Ask Washtenaw County Treasurer Catherine McClary about the perils inherent in underfunded retirement plans and she’ll tell you flat out: “It’s a time bomb for government at all levels. The assumption is that government will always be there and always pay. But while that’s been true in the past, it may not necessarily always be true in the future.”
That time bomb certainly seems to be threatening nationally. To meet its commitments, Illinois’ state pension fund will need another $80 billion, California a staggering $500 billion. Michigan, with an estimated $54 billion in unfunded obligations, is not quite in that class. But our state’s lower per capita income and higher poverty and unemployment rates make the fuse on our bomb that much shorter.
Hamtramck, where union contracts with plush pension plans form a big part of the city’s structural budget deficit, already is seeking state permission to declare bankruptcy. And as governor Rick Snyder noted after his election last November, Hamtramck is hardly alone: “There could be hundreds of jurisdictions” in Michigan in such acute financial distress.
Because pension funds invest heavily in the stock market, the 2008 meltdown blew a huge hole in plans across the country—and locally, too. Between 2008 and 2009, the city of Ann Arbor’s pension funds lost $104 million in value, while Washtenaw County’s lost $34 million.
The market’s partial recovery and their own sound investment strategies have put the city and county on track to make good on the losses, but officials fear that unless union contracts change, ever-rising costs will strain city and county resources for the foreseeable future. Already, the two governments together spend nearly $50 million a year on retirees’ pensions and health insurance.
“Retirement benefits, and especially health care benefits, have to change,” says Ann Arbor mayor John Hieftje. County administrator Verna McDaniel wholeheartedly agrees. “We have to bring health care costs down. If we don’t, we’ll have a huge problem.”
Over the years, the unions representing city and county workers have negotiated very generous retirement benefits. Most employees qualify for a pension, with lifetime family health insurance after just twenty-five years of service. They can begin collecting those benefits at age fifty—even earlier for police and firefighters. To pay for all this, Ann Arbor has a property tax dedicated solely to retiree benefits, which will bring in more than $9 million this year. Thanks to the millage, a rising stock market, and low payouts, as recently as 2004 Ann Arbor’s retirement plans were 150 percent funded, meaning that they held more than enough money to pay all current and anticipated benefits.
But as city staff cuts pushed workers into retirement, payouts rose. “By 2005, the percentage had dropped from 150 to 125,” says Tom Crawford, Ann Arbor’s chief financial officer. “By 2008, we were at 100 percent, and that’s where we thought it would stay.” Crawford sighs. “Then the market melted down, and that wiped out a chunk of the [investment] earnings”—a $104 million chunk. That wasn’t as disastrous as it sounds, Mayor Hieftje explains, because “benefits aren’t a one-time payment.” Even after the crash, he says, “there’s enough money in the fund to pay for benefits to those in the fund now and for those coming up in the next several years.”
Still, the meltdown had a huge impact. “We lost so much money that we also lost some of retirees’ [own contributions],” says Crawford, “and a year ago, we were about $6 million short.” Smoothing out the losses over five years, plus adding $1 million from the general fund, Crawford says, has since largely made up that deficit.
But what about tomorrow? Already, the city has more retirees, 879, than active employees, 728. Crawford explains that in itself the imbalance isn’t a problem. “If you’re 100 percent funded, then those 879 already have all the money in the trust fund they’ll need. That’s where we were in 2008.” But as the market losses of 2008-2009 are gradually accounted for, “we’re heading towards 75 percent funded,” he says—though even that is still enough to be able to pay all benefits due.
Between the stock market recovery and the continued inflows from the pension millage, “by 2015 everything will be all right—if there are no other economic disasters,” says city administrator Roger Fraser, somewhat reassuringly. “But,” Mayor Hieftje notes, “if this decade we’re in turns out to be as bad or worse than the one we just left, I don’t know if there’d be many pension plans left in place anywhere.”
Defusing the bomb lit by the market meltdown is one thing; defusing the bomb lit by rising retirement costs is another. “Retirement benefits have been a central theme of union negotiations for quite some time,” says Hieftje. “We’ve made some progress, but it is extremely difficult to get any of what was put into the contract in the ’70s, ’80s, and ’90s taken out—even though the economic situation has changed radically since then.”
The way Hieftje sees it, the current system is “punishing the taxpayer—they pay for it by more money going into benefits and less into services.” In future negotiations, he says, “we would really like to get longer years of service from the employee [before retirement], particularly from safety services, and greater participation from the employees”—meaning, contributing more of their own money to the retirement fund. Ideally, “we’d like to get the current [unionized] employees into the same plan as salaried employees,” Hieftje says, “and make it more like the U-M and private sector businesses.”
“We believe employees can put more in,” agrees Fraser, “and some already have. Our firefighters and our nonunion employees are at 6 percent [contribution], while AFSCME and the police unions are still at 5 [percent].” The city administrator grudgingly admits, however, that “by and large,” he’s “not that dissatisfied” with the city’s current union contracts, and that “compared to other places in southeastern Michigan, they are probably fair.”
Fraser also says there’s no comparison between Ann Arbor and Hamtramck. “Hamtramck is a financial nightmare: a small city dependent on a shared relationship with Detroit for a portion of their revenue—and Detroit has decided to stop paying.” Nor, in Fraser’s opinion, is Ann Arbor like any of Governor Snyder’s other financially distressed cities. “We’re in southeastern Michigan, so we still have difficulties,” says the city’s administrator. “But compared to other cities, we are doing fairly well.”
The 2008 market meltdown also rocked the county’s pension funds. “We’re trying to manage it,” says treasurer McClary, “but it’s tough. And we are underfunded at this point.” County retirement administrator Monica Boote confirms that “the pension plan is at 74 percent,” while noting that “anything over 70 percent is considered a healthy fund.” Like the city’s, the county’s pension investments took a big hit in 2008-2009, losing “about 23-24 percent of [their] value.”
The pension plan is only part of the county’s retirement benefits package. There’s also a separately funded health care plan—”a very immature fund,” Boote explains, “that’s been around less than ten years.” That fund lost 22 percent of its value in the meltdown, and is now just 24 percent funded. On top of that, Boote says, “the sheer number of retirements increased in 2009. We usually have twenty-five to thirty a year. But because it was an expired [union] contract year, in 2009 we had eighty retirements,” as employees hurried to leave ahead of possible benefit cuts.
Despite all this, county administrator Verna McDaniel stresses, “we were always able to meet our obligations” to the county’s retirees, though they had to shift $6.7 million from the general fund to the retirement fund in 2009 in order to do it.
“Both plans did well in 2009,” Boote says, and are recovering their value. But McDaniel warns that the county is anything but out of the woods. “Health care costs are a ticking time bomb,” the administrator stresses. “At the same time that we have to bring the fund balances up, we have to bring health care costs down. If we don’t, we’ll have a huge problem. And it could happen sooner rather than later if our retiree numbers increase dramatically or if we got a huge cut in state revenue sharing.”
So, McDaniel says, retirement benefits “will be near the top of the list” in this year’s union negotiations. “Particularly health care. We can’t hide from it, and we’ve got to take it on the front end or we’ll get it on the back end.”
McDaniel, who spent most of her career with the county in human services, characterizes the current health care plan as “generous,” but says “we can’t continue it out into the future. I’m not against our employees being compensated fairly, but the reality is we can’t afford it. We’ve lived good lives for a number of decades, but now change has come, and it’s going to hurt and hurt badly.”
“I don’t want to be overly harsh,” the county administrator concludes. “But this is going to be hard for everybody, and it is not going to be popular.”
“We’re at the mercy of the state”
The Ann Arbor Public Schools also face rising costs for pensions and retiree health care. But unlike the city and county, local school officials have virtually no control over those costs, because the state administers all school retirement funds.
“The percentage that we are required to contribute is based on the State of Michigan’s fiscal year,” explains Nancy Hoover, the district’s finance director. In the past five years, it’s jumped from 12.99 percent of payroll to 20.66 percent. “And if the current trend continues, it will be larger,” Hoover says. “Potentially much larger.”
“We’re stuck between a rock and a hard place,” says school board president Deb Mexicotte. “All the costs come to us, but without any control over any of those costs. And it is our expectation that they will continue to rise precipitously over the next several years.”
“We’re at the mercy of the state,” agrees interim superintendent Robert Allen (above), “and there’s absolutely nothing we can do about it.” Any reform in pensions and retiree health care “has to be done by the state legislature, and so far there hasn’t been the political will to address the problem. And when that number continues to climb—and it will continue to climb—it’ll be a disaster for the district, and for the state.”
“This is happening all over the state and not just in Ann Arbor,” Mexicotte concludes. “Ann Arbor has been very proactive, and we’re in better shape than the majority of districts in the state. But we had a $40 million reserve ten years ago and we have a $10 million reserve now, with a built-in structural deficit that’s only going to get bigger.”
The following letters to the editor appeared in the March 2011 Ann Arbor Observer:
To the Observer:
I have two beefs with the latest issue:
(1) The anti-union bias of Jim Leonard’s article on pension funds.
(2) The slur against the [Original] art fair’s jurying process in Mike Mosher’s article. If it was then (which I am not competent to evaluate), it is sure no longer “secretive” and “clubby.”
To the Observer:
No one you interviewed for your January feature on government pensions mentioned one really important fact: Washtenaw County actually succeeded in moving away from the defined benefit plan in the late 1990s in favor of a defined contribution plan (comparable to a 401(k)). Only within the last three years did the county reverse this decision and move back into a pension plan. As a member of the county administrative staff at the time, I thought it was a huge mistake.
In a defined benefits plan, the employee and employer both contribute a previously agreed-upon amount. If you leave before you are vested, you take only the money you put in yourself, plus some very low rate of return. This system rewards those who stay with the organization for 30 years to the exclusion of everyone else. If you are one of the former, a pension plan is awesome: when you retire, you receive specific guaranteed benefits, including a biweekly paycheck and health benefits, for the rest of your life. If you’re one of the latter, you’re out of luck.
The problem for the county is that when the plan’s investments perform poorly, the employer bears all the risk. The union contracts specify a “cap” on the county’s liability, but if the pension plan needs more funding at some point, where are you going to get the money?
Defined-benefit pensions are impossible to budget for, since there’s no way to predict how many people will retire, or at what cost. So if all of a sudden the county’s pensions costs go way up, there’s the distinct possibility that it will have to cut services and/or lay off employees in order to keep paying people who have already retired. With all due respect, that just seems crazy to me.