BALANCE SHEET BLOG – HOLLYWOOD, FL


Pension Reform
July 2, 2012, 12:52 PM
Filed under: Budget, City Commission, City Staff, Taxes

Editors’ Note:  Long-time Hollywood resident Larry Legg has sent us the following letter.  We believe that it warrants serious attention by the City Commission and City staff.  Residents, too, need to understand these issues. We are grateful to Larry for sharing his expertise on a difficult subject that affects us all.

Dear Balance Sheet,

I have been a CPA and business advisor for about 27 years now, 20 years of which were spent auditing government and not-for-profit entities.  I am also a life-long student of economics and politics, although you will never catch me running for office.  I’m not Republican or Democrat, nor a Tea Partier, but attempt to look at the world around us in an independent and objective manner, in light of the underlying economics.  Your blog has helped me better understand the difficulties that our city faces today.  There is one issue, however, that should not be swept under the carpet, and that is pension reform.  I know this is cliché, but the giant Gorilla is still in the room and, although only 800 pounds now, he’s still going to mess some things up!

After having observed a lengthy blogger debate on pension reform, and having studied much of the relevant evidential materials – including but not limited to comments on both sides of the issue, citywide financial audits, pension audits, actuarial reports, 2012 budget analysis, national municipal bankruptcies cases, etc. – I am convinced that, no matter who has to pay the tab, our city is still at a moderate to high level of risk of bankruptcy and/or austerity measures.  Pensioners have a legitimate argument, particularly with respect to “Legacy Costs and Liabilities.”  It is difficult to believe that any employer could breach such a promise, and I’m sure the courts are beginning to decide this very issue all over the country.  The debate appears to be in the hands of the judiciary at this point, so let’s all keep our eyes on the cases that are being filed in this alarming nationwide trend.  Many of your bloggers appear to be bogged down in the details due to their own special interests (which I fully understand), so they fail or refuse to see the big picture “from 30 thousand feet” so to speak.

The Facts:

The following are some highlights of my research on Hollywood’s citywide finances:

Assets as of last fiscal audit, September 30, 2011 $ 727 million
Liabilities Recorded on Books  (553) million
Liabilities Not Recorded on Books (Unfunded Pension costs)  (350) million
Liabilities Not Recorded on Books (Unfunded Healthcare costs)  (433) million
Citywide Net Deficit in Fund Balance – Adjusted Net Assets  (609) million
  • Unfunded pension liability is net of $66 million in downward adjustments related to the referendum, and as per the most recent actuarial reports and city staff.  This is a real debt that does not get recorded on the City’s books.  In addition to this debt, the City has an actuarial “unfunded” liability to legacy employees for their lifetime healthcare benefits of $433 million as per the most recent certified audit.

 

Your bloggers have properly enumerated the many wasteful projects Commissioners have spent our hard-earned tax dollars on for the past three decades.  This spending, I concur, must stop.  No more developer handouts, no more capital expenditures on non-essential infrastructure, etc…the list goes on and on.  For obvious reasons, city employees’ heads are in the sand regarding an expense item that currently makes up about 21 percent of Hollywood’s operating budget – i.e., pension expense.  There will be no winners in this process, unfortunately, so it’s easy to see why people naturally shy away from the subject.  The pain will be even worse if the City is forced to seek protection under the U.S. Bankruptcy Code.  The hard, cold economic facts and circumstances will drive the outcome:

  •  $609 million deficit in Net Assets;
  • Pension Expense that constitutes 21 percent of total revenues;
  • Unfunded pension liability of $350 million (approximately 50% funded) – severely underfunded according to most experts;
  • Unfunded Post Employment Healthcare Benefits of $433 million;
  • Pension expense as a percent of gross salaries is between 36% and 81%, depending upon which department, which is far above national averages;
  • Overly optimistic actuarial assumptions about returns – currently 7 percent.  That should be reduced to the “new normal”, which many economist and analysts (and astute private sector investors) agree is about 5 – 6 percent;
  • Weak stock market performances;
  • Weak investment returns on pension assets, compared to the broad market, unmanaged averages;
  • Declining Property Values; and
  • Aging Infrastructure

Our City’s current finances are not too different from several recent Chapter 9 municipal bankruptcy filings.

Opinion:

My advice to Commissioners and Future Commissioners:

  1. Honor Legacy costs.  I think that even in bankruptcy court the judges will lean toward such a requirement.  Keep an eye on these cases.
  1. Do not make promises you cannot keep.  The stock and bond markets are unpredictable. And you, your accountants, your actuaries, economists, and investment advisors can never accurately calculate how much money to set aside for some variable defined benefit, ad-infinitum into the future.  And, no organization in the world – whether for-profit, not-for-profit, or governmental – can afford 21 percent of its revenues in pension expense – period.
  1. Employ a contributory, 401(k) type plan like most organizations in this day and age – i.e., a defined contribution plan.
  1. Urge retired employees to push for further pension reform.  They need to understand that it is in their best interest to help devise a solution to this problem before their livelihoods are in jeopardy.
  1. Quit spending money on almost everything except for critical infrastructure and routine operations for a few years.  We need to get back on our financial feet.  That would include a complete moratorium on new hires for an indefinite period of time.
  1. Review the entire way of doing business, perhaps by way of an “Operational Audit”, and make changes.  Change is good, so long as it’s economical.
  1. Forget about your own pocket books and about getting re-elected when making decisions that affect 143,000 citizens and taxpayers – it’s your duty to do so.
  1. Stop caving to special interests.  They don’t run the city, “We The People” do, supposedly through YOU, our elected officials.
  1. Don’t raise the millage rate; it’s already one of the highest in the county.  Property owners have already paid an inordinate amount of money for taxes, and I don’t think they can bear further increases.

As always, I invite comments and questions.

Sincerely,

Larry Legg, CPA


20 Comments

Mr. Wilkie, show us the raw math. Finally you are getting to some solutions. I like some of your suggestions so far. Also, do this in your calculations: Assume a 20% increase in tax revenues (an increase which few will support), assume no new hires, and, assume no impending 2013 deficits (bad assumption), and then assume that all that cash is plowed straight into the pension plans; and then tell me how many years it will take to widdle away at $783 million in unfunded promises. It is not necessary for you to describe how defined benefit pension plans work because most all of the readers on this blog, and the business owners and taxpayers in this city that I have spoken to, understand all too well.

And, as far is payout over time, any prudent organization sets aside money for promises – i.e., funds them. Novel idea? I think not. We have obviously fallen way short on this note, by three quarters of a BILLION dollars! And, you are right, past commissions (for three decades) are accountable for not only making promises that they did not even understand, but that could possibly not be deliverable in the future, AND then not funding them sufficiently. Placing the blame squarely on the current commissioners, although they are accountable today for further bad decisions, is no solution. Mr. Furr and a few others have been genuinely trying to tell all of us for a few decades that we were going down the wrong path. Their solution was to reduce benefits; your labor representatives simply wanted to get the plan funded and keep their benefits…no secrets there. They did what they had to do. But, they could have done a better job at demanding the City fund the promises, as well as selecting and monitoring their investment managers. You must admit the investment performance of your plans is poor. Some of the unmanaged, broad indices performed better with far lower costs.

With respect to taxes, my properties have fallen in value 30 to 50%, and yet my tax bill is the same, maybe a few percent lower. This is fair? This is only one person’s opinion, but I do not believe the American taxpayer can handle further tax burdens, and I have a feeling that this concept is going viral.

And, finally, I do not advocate or wish for our City to file for bankruptcy, I am just saying that it may very well be the only way out should the unfunded liability continue to spiral out of control.

Have a fun 4th of July!

Comment by Lawrence Legg

I’m sorry… show you the raw math for what exactly?

Comment by Brian Wilkie

Your question about the fairness of your property values vs the taxes you pay is a difficult one to answer. From the perspective of an employee, I’d say that the services you’re receiving for those taxes haven’t decreased… at least not from a public safety standpoint. However, if you have a hiring freeze, you will see a reduction in services, and not much of a reduction in your property taxes I would wager. See, not filling a vacancy in the fire or police department doesn’t necessarily translate into a savings. There are standards and regulations which set specific levels of personnel for those departments to maintain. If there is insufficient personnel, then the city has to fill those shifts with current employees (overtime). How many overtime shifts do you think it will take to eradicate any savings realized by not hiring a new employee?

Comment by Brian Wilkie

I know you have stated that most people you have encountered seem to have a solid grasp of how a defined benefit pension works. Frankly, I was astonished by that statement because nearly everyone I encounter seems to think a pension is rocket science. I located a pretty basic explanation of the ‘unfunded liability’ aspect that you are discussing. I think it is important to reference this explanation so that everyone will be on the same page for any further discussion of this topic.

http://www.publicpensionsonline.com/public/images/Understanding%20Unfunded%20Liability.pdf

Comment by Brian Wilkie

Excellent commentary. But, rather than casting blame and finding fault in every word, let’s hear some solutions to a city-wide deficit of over a half billion dollars. Relying on fate doesn’t work well in a smart business environment. Frankly, I am now more convinced than ever that Chapter 9 is our only solution, unless of course the Dow slams through 15,000 and keeps going. I am not holding my breath for that. Are you? And, Mr. Wilkie, would you hold Hollywood bonds in your retirement plan? I wouldn’t do it for more than 50% of par.

Larry Legg, CPA

Comment by Lawrence Legg

I believe there is a distinct difference between ‘blame’ and ‘accountability’. People can place blame as they see fit. I hope those responsible are held accountable when the time comes.

While you may be convinced that Ch 9 is the most sound solution, I have to ask if you’ve considered the consequences of such an action? Hollywood has already been downgraded once as a result of claiming financial urgency two consecutive years. How much damage would a bankruptcy claim inflict on the city’s credit rating? Smart business environments don’t have much room for a city with a Ch 9 on its record.

A suggestion you ask? Don’t be misleading in the assessment of the city’s financial outlook. You pose a very grave picture, but your expertise should provide you with the ability to paint an clearer and more comprehensive explanation of how the ‘unfunded’ liability works. The city doesn’t face an enormous balloon payment in 5, 10, 20 or more years. These obligations are gradually paid out to the employees for their loyal career of service to the tax payers. The pension system as akin to a conventional mortgage…. with one exception: the city actually used to have opportunity to NOT make a payment on this obligation for a period of 8 years. That’s right… the DROP allowed the city to hang on to the pension money for 8 years and earn more interest on it to help reduce the cost of the obligation. After the referendum and the imposed pension reform, the city no longer has the ability to do this. The money leaves the fund immediately and the retired employee can earn the interest on the money. Bring back the DROP, and the city will see a reduction in the cost of the pension.

Another solution… don’t foolishly turn down over $3 million a year from the state in 175/185 funds because the pension no longer complies with state statutes. It’s difficult not to lay blame when one considers the foolishly executed plan by the city to cut costs… especially when the city effectively spent about $6 million just to save $8 million. ( estimated $2.5 million set aside for legal counsel for the anticipated legal challenges by the union; $3+ million lost in state 175/185 funds; $400+ thousand in marketing and election costs for the referendum). Add to this the cost of training several entry level firefighters and police officers who quickly resigned from their new position with Hollywood because they found better paying positions with other cities.

And finally… my last suggestion for the time being… redraw the beach and downtown CRA districts. Exclude areas which don’t meet the criteria, and allow those ad valorem tax funds to go to the general fund.

Comment by Brian Wilkie

I want to weigh in on the 175-185 State funds because it’s my understanding these funds can be used only for new benefits leading to more obligations, not savings. Hence I don’t see how turning down these funds can be termed “foolish” in this case.

As for redrawing the CRA districts, I agree, depending however on the extent of the obligations the City would have to assume. There’s been talk of reducing the Beach CRA boundaries but I’ve not seen the details on financial obligations that would be transferred to the City under such a scenario. That would be very useful information to have. Commissioner O’Sheehan has suggested capping the Beach CRA. That sounds like a really good idea to me.
Sara

Comment by Balance Sheet Blog

The employees had ratified contracts until October of 2012. The 175/185 funds would have been paid to the city for 2011 and 2012. The prudent move would have been for the city to work with the employees on concessions to get through to Oct 2012, and then negotiate for new contracts at that point. No need to threaten the residents with excessive tax hikes or impose substantial cuts on the employees for a net savings of $2 millions. That would have been EASILY achieved through concession from the three bargaining units. Seems pretty elementary to me. Unfortunately, my many pleas to the city manager and commission fell on deaf ears. Perhaps the lobbying from the other interest groups was more influential. After all, I’m just an employee and resident.

Comment by Brian Wilkie

FIVE THINGS TO KEEP IN MIND ABOUT PUBLIC-SECTOR PENSIONS:

In a Reuters article about cutting public-sector pensions, the author says that before doing so, five things should be kept in mind:

Pensions are not simply a gift from taxpayers. They are an integral part of total compensation, along with salary, health benefits and vacation. Unlike private-sector defined benefit pension plans, most state and municipal workers contribute hefty amounts from their salaries. Investment earnings account for more than 60 percent of all public pension revenue; employee contributions account for 12 percent and employer contributions cover around 28 percent.

Many workers do not get Social Security. Thirty percent of state and municipal workers work for states that have not opted into Social Security.

Pension underfunding is not as bad as one might think. A few states have dropped to frightening levels, especially those that failed to make necessary plan contributions for years. Nationally, aggregate asset/liability ratios have been rising. The funding level for all state plans combined was 77 percent last year, up from 69 percent in 2010. Although most public sector pension plans have a target funding ratio of 100 percent, ratings agencies consider a ratio of 80 percent to be adequate. By comparison, private-sector pension plans are considered at risk of default if their funded ratios fall below 80 percent. However, it is worth noting that public sector funding ratios rely on long-term rate assumptions of around 8 percent. Actuaries support that projection, since it is upheld by actual long-term investment history.

Pensions are more efficient than 401(k)s. Despite the underfunding of some plans, defined benefit pensions provide retirement benefits more efficiently than defined contribution plans. The efficiencies stem from pooling of longevity risk, maintenance of portfolio diversification and professional investment by pension fund managers. For example, a recent study found cost to New York City taxpayers 57 percent to 61 percent more to provide workers in the city’s five defined benefit plans with equivalent benefits via a defined contribution plan.

The retirement crisis is real. The Federal Reserve’s recently issued Survey of Consumer Finances contains these stunning figures: the median American family’s net worth fell nearly 40 percent in the three years ending in 2010, and the asset accumulation of most was set back almost two decades. Real income fell 7.7 percent. Sixty percent of households say the total value of their savings and investments — excluding their homes — is less than $25,000! Against that backdrop, pensions are the only safety net available to public sector workers, especially in states where they are not enrolled in Social Security. Thus there is a real risk that pension reforms could push public-sector retirees into poverty.

This information is cited from a Rueters news source based on industry and governement research.

Comment by Robert Strauss

Well said, Mr Strauss

Comment by Brian Wilkie

Hollywood never opted out of Social Security and all city employees receive it along with pensions.

Comment by Balance Sheet Blog

Yes, they do. But Pension Payments qualify as income thereby reducing the amount of SSI payments to pensioned retirees. We pay into SSI all our working careers, just as we pay into our Pension, but will receive less benefit from SSI because we paid into our pension.

Comment by Charles Kerr

People forget that most of us contribute a significant amount of our salaries to the pension fund. For hopefully a very long time, about 25 years. I would hope that my employer would keep their promise to me, since I made a promise to work for much less than the private sector doing the same type of work. I would sacrifice in the early years, that I might catch up in the long haul with hard work and loyalty I might receive merit increases,which have been frozen, and incentive pay for working 15 or 20 years. Both of which have been either eliminated or cut in half. I just ask that my employer keep up with their end of the bargain. We are about public service, keeping clean water in your faucets allowing you to flush your toilet and be safely disposed of, and many other aspects of public service. Most of which you don’t see until you have a problem or gripe. We shouldn’t be in the entertainment business or business consulting/ loan brokers or better yet grant givers. How many unpaid small business loans or special perks are given out? Just to have an empty storefront downtown, and never see a dime paid back. Sometimes they even get more free money
. Something has to change.

Comment by swrcam

Mr. Legg….Thank you for offering your educated and wise perception of the situation. I must admit that I do not possess the wealth of knowledge, experience or education that you do. However, I have done a bit of research in regard to municipal budgeting and pension mechanics. I would like to expound on a few items you discussed.

For starters, I wholeheartedly disagree with your suggestion that the city have a moratorium on new hires. This indicates that you are not informed enough to make a plausible suggestion with respect to this. I am an employee, and I know that police is understaffed… and fire is barely breaking even. Maintaining an understaffed level in either department puts both the residents and employees at risk… as well as the city when you consider the potentially dangerous situations which can occur as a result of an understaffed, overworked and exhausted public safety sector. NOT a thought that brings much peace of mind. Fatigue sets in, mistakes are made… and injury, death, or liability suits ensue. So, really think that through.

Second, I have to concur with Mr. Kerr ( rhyme not intended). Switching to a 401(k) is foolish. Research by pension experts has shown that 401(k)’s are an inefficient and inadequate means for accumulating a nest egg to keep a retiree above the poverty line after they reach retirement. Long story short, this means more retirees will be dependent on government aid when they reach those ‘golden’ years. So, trying to save our children from the burden of a pension is a goal which won’t be achieved by switching to a 401(k), it simply transfers the burden from one form to another. The mechanism which needs to be adjusted which will repair the pension burden is interest rates. A typical pension is funded by three sources: 1) employee contribution; 2) employer contribution; 3) returns on the investment. The investment returns usually cover about 73% of the overall cost of the pension. However, the terrible economy and rates of return have severely (albeit temporarily) disabled the biggest cost cutting mechanism of DB pensions. Mr. Legg mentioned this in his assessment. The rates of return have to come back up.. and the assumed return has to be reeled in. However, the flaw in his suggestion is that reducing the projected return will shift more of a financial burden to the city. This is why the assumed return was only reduced slightly and not to a drastically low 5-6% as Mr Legg suggests. That would have been a crushing blow to the city’s budget. The thinking is that a 5 year smoothing period for the pension will actually show a 7% return as it has in the past. So patience, and not a ” sky is falling” approach, is satisfactory for now.

The discussion on millage rates is misleading. Hollywood may have on of the highest millage rates in Broward county, but it’s a RATE. The tax revenue generated by the rate is the actual issue. The AMOUNT of taxes the resident pays at the end of the year is what matters. Hollywood had to raise the RATE because property VALUES dropped so much. IN the past 4 years, I’ve seen my tax bill drop by 66%!! Ft Lauderdale has a millage rate that is 4.1193. Hollywood’s is 7.4479. Yet, Ft Lauderdale collected $96.7 million to Hollywood’s $75.2 million.

There are several opinions on why/how this pension mess was created. Many of those opinions are uninformed. For years, the pension funds were generating millions of dollars a year in interest revenue for the city. As a student of the economy, Mr Legg, I’m sure you’ll acknowledge that the market economy has frequent and somewhat predictable cycles. Had the city adopted a fiscally responsible policy which established a stabilization fund for the pension to utilize surplus funds in the profitable years to help alleviate the costs in the slow years, there wouldn’t be a pension gorilla. Instead, the city officials decided to irresponsibly spend those funds on projects in the hopes of generating a positive perception of their actions by their constituents. And now, here we are in an extended economic slowdown, and the city is forced to reach into the employees’ and taxpayers’ pockets to cover their follies and pay the bills.

Comment by Brian Wilkie

The Mayor and the commissioners do not understand that they MUST STOP SPENDING, They refuse to accept this.

Comment by Bill Wynn

Our combined challenge is to remain current and involved. Thank you Sara, Laurie and Larry for providing open windows for residents and taxpayers to use as we try to select those who will take appropriate actions and lead the way toward fiscal solvency.

Comment by Just Beachy

Timely post. You will be told of another budget shortfall soon. Big changes need to be made or we will see this again and again every year and the tax payer is tired of paying for it.

Comment by Hollywood Helper

Excellent assessment of the financial condition of our city. This is a honest and UN biased statement of facts that the average citizen can read and understand! Every tax paying citizen of Hollywood should read this, not to mention our current City administrators along with those running for office this year.
There is truly a lesson to be learned here!

Comment by Skip Farinhas

I agree with everything except suggestion number 3. The benefit to the City in switching gears from DB to DC is so close to zero as to not be worth the trouble of switching. And a very healthy percentage of the blame regarding the ‘unfunded pension liability’ is due to the poor management practices of the City Leaders. They didn’t budget into the system what they should have when they should have and now it is painful to everyone involved from the residents on up.

Now, having said that…. excellent article and thank you for sharing. I do hope we can get our Commissioners to pay attention.

Comment by Charles Kerr

Excellent assessment and factual representation by Larry Legg. Kudos for taking the time, and to the Balance Sheet for publishing. Now let’s see if we can get the elected officials and their minions to pay attention and adjust the budget planning process with each department, including the Commission office, starting at ZERO. Justify each and every dollar, operationally, with focus and rationale.
Thanks again to Larry Legg.

Comment by Linda Wilson 44 yr. Hollywood Resident, and never running for office either!




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