A historic settlement in Detroit last week paved the way for the city to emerge from bankruptcy in what some would call a heroic feat of collaboration and philanthropy. The so-called grand bargain buys the city nearly a decade to get its finances in order. But while it has raised capital to reduce its debts and structured agreements to resolve others, Motor City’s pension problem has barely budged. It still owes $500 million in pension payments per year — more than twice the city’s annual income tax revenues.
The pension problem extends far beyond Detroit, to the United States’ largest cities: New York, Los Angeles and Philadelphia all have unfunded liabilities, while Chicago’s pensions are just 50 percent funded. Ballooning pension costs are trouble for city governments, retirees and, perhaps most of all, taxpayers, as infrastructure, schools and other needs are simply put off while the city pays for pensions, benefits and interest.
What can be done?
1. Change the Broken Pension Model
At a recent Penn Institute for Urban Research event, “Urban Fiscal Stability and Public Pensions: Sustainability Going Forward,” a panel of pension funding experts overwhelmingly agreed that transparency could help solve the pension crisis — that facts and figures revealing the degree of the problem would incite taxpayers to care and local officials to act. But talk alone can’t change a financial model that’s broken. The whole world knowing about Detroit’s problem hasn’t been a magic bullet for that pension crisis.
Stanford professor Joshua Rauh said new retirement benefits models will be necessary. He suggested that instead of creating pensions that promise terms they simply can’t deliver on in perpetuity, payouts should be linked to how well a retirement fund delivers. He noted that the S&P 500 went up by 75 percent between 2009 and 2013. Yet after studying 10 cities, he found that even though pensions are heavily invested in stocks, six of the 10 cities saw their unfunded liabilities fall by just an average of 16 percent; meanwhile in four cities, including New York and Philadelphia, these liabilities actually increased. This anecdote demonstrates the magnitude of the pension problem: Liabilities can grow faster than cancer and can’t easily be put into remission.
2. Elect Politicians Who Will Tackle the Problem
So many cities have dropped the ball on pension funding, there’s a contagion effect in play. On the expert panel, University of Pennsylvania professor Robert Inman said this has created a “prisoner’s dilemma”: Why should my city fund its pension if no one else is funding theirs? And the law has been ineffective in enforcing funding discipline, noted University of Minnesota professor Amy Monahan.
But, Monahan said, political economic forces strongly favor underfunding pensions since the time horizon of a politician is a reelection period. Politicians and taxpayers prefer to solve current crises (plowing snow after a blizzard) instead of dealing with future problems (a pension crisis in 2030).
A recent win for Democrat Gina Raimondo, Rhode Island’s governor-elect who campaigned on a record of presenting a fix to the state’s pension problems suggests that in the future, there may be some insurance for pols willing to take on pension reform.
3. Sue the Actuaries
Actuaries, who set recommended levels of contributing to pensions, have been far too optimistic. They’ve made bad assumptions about how many people will take early retirement and at what age retirees will die. They’ve suggested that pensions go unfunded based on predictions of controlled decline in the future.
Detroit has sued its actuaries for their analysis of the city’s liabilities, setting precedent for other cities to do the same. This fear of legal recourse could curtail the common practice of actuaries presenting overly optimistic gains for pension investments and low-level funding recommendations.
Likewise, pressure on the municipal bond industry could affect pensions. These days, cities with underfunded liabilities borrow money to fund operating costs. If the bond industry refused to sell debt to cities for any purpose other than capital expenditures, cities would be forced to deal with their pensions today rather than putting them off until tomorrow.
4. Ask the Experts
Cities could create new authorities, like a public pension funding authority run by independent professionals who could help cities deal with their situation. Such an authority could determine if a city’s unfunded liabilities are the result of an unwillingness to fund them or an inability to fund them. An unwillingness to fund the pensions might be corrected by simply exposing this fact to the public; an inability to fund the pensions could inspire bringing together other sources of capital and changes to contribution rates and benefits. All of these ideas would require political will, which is often in short supply on such a tricky issue. (See No. 2 above.)
5. Leave It to the Millennials?
No one at the Penn event suggested that changing demographics may solve the pension crisis, but that could be the case. Taxpayers who are middle-aged or older are more likely to have their own pensions they’re concerned about and don’t want to rock the boat about municipal pensions, for fear it could threaten their own retirement. But most younger workers can’t even dream of private sector pensions and it seems unfair that they will be held with the burden to sorting out the inevitable municipal pension crisis to come by either through higher taxes or city bankruptcy. Monahan noted that a “shared pain model” has been the only way that cities have gotten to resolve this crisis so far. Could there be some kind of “shared gain” approach wherein young people with no pension prospects could participate in the municipal pension system? It sounds crazy, but a big part of Philadelphia’s problem is simply that fewer than half of the 65,000 people in its pension system are active employees. If it had other young people paying into a shared citywide pension, could it all work out in the end? As Rauh said, a dramatically new system is needed. At the very least, new ideas have a better shot of working than the currently failing ones.
The Equity Factor is made possible with the support of the Surdna Foundation.