. Reducing the assumed rate of return to 7.375 percent may not be sufficient to cover the prospective growth in these liabilities. But despite the shortfall in returns over the past 20 years, that rate is lower than the 7.5 percent to 8 percent range that most pension plans assume based on longer-term historical experience.

The gap approaching $200 million is what's known as a pension plan's unfunded liability, and like a mortgage debt it must be amortized over time. In the city's case, the amortization process stretches until 2036, and when it's completed, the city's projected pension contributions would drop back down to about $15 million. (Again, by way of contrast, in the county UOPP plan, actuarial accrued liabilities of $146 million only exceed assets by $34 million, so the amount of unfunded liability to be amortized is much lower.)

Dealing with the city's much more acute problems may well be the biggest challenge of Mayor Madeline Rogero's first year in office. She's said she will be making recommendations to City Council within the next few weeks, which is more than the Pension Task Force was prepared to do after a year of study.

In the short run, it's hard to see how Rogero can avoid a tax increase to cover the $7 million jump in pension contributions that's due to hit the city budget a year from now.

Space constraints won't allow me to speculate on what Rogero may propose for the longer haul. Many believe the city should close its defined benefit plans and, following the lead of most private employers, offer new hires a 401(k)-like defined contribution plan. But I would remind them that 147 other municipalities in Tennessee participate in the Tennessee Consolidated Retirement System, which also covers state employees and school teachers. Hardly anyone is questioning the fiscal soundness and sustainability of TCRS. So perhaps city and county officials would do well to look to state answers to our local problems.