Recent Council Votes Add Uncertainty to City’s Legacy Debt

Monday, February 12, 2018, 8:01 am
By: 
Alice Dreger

As the City of East Lansing continues to struggle with looming budget deficits brought on by the need to make catch-up payments to address its large retirement-related debts, City Council has been voting to allow some City employees to add months or years of “service credits” to their City of East Lansing pensions.

Memos from City staff have been suggesting to City Council that approving these service credits is unlikely to add to the City’s debt problem. But an investigation by ELi suggests that, at best, these approvals by Council will add uncertainty to the City’s legacy debt. At worst, they may add to the City’s financial load.

While the up-front cost of the service credits are borne by the employees involved and not  by the City, if the market does not perform at the average anticipated rate of a 6.75% annual return, or employees live longer than expected, or the credits lead an essential employee to retire sooner than she or he otherwise would (necessitating replacement, leading the City in some cases to pay health benefits for both the retiree and new employee), the City could end up paying more for employment-related costs than it otherwise would.

A recent webinar presentation provided by the Michigan Employees’ Retirement System (MERS), the pension system used by East Lansing, warned municipal employers that, when employees are allowed by municipal governments to purchase these service credits, “a lot of these costs [could] end up being a lot higher than what we had assumed.”

That’s why City Council has been required to vote to approve employees’ purchase of the credits.

Said MERS staff in the webinar, “We’re not trying to discourage service credit purchases. We’re just trying to bring awareness to the impact it could have on a municipality, just making sure you understand before the governing body approves them.”

The pension debt problem faced by East Lansing:

According to the City’s latest Comprehensive Annual Financial Report, released late last year, “The City asked the voters to approve an income tax during the November 2017 election to alleviate some of the financial stress experienced with unfunded legacy costs, namely pension. The City has worked tirelessly over 20 years to change the fortunes of these legacy costs by removing the pension and retiree healthcare benefits from nonpublic safety employees, reducing the benefits of new public safety employees and making supplemental payments.”

But, “Even with all of these efforts, the City is still experiencing a decline in the funding level”—in other words, the legacy debt is ballooning—and the City “needs to find additional funds to contribute to these legacy costs.” With the income tax failing to pass, “The City is now working on what services or functions can be reduced or cut to free up tax dollars to fund the pension system. The fiscal year 2019 budget is expected to include many of the reductions to be identified over the coming months.”

MERS service credit purchases:

East Lansing employees who have defined benefit pensions, to which the City contributes, can ask to be allowed to purchase “service credits.” Basically, this is a way for employees to put a lump of cash into their pensions now in the hopes of benefitting in the long-run.

While the purchase of service credits doesn’t allow an employee to be vested in the retirement system sooner, according to MERS, it can “help them meet early retirement eligibility or increase their pension.”

Starting in October 2017, at the request of some employees, East Lansing’s City Council began approving the purchase of employee service credits on the Council’s consent agenda. Items on the consent agenda are approved in a block vote with no discussion.

From October 2017 through today, Council has used the consent agenda to approve a total of eleven employees’ requests spread out over six meetings: October 24, November 8, November 21, December 5, December 19, and January 30. In each case, Council approved the requests on the consent agenda.

Notably, for the November 21 and December 19 meetings, staff failed to attach the MERS service credit purchase resolutions being voted on, so the details of these credit purchases are unavailable. The legality of the votes on these credit purchases is unclear, since Council did not have before them the resolutions on which they were voting. (The Council-approved minutes for those meetings also do not include the resolutions.)

What City and MERS staff say about these credits:

As Council approached the first of these votes, Director of Human Resources Shelli Neumann assured Council in a memo that the employee asking for permission, a police sergeant, “will be paying the entire cost of the additional service time. The additional service time will not be used in calculating eligibility for retiree health insurance.”

MERS, however, warns municipalities that while MERS tries to calculate the service credit costs to put the financial burden entirely on the employee purchasing the credits, there are specific assumptions built into that calculation. And if those assumptions by MERS turn out to be wrong, then the employer—in this case, the City of East Lansing—may bear additional pension costs.

The assumptions, as noted above, include that the market will steadily return 6.75% per year and that employees won’t live longer than anticipated by the actuaries. East Lansing’s pension problem has stemmed in part by incorrect MERS assumptions in the past, including in terms of not anticipating the Great Recession caused by the market crash of 2007-2008 and thinking retirees would die earlier than turned out to be the case.

MERS has provided data on actual rate of return as shown below:

Year

MERS rate of return

Market rate of return per MERS

2001

7.72%

-2.48%

2002

3.43%

-8.95%

2003

8.00%

24.13%

2004

6.82%

14.24%

2005

6.51%

6.24%

2006

8.14%

12.61%

2007

8.12%

7.89%

2008

4.73%

-25.59%

2009

5.30%

17.10%

2010

5.74%

13.94%

2011

5.19%

1.83%

2012

5.42%

10.41%

2013

6.04%

14.47%

2014

5.90%

6.13%

2015

5.21%

-1.74%

2016

5.14%

11.17%

That’s an average of 6.09% actual rate of return.

According to the recent MERS webinar on the subject of service credit purchases, “if the assumptions are not met,” including the 6.75% rate of average annual return, “there could be additional liability” to municipal employers. In that webinar, MERS staff calls the assumption of a steady 6.75% return “a big one.”

The staff presenting the webinar add, “If a member ends up living a lot longer than what we assumed, or if we have a crash in the market, a lot of these costs end up being a lot higher than what we had assumed.”

City Manager George Lahanas (above) was Director of Human Resources before Neumann, and so is probably more familiar with the complexity of retirement-related debt than the average city manager. Asked about these credits, Lahanas notes that, “If [employees] do happen to leave before being eligible for the retiree health care benefit, the City would realize a significant financial benefit as we would not provide coverage to the retiree and their spouse for the remainder of their lives.”

But that scenario is relatively unlikely, and Lahanas declined to answer several questions about whether it might be the case that the purchase of these credits could lead a fully-vested essential employee to retire sooner that she or he otherwise would, leaving the City with the burden of retiree health costs while also having to replace that employee and pay the new employee’s salary and benefits.

Lahanas did suggest in his responses that employees who retire earlier than they would otherwise “are replaced by new hires with a lower benefit.” A number of City employee categories have been moved from defined benefit plans to hybrid plans, and those in hybrid plans are not eligible to purchase MERS service credits. (A 2016 report from the City's Financial Health Team indicated that, at that time, there were 126 East Lansing employees in the Hybrid Plan and 146 employees in the defined benefit/non-hybrid plan, of which 113 had required employee contributions.)

What is Council’s understanding?

Lahanas noted in his response to our questions that Council has been signing off on resolutions that explicitly state: “The employer understands this is an estimated cost, calculated using actuarial assumptions approved by the Retirement Board. Any difference between the assumptions and actuarial experience will affect the true cost of the additional service to the employer."

Wondering to what extent Council members have understood the issues at play, particularly given that the November 21 and December 19 votes were done without the proper resolutions being presented, we asked each Council member last week to explain why they have voted “yes” on these service credit applications.

Only Aaron Stephens responded to that inquiry. He called the 6.75% estimate “a conservative rate of return” and said that, if it is correct, “we end up completely fine on our end.” He added that “any money left over goes back into our fund, so that is another potential benefit.”

Back in November, we asked Councilmember Ruth Beier, a labor economist, about her understanding of these credits, and she responded at that time. She noted then, “There is no cost to the city as long as the actuarial assumption is perfect. If people live longer than predicted, the city loses. If people live shorter than predicted, the city wins.”

She did not at that time address the question of whether the City might end up paying more overall if essential employees, who require replacing, retire sooner than they otherwise would by virtue of being able to purchase the credits.

Beier noted that the purchase of these credits is relatively expensive. The MERS webinar indicated that many employees inquire about purchasing credits but cannot afford to do so; only those employees who can come up with the funds can purchase credits. One of the eleven service credit purchase requests approved by Council cost the employee over $90,000 in cash.

MERS does allow municipalities to opt-out of the service credit purchase option. It also allows municipalities to pass blanket resolutions allowing service credit purchases for entire divisions. East Lansing’s government has not pursued either of these options.

 

Recent City finance reporting from ELi:

Council Budget Retreat Postponed Pending Analysis of Public Input

$700K in Local Taxes Earmarked for Developer's Attorney, Financial Advisors, and Father

Five New Tax Proposals Now Under Consideration

Emergency Services Reaching "Tipping Point," Chiefs Warn

Council Seeks Public Input about Tough Financial Choices

 

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