Hamden Daily News

Pension Fund Mythology

By Mark Sanders

The town’s pension fund is a battleground of late. And for good reason. It occupies one of the few budget lines large enough to enable meaningful tax relief. This reality compelled me to examine the “conventional wisdom�? and try to think “outside the box”—a process that has led to a surprising but exciting conclusion.

Allow me to explain. Thus far, the discussion of how to address our pension responsibilities has focused on only two alternatives: (1) a steady and aggressive building up of the town’s pension fund (“Steady Augmentation Plan”), or (2) a massive ($55 million) lump sum augmentation of the fund through the issuance of pension obligation bonds, coupled with additional annual contributions as recommended by actuaries (“POB Plan”).

As different as these two approaches appear on the surface, they actually share a fundamental misconception—that the pension fund is severely under-funded. The truth of the matter, however, is that this reserve fund needs no further augmentation. Translation: we don’t really have a pension crisis!

Don’t believe me? Then consider these numbers, taken from the most recent Hamden retirement plan documents: (1) annual pension benefit payments to retirees and other beneficiaries total approximately $15 million; (2) the fund has a principal balance of $82 million, currently earning income of $7.5 million annually; and (3) current employees contribute at least $1.5 million to the fund each year.

So if you asked the man on the street what the town should contribute toward its pension responsibilities this year, he’d logically say $6 million, i.e. the difference between $15 million (annual benefits due) and $9 million (annual fund income and employee contributions). And he’d be right.

Yet most folks in town seem to believe that simply paying our pension obligations as they come due, i.e. “paying as we go,” is not enough. There is a widespread belief that we also need to be building up a reserve fund for pensions. Why?

I suspect it has a lot to do with our blind acceptance of our actuaries’ recommendation that we build up a $278 million pension fund. I contend, however, that the actuaries are giving us an unnecessarily inflated recommendation. Am I saying that the actuaries are making quantitative or analytical mistakes in their fund valuations? No, I’m sure they know their science well. However, it’s my reasoned opinion that although the actuarial analysis is technically correct, it is based on a flawed premise. Specifically, there is a misconception that a municipality’s pension obligations must be funded in the same way as those of a private company.

When a private company establishes a defined-benefit pension plan, it is logical that it be required to build up a fund of sufficient size so that, at any moment, it can pay all benefits contractually due over the life expectancy of the current and retired employees. The reason is that the company could go out of business at any moment. If that private employer shuts down before a pension fund is fully endowed, vested pension beneficiaries could be left high and dry.

By contrast, a municipality, such as the town of Hamden, will never go out of business. The town can and will honor its yearly pension benefit responsibilities because it has the power to tax. Therefore, there is no need for a fund to be built up to assure public employees that their pensions will be provided when they retire. They can rest assured that their benefits will be paid as long as there is a Hamden!

[Note: Although a municipality can adjust its debts under Chapter 9 of the U.S. Bankruptcy Code, the Bankruptcy Court’s 1991 dismissal of the bankruptcy petition of the City of Bridgeport has practically foreclosed that option for Connecticut towns.]

So since a pension fund is not necessary to protect the employees’ interests, why do we need to build up a fund at all?

  1. Is it required by law? No. In contrast to private pension plans, no aspect of state or federal law requires a Connecticut municipality to build up a pension fund to provide its retirement benefits.
  2. Do our union contracts require it? No. There is nothing in any of the town’s collective bargaining agreements that require the town to fund the pension plan in any specific amount. Indeed, the “Notes to the Hamden Retirement Plan’s Financial Statements of June 30, 2006�? confirms that the town makes contributions to the fund “at the discretion of the [Legislative Council].”
  3. Would it improve our bond rating? Perhaps. But so would a supplemental tax to retire all of our outstanding bonds! The question is not what can improve our bond rating, but rather does the cost (tax burden) required to achieve an improvement outweigh any future interest savings realized from the incremental ratings boost? Have you ever heard an administration official place a dollar value on the interest savings we might achieve with a slightly better bond rating? That silence speaks volumes. The crass reality is that bond ratings are most important to government officials as political tools (especially in an election year), i.e. as some kind of objective stamp of approval of their fiscal stewardship that can be trumpeted in debates and slick campaign literature.
  4. Is a pension fund a good investment? I reviewed the concepts of this column with a friend who is a union organizer/administrator in New York. He says that although municipalities and their unions may not need pension funds, those funds can be a good investment for the municipalities. Of course, this all depends on where the funds are invested and what is happening in the relevant markets. More fundamentally though, why should taxpayers today suffer higher taxes just so their tax dollars can be invested in the stock market, even if those investments might pay off for other taxpayers years down the road?
  5. Do financial professionals need our business? What do you think? Of course the question is rhetorical; I only mention it because we shouldn’t pretend to be oblivious to the way the world works. Politicians and financial professionals (investment bankers, fund managers, etc.) have always had a symbiotic relationship, to the detriment of the taxpayer. Are there “friendly” folks out there already licking their chops at the prospect of managing a $278 million portfolio, or underwriting a $55 million POB issue? Again, what do you think?

The absurdity of continuing to build up the pension fund becomes even more graphic when you consider that Hamden is phasing out the very retirement plan for which the fund was created. As the mayor stated in his budget address to the Council: “Instead of receiving a town pension, we can begin to transition some of our newly hired employees to the state of Connecticut’s Municipal Employee Retirement System. This assures that, over time, Hamden’s unsustainable pension plan will simply go away.”

So if Hamden’s pension plan is fading away, why engage in an aggressive building up of the fund today, for the ultimate benefit of a future generation of taxpayers? Has anyone stopped to consider what will happen to a $278 million pension fund when our defined benefit responsibilities begin to seriously wane, and eventually cease altogether? I can tell you. Taxpayers at that time will reap a $278 million windfall!

Is this fair? Is it even wise? What about preserving Hamden’s prosperity and livability today, before it can no longer be recovered? Will history judge us well if in needlessly sacrificing for future generations we deprive ourselves of the ability to leave them with anything but an empty shell of a town?

Isn’t it infinitely more logical and equitable for each generation to pay the pension benefit obligations that come due on its own watch? We have just been hit by the largest tax increase in Hamden’s history. Ordinary Hamden taxpayers have suffered enough. Why compound their misery with absurd solutions to mythical problems?

We should contribute no more than $6 million to the pension fund in fiscal year 2007-2008. Sure, $6 million is still a lot of money, but it’s a heck of a lot less than the annual costs associated with either a POB or Steady Augmentation Plan.

By budgeting only what is needed in a given year to meet our current benefit responsibilities, we can create a system that is both wise and fair. More importantly, the “pay as we go” approach can be an agent for significant relief for ordinary taxpayers. By contributing $6 million to the fund this year, rather than the sums required by the POB or Steady Augmentation Plans, we can save taxpayers at least $8 million—or 2 full mils!

Works for me.

(Endnote: I attempted to speak with Hamden’s actuaries about the concepts of this column prior to publication. They were quite willing to do so, but informed me that Finance Director Michael Betz had instructed them not to speak with me about the pension fund. As a result, I was forced to retain my own actuary for review purposes.)

Copyright © 2007 Hamden Daily News, reprinted with permission. Originally published on 12 April 2007.

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