City of Sarasota pensions: Local debt crisis

The city of Sarasota’s pension crisis has been a long time coming. City officials, however, may not have the luxury of a long time to solve it.

Nor do they have any options that will not be costly to taxpayers.

With a debt load threatening to crash down on the city’s ability to operate, Commissioner Shannon Snyder said the city would be bankrupt in eight years.

Here’s why: The city of Sarasota — in other words, “taxpayers” — has between $272 million and $402 million in unfunded retirement obligations for police, firefighters and general employees. That means for all of the retirement pensions it has promised former and current employees, the city doesn’t have and will need that much money to cover its obligations.

For context, the city’s entire general fund budget is expected to be about $58 million next year. About one in every five dollars the city spends in the general fund goes to pay for retirees. And while the retirement situation continues to worsen, the City Commission, past and present, has been slow to face this deficit and slower yet to act.

Until now.

Commissioners have spoken publicly of drastic actions that must be enacted to stem the growth of the city’s retirement expenses. Ultimately, the commissioners must decide. Under Florida’s right-to-work laws, after appeals and exhausting special magistrate rulings in contract disputes, elected bodies have the authority to impose a contract on public employees, even if those employees are represented by unions. It’s just politically difficult.

Before understanding the details of the retirement-fund problems, it helps to have context about the city’s entire debt load, including the city’s non-retirement debt.

Sarasota has about $144.3 million in outstanding debt for things such as road improvements, the new police department headquarters, Ed Smith Stadium renovations, water-and-sewer projects and so on. Those are the normal types of debts for a municipality and are not out of line. Indeed, the city’s debt-rating, is Aa2, considered strong. What’s more, there are dedicated funding sources for a large chunk — at least $40 million — of that debt, and overall that debt load is shrinking.

So the normal bond debt the city has issued is not the problem. The time bomb is in the city pension plans, which have become unaffordable.

Click here to view graphs about the city of Sarasota's debt

Retirement bomb
Here’s how the city pension system works:

In retirement, police officers receive 75% of the average of their highest three years of salary paid during their final 10 years of employment with the city. They also receive a 3.2% cost-of-living increase in pension payments each year. (The rate of inflation the past 20 years has averaged 2.5%.)

An independent actuary takes several assumptions based on averages, such as normal length of employment, wage increases over that time, percent that employees contribute to the retirement fund (6% right now), retirement age, life expectancy, net returns on investment and so on and determines how much money that is required to fund all of the employees during their entire retirement.

From there, the actuary walks back the total promised amount, minus the employee contributions, and determines how much money the city needs to contribute to the plan each year to make it sustainable. Lately the city has been paying 25% of the cost, but that will increase to 28% next year. So for 2012-13, nearly $12 million out of a $58 million general fund budget will go to retirees. That’s nearly 21%.

One of the reasons city taxpayers must contribute 25% to 28% of the annual funds needed for the pensions can be attributed to what has become a sensitive issue: the net annual return on investment that actuaries have assigned to the pension system’s investment funds. The industry standard has been about 8% to 8.5%. That is what a conservatively invested retirement fund is expected to earn each year over time.

But the city’s actual return has averaged closer to 5% for the past 10 years. Last year, it was at 1%.

That is why some commissioners think that assuming 8% is sharply underestimating the real looming costs. They are pushing for an assumed rate of investment return of 6% to see the obligations more realistically — more responsibly, they say.

But that two-percentage-point change turns a huge hole into a chasm. Under the assumed 8% return, the city’s unfunded retirement obligations are about $272 million. But with a 6% return, the unfunded obligation rises to $402 million. That’s because the payout costs remain the same, but the fund grows slower.

The reasons for the decline in fund returns the past decade are twofold. First, the stock investments have taken a 10-year hit. The dot-com bubble burst at the turn of the century, and then the stock market lost half of its value in the 2008 meltdown.

But the retirement fund also has a lot invested in fixed-income instruments that have a guaranteed rate of return. Those have been hurt by U.S. monetary policy. As the economy collapsed, the Federal Reserve Bank kept interest rates low with the hope of spurring borrowing and spending. But those low interest rates became reflected in what the city earned on its fixed-income investments.

The result is the city is required to pitch in much more to make the fund sustainable each year — 28% of the annual total.

And that has ramifications for the entire city budget and for city operations as a whole. If interest rates and the funds’ rate of return stay low, the city’s contribution will keep increasing, squeezing out more of the rest of the budget. This is not a far-out scenario. It is already happening.

It becomes so dire that one commissioner publicly has raised the issue of getting rid of the police department. While that sounds extreme, and there does not appear to be political support for such a move now, the options are stark.

Eight painful options
There are at least eight alternatives. Seven are difficult, with varying degrees of effectiveness. The eighth is relatively easy and probably ineffective as a long-term solution.

1. Keep cutting. Personnel costs make up 80% of the city budget, and the city has already cut 24% of its employee base since the recession began. That is obvious in city departments, where one can walk down a hallway of mostly empty cubicles.

It becomes clear that the city’s pensions are part of the reason services are being cut and employees are being laid off — along with the decline in property values. As property values recover, the massive retirement obligations will be a bigger driver for layoffs. And cutting city services and employees is an increasingly difficult political proposition.

2. Raise taxes. This is a non-starter. There is no political support for raising taxes on a community struggling to get out of a recession with high unemployment and a crummy real estate market. It is technically an option, but one that also could exacerbate the economic challenges. Higher taxes typically slow economic growth and stunt property values, factors that would put increasing pressures on the city’s tax revenues.

3. Borrow the difference. The city could borrow a lump sum to cover the unfunded obligations for all three pensions. There are serious defects with this solution.

First, the borrowed money would still need to be invested, and that would run into some of the same issues as with the retirement fund. The city actually could lose principal on the borrowed money but still have to pay back the whole thing.

Another factor: The city probably cannot qualify for a loan even at the lowest amount. Although the city’s debt rating ticked up to Aa2 for general obligation bonds in 2011, the city does not have the bonding capacity to borrow $300 million to $400 million.

“I know it’s not there,” said Chris Lyons, the city’s finance director.

4. Close the retirement funds. Closing the fund and putting everyone in a 401(k)-style retirement plan would mean borrowing the money for the unfunded pension liabilities, running into the same pitfalls as option three.

5. Eliminate police. The city could merge the police department with the Sarasota County Sheriff’s Office. It is not unprecedented. The city merged its fire department with the county in the mid-1990s to save money on overlapping districts near the borders and create efficiencies. That merger seems to have worked well.
But the police department has a near mythic standing in the city’s consciousness. People tend to identify two things most strongly with city government. First, the police and second is zoning. Sarasotans are proud of their police force and fear they would not get the same sort of protection if it were in the hands of the sheriff’s office.

But there also are financial pitfalls to that plan. First, in the police contract is a section stating that if the department is merged with another department, the city pension board must still administer the plan and the merger could not diminish the retirement benefits. So it is not clear how much the city could save. It is also unknown if the county and sheriff would be open to a merger.

6. Declare bankruptcy. If the city declared bankruptcy, it could nullify its contracts and restructure the retirement in an affordable way. That has the drawback of a severe public relations black eye. Further, it is not clear it accomplishes more than the City Commission already has the authority — if not the will — to accomplish by imposing a new contract.

7. Dissolve the city. The city could merge with the county, as Miami did with Dade County and Jacksonville did with Duval County.

8. Delay further. Probably the most likely option is delay the tough decisions by gently tweaking the retirement plans at the edges and keeping an 8% assumed rate of return. The problem is that the Police Benevolent Association and the Teamsters Union are not of a mind to bend much on retirement benefits.
Sharply changing employee-retirement plans will require a majority of city commissioners voting to impose a contract with affordable provisions. It’s not clear that majority exists.

CITY LEADERS SPEAK OUT
Sarasota’s mayor and commissioners discuss the pension problem.

Mayor Suzanne Atwell: “This problem developed slowly over the years as commissions enacted future benefits which did not require immediate funding. … The current commission has addressed the issue, made some changes and will probably consider further changes during our upcoming budget deliberations. One of the major concerns is the assumed rate of return on funded liabilities.”










Commissioner Shannon Snyder: “We may not be able to survive through the end of decade. The issue is completely understated. We can start to turn law enforcement over to the sheriff now in an orderly fashion or in five years in a panic.”












Commissioner Paul Caraguilo: “The math is very important, but … I want to offer a benefit package that allows us to retain and recruit people. It’s not just about retirees, but about down the road. It’s all too much. I’d be in favor of imposition of a contract as along as its not absurd. It’s about judgment, not about fear. It can’t be about fear.”











Commissioner Terry Turner: “It is not just a pension cost crisis. It is a health care cost crisis, too. By any reasonable estimate, the current labor contract costs exceed the tax payer's ability to pay. It is, therefore, essential that the city negotiate labor contracts whose terms are fair both to the employee and to the taxpayer.”











Commissioner Willie Shaw did not return a call for comment as of press time.