Lessons learned from city pension deficits

Back in the 1990s, big American cities offered generous pension plans to their workers, confident that a booming economy would cover the high costs.

Things didn't turn out that way. Now, even as some employees anticipate retirement payouts totaling $1 million or more, municipal meltdowns have begun.

Here in San Diego, the nation's seventh-largest city faces an estimated $1.2 billion pension deficit. In Houston, the shortfall is $1.9 billion, and voters in May bailed out the city by allowing it to renege on pension promises. And in Wisconsin's Milwaukee county, similar pension problems have claimed the political careers of seven county supervisors.

There are plenty of pointing fingers ready to blame greedy labor unions, clueless politicians, and inept accountants. A rash of federal investigations suggests that even some government players may be crooks.

But observers say there's good news amid the bad. The administrators of many municipal pension plans are learning from their scandal-plagued counterparts, and reformers hope to develop new laws to prevent future financial disasters.

If municipal employees keep their jobs amid budget cutbacks, news reports suggest that hundreds of them will get huge windfalls upon retirement.

Consider a hypothetical 40-something municipal employee making $40,000 a year in Houston. Under the city's pension plan, she could retire at age 65 and get annuities totaling $2.7 million, according to Joseph Esuchanko, a Michigan actuary. "It was very possible for a municipal employee to retire and have income greater than when he was working," said Mr. Esuchanko, whose calculations shocked the Houston city officials who hired him.

In Wisconsin, the Milwaukee Journal Sentinel calculated that the pensions of top Milwaukee County executives would grow as much as 253 percent under a plan approved in 2000.After a scandal broke in 2002, seven county supervisors were recalled and the chief executive resigned.

Like San Diego and Houston, Milwaukee adopted a pension option known as a Deferred Retirement Option Program, or DROP. The options allow workers to divert money that would have gone into their pension benefits into special accounts, sometimes with a guaranteed rate of return. Upon retirement, the workers can take the money from their DROP accounts as a lump sum and continue to receive checks for pension funds they earned before entering DROPs.

"They're a flexible tool to encourage retention of employees who were valuable to the organization," says Nick Greifer, manager of policy analysis with the Government Finance Officers Association. "Someone at age 60 might be retiring, so you set up a DROP plan, and they stick around another five years."

Public employees gladly accepted the lucrative pension options, and many say they're well deserved, even if they're more generous than those offered by some private employers. "A lot of people make the decision to stay and do a good job," says Judie Italiano, president of the San Diego Municipal Employees Association. "They appreciate the benefits they get as public employees. That's the trade-off a lot of them make" when they could earn more elsewhere.

Not all pension plans with DROP options are in trouble. The one for public-safety workers in Los Angeles, for example, is designed to be "cost neutral" and not affect the city's bottom line. But elsewhere, workers who delayed retirement to pursue new options sucked both their salaries and hefty DROP payments out of municipal budgets, Esuchanko says. Then came the economic downturn of 2000-2003, which socked investments and interest rates.

"It brought to the fore that much of the funding of benefits was really based on funny money, money that was there as long as the stock market kept on at that blinding performance pace," says Tom Branan, owner of The Public Retirement Journal, a public retirement trade publication. "That kind of money isn't real, and it can evaporate overnight."

What is real, Mr. Branan says, are the financial obligations of cities and countries that are stuck with their pension obligations. And an improving economy might not help much: The greater the loss, "the more difficult it is to make up, unless the investments are very aggressive," says James B. Davis, a Fort Lauderdale tax attorney and municipal pension-plan adviser. "It's not likely that a plan that had heavy losses would invest aggressively."

Critics say many pension plans need serious overhauls. Municipal governments must keep an eye out for conflicts of interest on pension boards, they say. "When you have nine people on a board voting on things that affect their retirement, that's not good," says April Boling, president of the San Diego County Taxpayers Association.

In San Diego, voters this fall will consider ordering the city to save money by paying off the pension deficit in 15 years instead of 30. Voters will also decide whether to mandate that city pension plans always be fully funded.

That last part makes sense to Ms. Italiano, the San Diego municipal employee representative. If officials "see they can't afford it," she says, "they shouldn't be trying to appease folks."