STUMP » Articles » Dallas Police and Fire: The Pension that Ate Dallas » 22 November 2016, 06:16

When pensions make the pages of the NYTimes, it’s rarely for good news.

The Dallas Police and Fire pension fund made it to the pages of the NYT.

Guess what:

Dallas Stares Down a Texas-Size Threat of Bankruptcy

DALLAS — Picture the next major American city to go bankrupt. What springs to mind? Probably not the swagger and sprawl of Dallas.

But there was Dallas’s mayor, Michael S. Rawlings, testifying this month to a state oversight board that his city appeared to be “walking into the fan blades” of municipal bankruptcy.
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But under its glittering surface, Dallas has a problem that could bring it to its knees, and that could be an early test of America’s postelection commitment to safe streets and tax relief: The city’s pension fund for its police officers and firefighters is near collapse and seeking an immense bailout.

Over six recent weeks, panicked Dallas retirees have pulled $220 million out of the fund. What set off the run was a recommendation in July that the retirees no longer be allowed to take out big blocks of money. Even before that, though, there were reports that the fund’s investments — some placed in highly risky and speculative ventures — were worth less than previously stated.

What is happening in Dallas is an extreme example of what’s happening in many other places around the country. Elected officials promised workers solid pensions years ago, on the basis of wishful thinking rather than realistic expectations. Dallas’s troubles have become more urgent because its plan rules let some retirees take big withdrawals.

Now, the Dallas Police and Fire Pension System has asked the city for a one-time infusion of $1.1 billion, an amount roughly equal to Dallas’s entire general fund budget but not even close to what the pension fund needs to be fully funded. Nothing would be left for fighting endemic poverty south of the Trinity River, for public libraries, or for giving current police officers and firefighters a raise.

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“The City of Dallas has no way to pay this,” said Lee Kleinman, a City Council member who served as a pension trustee from 2013 until this year. “If the city had to pay the whole thing, we would declare bankruptcy.”

Other ideas being considered include raising property taxes, borrowing money for the pension fund, delaying long-awaited public works or even taking back money from retirees. But property taxes in Dallas are already capped, the city’s borrowing capacity is limited, and retirees would surely litigate any clawback.

This month, the city’s more than 10,000 current and retired safety workers started voting on voluntary pension trims, but then five people sued, halting the balloting for now.

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To many in Dallas, the hole in the pension fund seems to have blown open overnight. But in fact, the fuse was lit back in 1993, when state lawmakers sweetened police and firefighter pensions beyond the wildest dreams of the typical Dallas resident. They added individual savings accounts, paying 8.5 percent interest per year, when workers reached the normal retirement age, then 50. The goal was to keep seasoned veterans on the force longer.

Guaranteed 8.5 percent interest, on tap indefinitely for thousands of people, would of course cost a fortune. But state lawmakers made it look “cost neutral,” records show, by fixing Dallas’s annual pension contributions at 36 percent of the police and firefighters’ payroll. It would all work as long as the payroll grew by 5 percent every year — which it did not — and if the pension fund earned 9 percent annually on its investments.

Buck Consultants, the plan’s actuarial firm, warned that those assumptions were shaky, and that the changes did not comply with the rules of the state Pension Review Board.

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In his meeting with the trustees, Senator Whitmire recalled that in 1993 he had voted enthusiastically for the plan that sent the pension fund on its ill-fated quest for 9 percent investment returns.

“We all know some of the benefits, guaranteed, were just probably never realistic,” he said. “It was good while it lasted, but we’ve got some serious financial problems because of it.”

Okay, Whitmire. It would be best if you kept your mouth shut.

Note that this guy voted for this insane benefit boost in the early 90s, well before the dot-com boom. At least the idiots in 1999/2000 could argue that they thought huge growth would last forever. But in 1993? Come on. There had been the ongoing savings and loan crisis, and I know of multiple insolvencies in insurers at the time – the most famous being Executive Life (which led to the development of more robust risk capital requirements), and it wasn’t like things were really going great guns at the time.

But this does point out how much politicians love to promise to pay somebody something 20+ years later. They think they won’t be around when the bill hits, and sometimes they’re correct.

GRAPHS OF DECLINE

Note: these graphs end in 2014. The Public Plans Database hasn’t been updated for Dallas Police and Fire yet, but I will be showing you more recent results in a later section of this post.

This is what the contribution pattern has looked like:

Note: very high percentage of payroll, even compared with national averages. But they’ve been pretty good about contributing close to 100% of the required contribution.

This is what the funded ratio looks like:

60% funded in 2014. Just wait, it will get worse when we look at a more recent report below.

This is what the net cash flow looks like:

Let me explain this last graph, which I don’t show as often as the first two above.

This is looking at actual cash flows — money comes in from contributions, and goes out to benefits. There can also be investment income cash flows, and cash flows for expenses, etc. But the point is this: if the cash flows are negative, more cash is going out than coming in. Now, asset value can grow with negative cash flow (unrealized capital gains, for one) — you don’t look at cash flow in a vaccuum.

That’s why the cash flow is measured against assets.

In 2014, the net cash flow was -4% of assets. This is a higher outflow than the national average of -2.3% for plans of that type.

Finally, what is one of the things driving this loss?

This:

A reminder: in August 2014, I noted Dallas’s asset concentration risk – two investments (not sectors, but specific investments) killed their portfolio. I understand there’s still a federal investigation ongoing over this.

Additional Dallas posts:

• October 2016: Texas Update: Houston and Dallas Try to Clean Their Pension Messes
• September 2016: Texas Trouble: Pensions in Dallas and Houston
• September 2014: Public Pensions and Alternative Assets: Dallas Shows How It Can End

A note on that last post: I wrote that over two years ago. Here is a quote:

This isn’t something special about real estate, but the whole of real estate, hedge funds, private equity, and other alternative assets that public pensions pursue because they have a “plausible” case that these yield higher returns than publicly-traded stocks and bonds.

But it turns out, they don’t necessarily.

What they can do is lose a lot more than publicly-traded stocks and bonds rather rapidly, because their true
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This is why people like David Sirota and Ted Siedle have been focusing on the fees paid to hedge fund managers and the like (including the kickbacks such as nice trips to Napa for pension fund managers). That’s something people understand concretely — that those managing the funds may have incentives that are more about benefiting themselves than benefiting the pensions.

It doesn’t require outright fraud. It only requires not looking too closely at what one is investing in, because one doesn’t have much interest in looking very closely.

Now that Calpers is pulling out of hedge funds, other funds may just start looking more closely at their alternative asset portfolios. But then that would require them to start having to ask for more tax money to fund the pensions.

The tricks are running out. It’s about time.

Again, two years ago. I was writing about how it “ends”, but as you can see, it didn’t end then. The last two years have been involved with Dallas trying to untangle itself from its crazy investments.

But one of the investments alone caused a $60 million hole in the fund in 2014 — out of a fund worth about $3 billion, that’s only 2%. But they were counting on funds to grow … other funds had blockbuster years in 2014.

But not Dallas Police and Fire:

Keep in mind, over all those years, they had been “expecting” a 8.5% annual return. And they can’t even meet the average for the country.

THE ACTUARIES HAVE SOME BAD NEWS

In the actuarial valuation for January 1, 2015, here are some key items:

• Discount rate was changed from 8.5% (HOLY CRAP) to 7.25%

• This discount rate change increased the total unfunded liabilities by about $620 million. That, by itself, was about 50% of the prior unfunded liability.

• The investment experience for the year was a $400 million hit on the unfunded liability. So that increased the unfunded liability by about 30%.

• The funding plan would never reach 100% funded (take a look on page 6 — in the prior valuation, it had a funding period of 26 years — for the 2015, it was infinite)

• Funding ratio was about 64%

It’s not a pretty report.

And if you think that one was ugly, check out the most recent actuarial report.

THE NEWER ACTUARIES HAVE SOME WORSE NEWS

So there was a switch between actuarial firms between the previous report and this one.

There are several issues, so let me try to pull out what I find the most important.

According to the Actuarial Valuation of Dallas Police and Fire for January 1, 2016:

• The funded ratio was 45%. A huge amount of the drop came from recognizing the market value of the assets (much lower than the smoothed value), as well as the bad year of results.

• The return on assets was -8.47% on a market value basis for 2015. Given this is below the discount rate of 7.25%, this added about $600 million to the unfunded liability.

• The ten-year average return (whether on a smoothed, actuarial or a market value basis) was about 1.76%. That is hideous.

• The funding plan will not fill the unfunded liability hole, even in infinite time, given all the assumptions.

• The unfunded liability as of January 1, 2016 under all the measurements was $3.3 billion, and the prior was $2.1 billion (from the prior valuation).

As noted by the NYT article, a $1.1 billion contribution would fill only one-third the hole…. if it had been done on January 1, 2016.

Because one of the assumptions in the valuation, and I quote the report directly:

7. The market value of assets as of the valuation date is $2.680 billion, based on unaudited financial statements. It should be noted that DROP account balances as reported for valuation purposes account for $1.505 billion (56.1%). It is assumed that participants will draw down these balances over a ten-year period. The System’s solvency will be significantly impacted if these funds are withdrawn more quickly.

And, of course, those funds have been withdrawn quite a bit this year.

This is related:

See those ages? I bet a lot of people are trying to pull those funds as early as they can, which would not necessarily have been their behavior before. And there are an awful lot of people in the almost-eligible range.

One bright note: The new actuaries did an experience study and had a variety of assumptions updated. Turns out, if you check the experience study, their mortality assumption was a bit low for retirees (that is, people actually died earlier than the table they were using, at a notable margin). So this was a case where they were being a little too conservative. You never know til you actually look.

The bright note is not that people are dying earlier, but that the demographic assumption sets used in prior valuations were not necessarily too “positive” in terms of the valuation. But this was pretty small compared to the impact of the bad investment returns, and the recognition of market value of assets.

I understand why the DROP participants are trying to grab the money and run, but it does call into question how much will be left once they take that money with them. The document linked here, a valuation as of January 1, 2016, is dated July 2016.

I rather think the run-on-the-bank problem may not be able to sit around to wait for the full actuarial valuation to be done.

A REMINDER AND COMPARISONS

• The State of Texas will not be bailing out Dallas Police and Fire (or any other municipal pension fund)

• The general fund budget for Dallas is about $1.1 billion.

• Dallas General Obligation debt is about $1.8 billion.

That moment-in-time pension debt from January 1, 2016 was $3.3 billion, remember. Compare it to the two numbers above.

So yes. That pension.

I don’t think it’s going to get paid in full. Yes, some money is going to be extracted from taxpayers, and they may try a pension obligation bond ploy, but I don’t think they’re going to plug that hole.

Enjoy.

Compilation of Dallas posts