Freeze & 40: A Plan for Pension Reform in Jacksonville
A Proposal to Reform the Jacksonville Police and Fire Pension Fund and Restore Jacksonville’s Financial Future submitted by Tom Majdanics, Michael Yang, Christopher Owens and Felisa Franklin Read their proposal and respond with suggestions if you like! Join us for some serious wonky analysis after the jump!
The following proposal to reform Jacksonville’s Police and Fire Pension Fund is authored and humbly submitted by a team of four Jacksonville residents who desire the best for our city’s future. We consider this reform proposal to be a working draft and offer it to the public to be chiseled and polished by our fellow Jacksonville citizens, as well as interested parties across Florida and the nation.
We are grateful to the Stanford Graduate School of Business for offering the open online course, “The Finance of Retirement and Pensions,” which attracted over 44,000 participants from around the world. The course equipped us with the knowledge and tools to assess the Jacksonville Police and Fire Pension Fund and propose reforms. We are honored our proposal was one of five from across the nation to be hand-selected as having the most promising ideas to address the trillions of dollars in unfunded pension liabilities that are threatening the financial future of many U.S. state and local governments. As described within, we believe the condition of the Jacksonville Police and Fire Fund is the greatest threat to the short- and long-term financial health of our city government and Jacksonville’s quality of life. It is our hope the insights and reforms in this report can help reposition and strengthen Jacksonville’s financial future.
We would appreciate your feedback to make these reform proposals stronger. Please send your
comments to jaxpensionreform@yahoo.com.
Respectfully,
Tom Majdanics
Michael Yang
Christopher Owens
Felisa Franklin
Page 1: Guiding Principles of Pension Reform
Page 2: Police & Fire Pension Economics 101 – Summing the Benefits
Page 3: Finding The Source of the $1.7 Billion Unfunded Liability
Page 4: Freeze & 40: Piecing Together a Joint Pension Reform Solution
Page 5: Summary Conclusions, Sources, Exhibits
Part 1 - Introduction
The condition of the Jacksonville Police and Fire Pension Fund (“PFPF” or “the Fund”) is presently the greatest threat to the short- and long-term financial health of our city government and Jacksonville’s future quality of life.
The size and depth of the PFPF’s challenges are daunting. While the Fund has only 5,000 combined active employees and retirees, its $1.7 billion Unfunded Accrued Actuarial Liability (“unfunded liability”) is nearly twice the size of Jacksonville’s general revenue fund. Today, $148 million - nearly 15% of Jacksonville’s general fund budget - is allocated to the Fund alone for current and future pension benefits. The $148 million allocation to the PFPF exceeds the combined budget for city-wide Public Works, Parks and Recreation, Public Libraries, the Jacksonville Children’s Commission, Neighborhoods Department, Economic and Downtown Development, Special Events, the Cultural Council, Public Service Grants, and Veteran’s Services.
In its most recent filing, the PFPF reported $1.1 billion in assets and $2.8 billion in liabilities, a funding level of 39%. This funding level is dangerously far below the recommended 80% threshold suggested by the U.S. Government Accountability Office. It ranks among the very worst pension plans not only in Florida but also the nation. Despite claims that the city consistently met its annual required contribution to the PFPF, the Fund’s unfunded liability has skyrocketed from $125 million in 2000 to its current level of $1.7 billion – an increase of over $100 million per year. We are now faced with addressing a $1.7 billion burden, which equates to $2,000 for every man, woman, and child in the city.
Given the size and scope of the problem, taxpayers must follow the pension situation with the attention it demands. It is our duty as citizens, bearing a share in our city’s responsibilities, to form a clear opinion and make up our minds on what ought to be done. In the past decade, things have gone from bad to worse. Ten years ago, the taxpayer-funded allocations to the PFPF totaled $22 million. Four years ago, it was $81 million. Today, it is $148 million. The future points to even higher allocations to the Fund.
Most recently, the increased allocation to address the PFPF’s unfunded liability resulted in the city’s largest one-year property tax millage increase in a generation. As a result, Duval County property tax rates are now at its highest levels since 1991. Current examples like Detroit or Stockton (California) illustrate the path ahead for Jacksonville if existing trends continue – a path littered with higher taxes, large cuts to city services including public safety, and/or financial bankruptcy.
This historic tax increase is only the first sip, the first taste of a bitter cup which will be offered annually to the citizens of Jacksonville – unless action is taken toward reform.
While the problem is daunting, it is fixable. There is a way forward. A principled and fair solution can be crafted which preserves financial peace of mind of retire
Part 2 - Guiding Principles of Pension Reform
The following proposal is authored and humbly submitted by four Jacksonville residents who desire the best for our city’s future. We consider this reform proposal to be a working draft and offer it to the public to be chiseled and sharpened by our fellow Jacksonville citizens as well as interested parties across Florida and the nation. Our reforms have been crafted in alignment with six guiding principles:
1. 50-50 shared responsibility. Responsibility for the PFPF’s $1.7 billion unfunded liability shall be equally shared between taxpayers and all pension fund members (current employees and retirees). Through acts of commission and omission, this daunting problem was jointly created and has placed our city’s financial health and future quality of life in jeopardy. Only jointly can we solve the problem. Current and future taxpayers cannot shoulder the burden alone.
2. No new taxes. No new tax increases or other revenue charges – including higher utility rates or sales of taxpayer-owned city land or assets – shall be enacted to pay off the $1.7 billion unfunded liability. As noted above, Jacksonville taxpayers have just borne the largest one-year property tax millage increase in a generation, resulting in the highest tax rates in over 20 years. Another large tax increase will place Jacksonville on the path to competitive bankruptcy – where the relationship between Jacksonville’s tax burden and its offering of public goods and services to taxpayers will be grossly uncompetitive versus surrounding counties and peer Southeastern cities. Incremental tax increases will correspondingly reduce any remaining advantage Jacksonville possesses to attract new business investment and grow our city economy. In addition, new taxes will crowd out taxpayer capacity to fund improvements to roads, public libraries, education, parks, veteran services, or downtown development. Ironically, tax increases to pay for police and fire retiree benefits will negatively impact our ability to fund today’s police and fire departments, increase the size of the police force, or add fire stations.
3. Preserve retiree peace of mind. Current retirees, particularly those aged 65 or greater with limited benefits, must retain peace of mind in their retirement years.
4. Continue to attract and retain top quality talent to our city’s police and fire departments. Reforms to our pension system cannot come at the expense of a quality public safety workforce and the public safety services provided to citizens.
5. Provide clear transparency of retiree benefits to all citizens. Pension benefits are complex to dissect and scrutinize for the average Jacksonville taxpayer. Our civic ability to monitor the compensation levels of our public safety workforce is hampered by a convoluted maze of benefit multipliers, rate of return projections, life expectancy assumptions, cost of living adjustments, and actuarial analyses. Reform must be accompanied by changes to public retirement benefits that allow citizens to clearly and easily comprehend how their tax dollars are committed.
6. Guarantee that another pension financial calamity will never be experienced again. It took multiple failures and oversights over multiple years to build the $1.7 billion liability we must now jointly address. Reforms must be structured such that taxpayers have confidence that this portion of our history will never repeat itself.
Part 3 - Police & Fire Pension Economics 101 – Summing the Benefits
Before we propose changes to the pension system aligned with the above guiding principles, we must first define the roots and genesis of the problem – that way, we know where to focus reforms.
The economics – and the potential flaws – of a pension fund are revealed by answering several questions. What pension benefits is a retiree eligible to receive, based on years of service? How much is an employee contributing to his future pension while working? (Note: While we recognize some PFPF retirees are women, we will address a retiree as “he” going forward.) How soon can a retiree begin collecting his pension? How, if at all, are the retiree’s benefits adjusted annually for inflation? How long are we assuming the retiree – and his spouse – will live and collect pension benefits? What investment rate of return are we assuming on pension fund investments made by taxpayers? How are we representing the present value of future pension liabilities? And just how did this $1.7 billion unfunded liability happen in the first place?
By illustrating the pension benefits of a standard Jacksonville police officer, we can view how the problem came about and how it can be solved. As the saying goes, the devil is in the details. The source of our $1.7 billion unfunded liability is in the details as well.
So let’s look at a standard Jacksonville police officer as an example. (The below explanation is illustrated in Exhibit 1 at the end of this report.) On its website, the Jacksonville Sheriff’s Office (“JSO”) notes that salaries for police “officers start at $36,235 annually, reaching $54,696 after six years and $62,476 after seventeen years.”
Let’s assume a new, male officer is hired at age 23 and receives incremental raises to $54,696 by year 6 of his service. He receives additional raises in his career leading to a salary of $62,476 in his 17th year of employment. This salary remains for years 18-20 of his service at the JSO. Over his 20 years of work, the officer will earn approximately $1.1 million in salaries and pay 7% of his salary over his time of service, or about $80,000, into the PFPF as a contribution to his pension. Based on the current pension agreement, having served 20 years, the officer is eligible to retire and can begin receiving a pension immediately at age 43. His initial pension is 60% of the average of the last two years of his salary while working. In this example, the officer made $62,476 in each of his final two years of work – 60% of which is $37,486.
In year 1 of retirement at age 43, the officer will collect a pension $37,486. Per the agreement, in year 2 and in subsequent years, his pension will grow by a fixed amount of 3%, compounded annually, regardless of inflation. Thus, in year 2, the retiree will receive a pension of $38,610. How long should we expect the retiree to live and collect a pension? According to the Federal Social Security website, a 43-year old male is expected to live on average about 40 more years. So we can expect, on average, that in year 40 of his pension (at age 83), the retiree will receive $118,718, and then pass away. But we’re not finished yet with benefits. A surviving spouse is entitled to receive a pension benefit equal to 75% of the benefit when the retiree died – and this benefit also grows at 3% annually. On average, we assume that a male retiree is married to a woman three years his junior. So the 80-year-old widow will receive a benefit of $92,106, growing at 3% per year until she passes away. Per the Social Security website, we can expect this survivor benefit to last six years in this example.
In summary, based on the above assumptions, current and future taxpayers should expect to pay a total of $3.4 million in pension benefits to the officer and his surviving spouse during their lifetimes over a retirement span of 46 years - 40 years of the officer’s retirement and six years of survivor benefits to the spouse. Using the same method, we can also estimate the value of benefits for two other hypothetical retirees – one is a firefighter who retires after 20 years – starting at a $32,000 salary and ending at $50,000 at age 43. The other is a senior department leader who retires after 30 years of service at age 53, earning $100,000 per year in his last two years of service (he is eligible to retire with a pension equal to 80% of his final salary, since he worked 30 years.) We can estimate the total salaries earned, total employee contributions to the PFPF, and the total estimated pension benefits to be collected by each of the three employees in Chart 1 below.
Chart 1 - Estimated PFPF Total Retiree Pension Benefits for Varying Salary Levels
The PFPF hires actuaries and statisticians to estimate the total amount of pension benefits all current employees and retirees will receive over the coming decades. In addition, actuaries calculate an annual “normal cost” to the city. The normal cost is the amount the city needs to place into the Fund to pay off estimated pension payments earned in the past year, which will be paid out in later years. As of this writing, the PFPF has approximately $1.1 billion in assets and a discounted projection of $2.8 billion in outstanding pension liabilities. Since the $2.8 billion liability is greater than the funds $1.1 billion in assets, the PFPF has a $1.7 billion unfunded liability, and is funded at the 39% level ($1.1 billion in pension assets divided by $2.8 billion in pension liabilities). Actuaries also calculate the amount of monies needed annually to pay off the unfunded liability over time. As both the normal cost and the unfunded liability grow, the city’s contribution to the PFPF grows in tandem. That’s how annual taxpayer contributions grow from $22 million to $148 million in a decade.
Part 4 – Finding The Source of the $1.7 Billion Unfunded Liability
Since we now understand how pensions are calculated and how much a retiree can expect to receive in benefits, we are in a position to assess how the $1.7 billion unfunded liability came about. We make three claims, backed by evidence, that point towards the root causes of the liability.
1. Lifetime pension benefits for retirees are set at financially unsustainable levels, far above what is needed to attract and retain a quality public safety workforce.
2. The estimated cost for providing enhanced pension benefits in 2001 was severely miscalculated and misrepresented to taxpayers over multiple years. The PFPF was consistently underfunded as a result of underestimated retiree life expectancies and deeply flawed discount rates for valuing pension liabilities.
3. Reporting on the Fund’s performance and long-term viability is proactively infrequent, opaque, and inaccessible to citizens, preventing regular external oversight.
Let’s address each claim in turn.
Claim #1: Lifetime pension benefits for retirees were set at financially unsustainable levels, far above what is needed to attract and retain a quality public safety workforce.
The most recent changes to pension benefits occurred in 2001. The 2001 changes impacted the size and growth of a retiree’s pension for current employees. These changes were also made on a retroactive basis for those already retired.
In effect, retirees received a large raise. For those retiring after 20 years, the first pension payment increased from 56% of an officer’s final salary to 60%. Annual cost of living adjustments (COLAs) were previously zero for the first five years of a pension, then directly tied to the rate of inflation. While inflation has averaged in the 2.0 to 2.5% range over the past decade, pension COLAs are fixed at 3%. This arrangement is prohibitively expensive to taxpayers when compounded over decades of a retirement. In 2013, inflation was only 1.5%. But PFPF retirees will still receive a 3% increase to their pension, which is in effect a 1.5% raise funded by taxpayers.
Are retiree benefits too high? That’s a judgment call for citizens and their elected officials to make, based on their assessment. We believe the answer is “yes” and offer two pieces of evidence.
Chart 1 of this report is our first piece of evidence. A standard police officer retiring after 20 years and his survivor can expect to collect over $3.4 million in pension benefits during their lifetimes, starting at age 43. This is over three times the $1.1 million in total salary the officer earned during his 20 years on the force. In total, the officer will receive a combined $4.5 million of salary and pension for 20 years of service, over $220,000 per year. A senior leader in the department making $100,000 will collect nearly $5 million in pension benefits, in addition to about $2 million in salary while working. Spread across the entire police and fire departments, this sums to billions upon billions of pensions.
Do taxpayers need to fund a multi-million dollar retirement to every member of the police and fire department to attract and retain a high quality workforce? Our judgment says “No.” But we wanted to make a comparison of Jacksonville police benefits to another profession with a similar risk profile. As a result, we looked at the pension plan for current members of the U.S. Military. Similarly, members of the armed forces are able to retire and receive pensions after 20 years. How do the pension benefits of men and women in the Armed Forces compare?
Chart 2 below compares total estimated pensions and survivor benefits received over a lifetime if both a service member and a Jacksonville policeman or firefighter retired at the same age of 43 with the same ending salary.
Chart 2 - Comparison of the Value of Military vs. PFPF pension benefits with Same Ending Salary
Members of the U.S. Military have a lower base pension benefit, a lower annual COLA, and a lower surviving spouse benefit. Using our example of a police officer who retires after 20 years with an ending salary of $62,476, he and his survivor would receive a total of $3.4 million of pension benefits over their lifetime. This is 80%, or about $1.5 million, higher than the $1.9 million in pension benefits that a member of the U.S. Military would receive. It must be noted that a member of the PFPF does have $80,000 deducted from their salary over the course of 20 years of service, which is invested in their pension benefit. This does partially reduce the disparity. But the difference between the estimated total pension benefits of the PFPF versus a U.S. Military retiree still remains expansive.
Thus, we conclude that lifetime pension benefits for PFPF retirees have been set at financially unsustainable levels, far above what is needed to attract and retain a quality public safety workforce.
It is critical to note that in presenting the above examples, we do not wish to diminish the value police and fire department employees provide to Jacksonville. The services we count on every day are essential to Jacksonville’s quality of life. We deeply respect and appreciate the commitment and service of our police officers and firefighters. However, we believe setting pension compensation at multi- million dollar levels – significantly above the U.S. Military, for whom we also carry a deep respect – is not necessary to attract and retain a high quality public safety workforce. While it is a guiding principle that retirees should have a pension that provides a base peace of mind, a multi-million dollar benefit is not what we had in mind. This level of benefits is unsustainable and comes at the long-term citizen expense of uncompetitive tax rates or shrinking city services.
Claim #2: The estimated cost for providing enhanced pension benefits in 2001 was severely miscalculated and misrepresented to taxpayers over multiple years. The PFPF was consistently underfunded as a result of underestimated retiree life expectancies and deeply flawed discount rates for valuing pension liabilities.
As noted earlier, the city elected to significantly enhance future pension benefits for employees and also retroactively boost pension to then-current retirees in 2001. How could such a financial decision have been justified, given the additional millions of dollars involved?
There are two items in the claim. First, retiree life expectancies were underestimated by the Fund and later updated. How does this affect the Fund and its liability? Once again, take the example of our officer. If he and his spouse live for two more years versus what we modeled in our example, taxpayers would pay out an additional $250,000 in pension benefits. Across 5,000 employees and retirees, that’s an extra $1.25 billion of pension benefits to be funded! The 3% COLA on pensions makes any upward adjustments to retiree life expectancy very, very expensive.
At present, the Fund is using the “RP-2000 Combined Healthy Mortality Table” to estimate the life expectancies of employees and the duration they and their spouse will receive retirement benefits. We do not proclaim to be experts on mortality tables, but it does give us pause that billions of dollars of liabilities are being estimated off of forecasts created over 10 years ago. Is the $1.7 billion unfunded liability even higher today because most current life expectancies are not incorporated in pension liability estimates?
The second item in the claim relates to deeply flawed discount rates for valuing pension liabilities. Let’s illustrate this with an example. Suppose you bought a house with a unique mortgage. You pay nothing up front, but simply owe the bank $200,000 in exactly 20 years for the house. If you do not come up with the $200,000 in 20 years, your home will be foreclosed.
If you are to pay the bank $200,000 in 20 years, how should you value the liability on your personal balance sheet today? $200,000? Something else? Based on the accounting of the PFPF from the 2000s, the PFPF would have valued the liability today at only $39,123. Why $39,123? Because the PFPF assumed that its investments would grow by 8.5% per year. So, they could take $39,000 of taxpayer and employee contributions to the PFPF, invest it in a portfolio of stocks and bonds, assume they will earn 8.5% per year and then have the $200,000 to pay the bank in 20 years. According to the PFPF, the above scenario would be in perfect balance, by assuming that the $39,000 will grow by 8.5% per year for 20 years.
That’s a very liberal way to value a major liability like a mortgage – or a retiree pension. What if the 8.5% rate is not reached every year? What would happen then? Today, the assumed rate of return has been reduced to a more conservative rate of 7%. The same $200,000 liability in 20 years would now instead be valued at just under $52,000. As a result, the homeowner would need to fund an additional
$13,000 – or an additional 33% over the original estimate – for his assets and liabilities to be “balanced.”
If the homeowner did not fund the difference immediately, it would be booked as an unfunded liability. It is adjustments like these, applied over billions of dollars of pension liabilities, which have added hundreds upon hundreds of millions of dollars to the PFPF’s unfunded pension liability.
According to the PFPF, the current value of all future pension liabilities is $2.8 billion. The $2.8 billion is the result after discounting all projected liabilities at a 7% rate, which is the present anticipated (but not guaranteed) rate of return on the Fund’s investments. But is discounting liabilities by 7% the right amount? Most financial experts would say that 7% is still too aggressive and should be reduced further, which would further increase the unfunded liability and the threat to Jacksonville’s long-term finances. Overall, there is general consensus among the financial community that the appropriate rate for valuing pension liabilities is separate from the question of what pension funds are hoping to earn on their investments.
The City of Jacksonville and the PFPF have been systematically miscalculating and misrepresenting the value of pension benefit liabilities. Pension liabilities had been incorrectly valued for numerous years. Later upward adjustments to the value of liabilities have in turn added to the PFPF’s unfunded liability. Pension liabilities arguably are still undervalued today with a 7% discount rate on liabilities and potentially outdated life expectancy assumptions for retirees.
This has led to consistently insufficient funding policies and the gravely erroneous belief that benefits can be greater, city services can be greater, or taxes lower while still funding benefits securely. As a result, 13 years after pension benefits were enhanced, we are now faced with a $1.7 billion unfunded liability to address.
But couldn’t citizens have uncovered this problem sooner and enacted reforms before the problem became so large? This leads us to claim #3.
Claim #3: Reporting on the Fund’s performance and long-term viability is proactively infrequent, opaque, and inaccessible to citizens, preventing regular external oversight.
In preparing this analysis, we were surprised at the dearth of publicly available information on the PFPF. With such a large liability looming over the taxpayers of Jacksonville, we consider it an absolute must to have online access to the Fund’s two most critical documents: its comprehensive annual financial report (CAFR) and its actuarial valuation report. Neither is presently available online. In addition, given the billions of dollars involved in the PFPF, we are surprised the Fund would order an actuarial valuation report only every three years. Three years is an eternity in finance. No reputable financial advisor would recommend going three years without reviewing one’s personal savings and plan. Yet that has been the practice of the PFPF. In every released actuarial valuation report in the past decade, the size of the PFPF’s unfunded liability was calculated to markedly increase by hundreds of millions of dollars.
At present, we must be certain that all benefit assumptions are current and stakeholders have the latest information on the viability of the Fund, including any potential changes (good or bad) in assets and unfunded liabilities. So why does the PFPF fail to place its actuarial valuation and detailed annual report online for review and inspection? Why does the PFPF not mandate an actuarial review annually? We can only speculate on the reason, but the consistent lack of transparency has been a contributor to the growth of the $1.7 billion unfunded liability, as citizen oversight has been restricted.
Part 5 – Freeze & 40: Piecing Together a Joint Pension Reform Solution
In our opinion, the City and the Jacksonville Police and Fire Pension Fund have severely underperformed both politically and financially in managing and overseeing the Fund, placing a $1.7 billion liability at the feet of citizens to address. The need for comprehensive reform is evident and urgently needed.
We have aligned the following reform proposals with six guiding principles in mind:
1.) a 50-50 joint responsibility for the $1.7 billion unfunded liability between taxpayers and all fund members;
2.) no new taxes of any kind;
3.) preserve retiree peace of mind;
4.) continue to attract and retain top quality public safety talent;
5.) provide clear transparency of retiree benefits to all citizens; and
6.) guarantee that another pension financial calamity will never happen again
The reform plan is called “Freeze & 40,” and contains two sister components related to the Fund’s investment management fees and annual pension cost of living adjustments, titled “Fee Chopper” and “Diet COLA,” respectively.
The net financial effect of the plan is to reduce the PFPF’s unfunded liability to a point where taxpayers contribute $56 million of “annual amortized cost” per year towards the unfunded liability, plus fund management expenses. (Today, taxpayers pay 100% of the cost, about $112 million).
After a change to the retirement structure of current employees, the city will save $56 million per year, which equates to around 1.25 mills of property taxes. We advocate returning at least 0.5 mills back to Jacksonville taxpayers through a property tax cut. This would reduce the millage rate to 10.94 mills, which approximates the tax rates of the late 1990s of the Delaney mayoral administration.
While this is a reduction over the current millage rate of 11.44, it is still 29% higher than the 8.48 millage rate levied in 2008 and 2009. Property taxes would be effectively reset to the period prior to the 2001 pension agreement that began our pension problem and before the real estate bubble that temporarily distorted city revenues and spending.
There will be $25 to $30 million in remaining savings from the Freeze & 40 plan, which can be re- allocated by the City Council to core strategic priorities. We recommend a comprehensive strategic review of present public safety spending and that the top priority of remaining savings be the strengthening of public safety through the addition of new officers and fire stations.
Core Reform Proposal: Freeze & 40
As described across this proposal, the complexity, unpredictability, and opaqueness of defined benefit pensions has been harmful to the City of Jacksonville, resulting in a $1.7 billion undefined benefit that threatens the financial health of our city government and Jacksonville’s quality of life. Jacksonville is not alone in facing this problem. Across the nation, hundreds of states and cities face trillions of dollars of unfunded liabilities, as they have been unable to successfully manage their respective pension funds.
As a result, we advocate that the city get out of the business of funding long-term defined benefit pensions to employees - replacing complexity, unpredictability and opacity with a modern structure of benefits that is simple, reliable and 100% transparent.
We propose the following reform component, named “Freeze & 40.”
First, all defined pension benefits earned by current employees will be frozen at present earned levels. An officer, for example, who has served 15 years would still be eligible to receive a pension at 45% of their last two year’s average salary upon retirement after 20 years. The employee has earned the core value of the defined benefit pension.
Replacing the defined benefit pension, employees will receive a defined contribution via a modern, cutting edge 401k that is designed for the special risk profile of employment as a police officer or firefighter. The city will fund $40 million of defined contributions in year 1. The normal annual taxpayer cost of current pension benefits is presently calculated to be approximately $36 million. In exchange for switching from a defined benefit pension, the new 401k benefit will be robust, portable and immediately vesting.
The city 401k will provide a 12-to-1 match on the first 2% of all employee contributions. With the average employee in the PFPF making an average salary of $60,000, he would contribute $1,200 to his own 401k and receive a city match of $14,400. Presently, there are between 2,700-2,800 total PFPF- qualifying employees across the police and fire departments. Allocating $40 million in defined contributions equally among them is approximately $14,300 to $14,800 per employee. Senior employees will receive a larger match in tandem with the higher salaries they earn. In addition:
The shift to a modern 401k will reduce the unfunded liability to taxpayers as the DROP (Deferred Retirement Option Program) program for retirees will be abolished. In DROP, after 20 years, an employee can elect to continue to work in the police or fire department, receive their current salary, defer their pension, and receive a guaranteed 8.4% return on deferred pension dollars. DROP, in effect, allows retirement-eligible employees a “triple dip” that is prohibitively expensive to taxpayers. Going forward, police and fire department leadership will need to optimally manage human resources to ensure their departments have appropriate succession plans in place for key leaders and employees, and not instead rely on the expensive “triple dipping” of DROP as a crutch.
Reform Component #2: Fee Chopper
In order to pay for future pension benefits, the PFPF has over $1.1 billion invested in various securities. The PFPF can save over $6 million per year and reduce the $1.7 billion unfunded liability by shifting its current investments from high-cost, high-fee, money management firms to low-cost index funds that closely replicate broader stock and bond indexes. According to an analysis provided to the Jacksonville Pension Reform Task Force, the Fund’s investment strategies are skewed towards active management, with 83% of equity funds actively managed by firms that charge significant fees to the Fund – and by extension, to taxpayers. Despite this strategy, the most recent 10-year investment return of the PFPF underperformed a comparative set of examined pension funds. The Fund paid 74 basis points in fees (0.74% of assets) in 2012 and 78 points in 2013. By comparison, the State of Florida Retirement System paid just 30 points in fees in 2011. Across $1.1 billion in investments, 78 basis points results in $8.6 million in annual management fees. If the Fund replicated the State of Florida’s fees, only $3.3 million in fees would be realized.
We believe that the Fund can shift its investments to reputable index funds which closely replicate the Fund’s portfolio strategy for less than 25 basis points. As a result, the Fund can save over $6 million per year which can be used to pay down the unfunded liability, with no impact on investment returns. These reforms can be enacted and the proceeds realized in a matter of weeks.
Reform Component #3 – Diet COLA
A large portion of the estimated $1.7 billion unfunded liability is a result of the 3% fixed, compounded cost-of-living adjustments (COLAs) to retiree pension payments. Prior to the 2001 pension agreement, no COLAs were enacted in the first five years of a pension. After 5 years, the COLA was the lesser of inflation or 3%. The current practice of 3% annual COLAs is, in our opinion, financially unsustainable and destructive to Jacksonville taxpayers. In contrast, U.S. Military pensioners receive a COLA of “Inflation minus 1%” on their pensions until they reach the age of 62, and then receive a COLA equal to the rate of inflation.
The financial unsustainability of 3% fixed COLAs is especially true for larger pensions in excess of $60,000, where retirees are guaranteed to receive an annual raise of $2,000 or more, per year, every year, for the rest of their lives. In the past 10 years, there were several instances where inflation was less than 2% - yet retirees received their 3% increase to their benefit. This is effectively a raise to retirees, paid by taxpayers. In the long-term, these raises come at the expense of higher tax rates or reduced public services offered by the city.
Later this decade, due to the compounding effect of 3% fixed COLAs, we estimated that the average PFPF retiree will earn more from their pension than the average front-line employee in the police and fire department will earn in salary for performing their job. As a result, we believe that the 3% fixed annual COLA needs to go on a diet.
Adjustments to COLAs are aligned with guiding principles #1 and #3. In order to share the burden of the $1.7 billion unfunded liability equally between taxpayers and all pension fund members, fixed COLAs need to be adjusted downward in a fair manner. However, we must also make sure to preserve retiree peace of mind in the adjustment process.
After taking into account reductions to the unfunded liability as a result of the first two components of our reforms, the balance of the reduction will come from adjustments to COLAs. We propose the maximum COLA offered to retirees going forward be the rate of inflation. Depending on the age of the retiree and the size of the retiree’s benefit, COLAs should be varied. Older retirees with a smaller pension benefit should receive the maximum COLA available. Retirees with a pension in excess of $80,000 per year should receive the smallest annual COLA. The youngest retirees retire in their 40s and 50s and possess who have 10-20+ working years available in their careers should also receive small COLAs.
The below Chart 2 illustrates a range of potential COLAs based on the retiree’s age and the size of their pension benefit. After tabulating the impact of the first two components of our reforms, actuaries can calculate the range of COLA adjustments needed to provide a 50-50 shared responsibility between taxpayers and fund members for the unfunded liability.
A “lowest” COLA, for example, might be the annual prevailing inflation rate minus a fixed percentage of 1.5% or 2%. As a result of these proposed reforms, the aggregate sum of benefits collected by a retiree with a large pension may not approach the $5 million range in lifetime benefits as described in Chart 1. However, the retiree will still certainly retain financial peace of mind in their retirement.
Summary Conclusions
The condition of the Jacksonville Police and Fire Pension Fund is presently the greatest threat to the short- and long-term financial health of our city government and Jacksonville’s future quality of life. While the problem of solving the PFPF’s $1.7 billion liability is incredibly daunting, it is fixable. There is a way forward. We have presented what we believe is a principled and fair solution that preserves financial peace of mind of retirees, limits the burden of taxpayers, and repositions the City of Jacksonville’s finances for success.
At the heart of our reforms is modernizing the system of retirement benefits provided to police and fire employees. The current system is outdated, risky, overly complex, and opaque. It is also prone to manipulation through the political adjustment of key actuarial assumptions that allow expensive and unsustainable pension benefits to be initially presented at a cost to taxpayers that far understates proper financial reality. This pattern has manifested itself across the nation, creating trillions of dollars in unfunded pension liabilities that are threatening the financial future of numerous U.S. state and local governments. To put it mildly, the first cities to truly face the full brunt of their pension problems, such as Detroit and Stockton (California), have not fared well. Jacksonville must take a different path to preserve our quality of life and competitive tax levels which fuel future economic growth.
The solution, in our opinion, requires the shared sacrifice of taxpayers and both PFPF current and future employees and retirees. In our proposal, taxpayers can continue to maintain a limited tax burden, but prevailing property tax rates will remain significantly above levels assessed just 5 years ago. Employees and retirees can continue to plan on retirement with financial peace of mind and security. But those who anticipate collecting millions of dollars of growing pension benefits over 40+ years – levels far above those offered to men and women in the U.S. Military – will need to adjust their expectations. The problem cannot be wholly solved by placing the entire burden for the $1.7 billion unfunded liability on taxpayers. It cannot be wholly solved by current employees and retirees and taking away the financial peace of mind of their retirement. It cannot be wholly solved by slashing the benefits of new policemen and firemen or marring our ability to attract and retain top talent to our public service departments.
We hope our reform proposals positively shape the present pension debate in Jacksonville. Please send any comments to jaxpensionreform@yahoo.com. We would appreciate your feedback to make these reform proposals stronger, as our city’s best thinking will be needed to arrive at the very best solution for Jacksonville.
Jointly, this problem was created. Jointly, it can and will be solved.
Tom Majdanics
Michael Yang
Christopher Owens
Felisa Franklin
Sources:
Details on Jacksonville Police and Fire Pension Fund Finances and Benefits:
• Jacksonville Police and Fire Pension Fund Comprehensive Annual Financial Reports (CAFRs), FY
2008-2012 (not available online);
• Jacksonville Police and Fire Pension Fund Actuarial Valuation Reports for FY 2008, 2011 and
2012 (not available online)
• PFPF Summary Plan Booklet: https://www.coj.net/departments/police---fire-pensionfund/
summary-plan/summary-plan-2012---2014---advisory-update---jan-2.aspx
US Military Pension and Survivor Benefits:
• https://militarypay.defense.gov/Retirement/index.html
• https://militarypay.defense.gov/survivor/sbp/04_cost_spouse.html
Jacksonville Sherriff’s Office – Police Officer Salaries:
• https://www.joinjso.com/careers/police_officers.php
Investment Fees paid by PFPF vs. State of Florida retirement system:
• https://www.coj.net/retirement-reform/docs/oct-29/jt-jacksonville-testimony---oct-29-2013-
(amended).aspx
Current and Historical Jacksonville Property Tax Rates:
• https://www.coj.net/departments/property-appraiser/millage-rates.aspx
• https://www.truthaboutpensions.net/Pension_Burden.html
Historical City Contributions to the PFPF:
• https://www.coj.net/retirement-reform/docs/retirementreform-finance-62713.aspx
We are grateful to the Stanford Graduate School of Business for offering the open online course, “The Finance of Retirement and Pensions,” which attracted over 44,000 participants from around the world. The course equipped us with the knowledge and tools to assess the Jacksonville Police and Fire Pension Fund and propose reforms. We are honored our proposal was one of five from across the nation to be hand-selected as having the most promising ideas to address the trillions of dollars in unfunded pension liabilities that are threatening the financial future of many U.S. state and local governments. As described within, we believe the condition of the Jacksonville Police and Fire Fund is the greatest threat to the short- and long-term financial health of our city government and Jacksonville’s quality of life. It is our hope the insights and reforms in this report can help reposition and strengthen Jacksonville’s financial future.
We would appreciate your feedback to make these reform proposals stronger. Please send your
comments to jaxpensionreform@yahoo.com.
Respectfully,
Tom Majdanics
Michael Yang
Christopher Owens
Felisa Franklin
Page 1: Guiding Principles of Pension Reform
Page 2: Police & Fire Pension Economics 101 – Summing the Benefits
Page 3: Finding The Source of the $1.7 Billion Unfunded Liability
Page 4: Freeze & 40: Piecing Together a Joint Pension Reform Solution
Page 5: Summary Conclusions, Sources, Exhibits
Part 1 - Introduction
The condition of the Jacksonville Police and Fire Pension Fund (“PFPF” or “the Fund”) is presently the greatest threat to the short- and long-term financial health of our city government and Jacksonville’s future quality of life.
The size and depth of the PFPF’s challenges are daunting. While the Fund has only 5,000 combined active employees and retirees, its $1.7 billion Unfunded Accrued Actuarial Liability (“unfunded liability”) is nearly twice the size of Jacksonville’s general revenue fund. Today, $148 million - nearly 15% of Jacksonville’s general fund budget - is allocated to the Fund alone for current and future pension benefits. The $148 million allocation to the PFPF exceeds the combined budget for city-wide Public Works, Parks and Recreation, Public Libraries, the Jacksonville Children’s Commission, Neighborhoods Department, Economic and Downtown Development, Special Events, the Cultural Council, Public Service Grants, and Veteran’s Services.
In its most recent filing, the PFPF reported $1.1 billion in assets and $2.8 billion in liabilities, a funding level of 39%. This funding level is dangerously far below the recommended 80% threshold suggested by the U.S. Government Accountability Office. It ranks among the very worst pension plans not only in Florida but also the nation. Despite claims that the city consistently met its annual required contribution to the PFPF, the Fund’s unfunded liability has skyrocketed from $125 million in 2000 to its current level of $1.7 billion – an increase of over $100 million per year. We are now faced with addressing a $1.7 billion burden, which equates to $2,000 for every man, woman, and child in the city.
Given the size and scope of the problem, taxpayers must follow the pension situation with the attention it demands. It is our duty as citizens, bearing a share in our city’s responsibilities, to form a clear opinion and make up our minds on what ought to be done. In the past decade, things have gone from bad to worse. Ten years ago, the taxpayer-funded allocations to the PFPF totaled $22 million. Four years ago, it was $81 million. Today, it is $148 million. The future points to even higher allocations to the Fund.
Most recently, the increased allocation to address the PFPF’s unfunded liability resulted in the city’s largest one-year property tax millage increase in a generation. As a result, Duval County property tax rates are now at its highest levels since 1991. Current examples like Detroit or Stockton (California) illustrate the path ahead for Jacksonville if existing trends continue – a path littered with higher taxes, large cuts to city services including public safety, and/or financial bankruptcy.
This historic tax increase is only the first sip, the first taste of a bitter cup which will be offered annually to the citizens of Jacksonville – unless action is taken toward reform.
While the problem is daunting, it is fixable. There is a way forward. A principled and fair solution can be crafted which preserves financial peace of mind of retire
Part 2 - Guiding Principles of Pension Reform
The following proposal is authored and humbly submitted by four Jacksonville residents who desire the best for our city’s future. We consider this reform proposal to be a working draft and offer it to the public to be chiseled and sharpened by our fellow Jacksonville citizens as well as interested parties across Florida and the nation. Our reforms have been crafted in alignment with six guiding principles:
1. 50-50 shared responsibility. Responsibility for the PFPF’s $1.7 billion unfunded liability shall be equally shared between taxpayers and all pension fund members (current employees and retirees). Through acts of commission and omission, this daunting problem was jointly created and has placed our city’s financial health and future quality of life in jeopardy. Only jointly can we solve the problem. Current and future taxpayers cannot shoulder the burden alone.
2. No new taxes. No new tax increases or other revenue charges – including higher utility rates or sales of taxpayer-owned city land or assets – shall be enacted to pay off the $1.7 billion unfunded liability. As noted above, Jacksonville taxpayers have just borne the largest one-year property tax millage increase in a generation, resulting in the highest tax rates in over 20 years. Another large tax increase will place Jacksonville on the path to competitive bankruptcy – where the relationship between Jacksonville’s tax burden and its offering of public goods and services to taxpayers will be grossly uncompetitive versus surrounding counties and peer Southeastern cities. Incremental tax increases will correspondingly reduce any remaining advantage Jacksonville possesses to attract new business investment and grow our city economy. In addition, new taxes will crowd out taxpayer capacity to fund improvements to roads, public libraries, education, parks, veteran services, or downtown development. Ironically, tax increases to pay for police and fire retiree benefits will negatively impact our ability to fund today’s police and fire departments, increase the size of the police force, or add fire stations.
3. Preserve retiree peace of mind. Current retirees, particularly those aged 65 or greater with limited benefits, must retain peace of mind in their retirement years.
4. Continue to attract and retain top quality talent to our city’s police and fire departments. Reforms to our pension system cannot come at the expense of a quality public safety workforce and the public safety services provided to citizens.
5. Provide clear transparency of retiree benefits to all citizens. Pension benefits are complex to dissect and scrutinize for the average Jacksonville taxpayer. Our civic ability to monitor the compensation levels of our public safety workforce is hampered by a convoluted maze of benefit multipliers, rate of return projections, life expectancy assumptions, cost of living adjustments, and actuarial analyses. Reform must be accompanied by changes to public retirement benefits that allow citizens to clearly and easily comprehend how their tax dollars are committed.
6. Guarantee that another pension financial calamity will never be experienced again. It took multiple failures and oversights over multiple years to build the $1.7 billion liability we must now jointly address. Reforms must be structured such that taxpayers have confidence that this portion of our history will never repeat itself.
Part 3 - Police & Fire Pension Economics 101 – Summing the Benefits
Before we propose changes to the pension system aligned with the above guiding principles, we must first define the roots and genesis of the problem – that way, we know where to focus reforms.
The economics – and the potential flaws – of a pension fund are revealed by answering several questions. What pension benefits is a retiree eligible to receive, based on years of service? How much is an employee contributing to his future pension while working? (Note: While we recognize some PFPF retirees are women, we will address a retiree as “he” going forward.) How soon can a retiree begin collecting his pension? How, if at all, are the retiree’s benefits adjusted annually for inflation? How long are we assuming the retiree – and his spouse – will live and collect pension benefits? What investment rate of return are we assuming on pension fund investments made by taxpayers? How are we representing the present value of future pension liabilities? And just how did this $1.7 billion unfunded liability happen in the first place?
By illustrating the pension benefits of a standard Jacksonville police officer, we can view how the problem came about and how it can be solved. As the saying goes, the devil is in the details. The source of our $1.7 billion unfunded liability is in the details as well.
So let’s look at a standard Jacksonville police officer as an example. (The below explanation is illustrated in Exhibit 1 at the end of this report.) On its website, the Jacksonville Sheriff’s Office (“JSO”) notes that salaries for police “officers start at $36,235 annually, reaching $54,696 after six years and $62,476 after seventeen years.”
Let’s assume a new, male officer is hired at age 23 and receives incremental raises to $54,696 by year 6 of his service. He receives additional raises in his career leading to a salary of $62,476 in his 17th year of employment. This salary remains for years 18-20 of his service at the JSO. Over his 20 years of work, the officer will earn approximately $1.1 million in salaries and pay 7% of his salary over his time of service, or about $80,000, into the PFPF as a contribution to his pension. Based on the current pension agreement, having served 20 years, the officer is eligible to retire and can begin receiving a pension immediately at age 43. His initial pension is 60% of the average of the last two years of his salary while working. In this example, the officer made $62,476 in each of his final two years of work – 60% of which is $37,486.
In year 1 of retirement at age 43, the officer will collect a pension $37,486. Per the agreement, in year 2 and in subsequent years, his pension will grow by a fixed amount of 3%, compounded annually, regardless of inflation. Thus, in year 2, the retiree will receive a pension of $38,610. How long should we expect the retiree to live and collect a pension? According to the Federal Social Security website, a 43-year old male is expected to live on average about 40 more years. So we can expect, on average, that in year 40 of his pension (at age 83), the retiree will receive $118,718, and then pass away. But we’re not finished yet with benefits. A surviving spouse is entitled to receive a pension benefit equal to 75% of the benefit when the retiree died – and this benefit also grows at 3% annually. On average, we assume that a male retiree is married to a woman three years his junior. So the 80-year-old widow will receive a benefit of $92,106, growing at 3% per year until she passes away. Per the Social Security website, we can expect this survivor benefit to last six years in this example.
In summary, based on the above assumptions, current and future taxpayers should expect to pay a total of $3.4 million in pension benefits to the officer and his surviving spouse during their lifetimes over a retirement span of 46 years - 40 years of the officer’s retirement and six years of survivor benefits to the spouse. Using the same method, we can also estimate the value of benefits for two other hypothetical retirees – one is a firefighter who retires after 20 years – starting at a $32,000 salary and ending at $50,000 at age 43. The other is a senior department leader who retires after 30 years of service at age 53, earning $100,000 per year in his last two years of service (he is eligible to retire with a pension equal to 80% of his final salary, since he worked 30 years.) We can estimate the total salaries earned, total employee contributions to the PFPF, and the total estimated pension benefits to be collected by each of the three employees in Chart 1 below.
Chart 1 - Estimated PFPF Total Retiree Pension Benefits for Varying Salary Levels
The PFPF hires actuaries and statisticians to estimate the total amount of pension benefits all current employees and retirees will receive over the coming decades. In addition, actuaries calculate an annual “normal cost” to the city. The normal cost is the amount the city needs to place into the Fund to pay off estimated pension payments earned in the past year, which will be paid out in later years. As of this writing, the PFPF has approximately $1.1 billion in assets and a discounted projection of $2.8 billion in outstanding pension liabilities. Since the $2.8 billion liability is greater than the funds $1.1 billion in assets, the PFPF has a $1.7 billion unfunded liability, and is funded at the 39% level ($1.1 billion in pension assets divided by $2.8 billion in pension liabilities). Actuaries also calculate the amount of monies needed annually to pay off the unfunded liability over time. As both the normal cost and the unfunded liability grow, the city’s contribution to the PFPF grows in tandem. That’s how annual taxpayer contributions grow from $22 million to $148 million in a decade.
Part 4 – Finding The Source of the $1.7 Billion Unfunded Liability
Since we now understand how pensions are calculated and how much a retiree can expect to receive in benefits, we are in a position to assess how the $1.7 billion unfunded liability came about. We make three claims, backed by evidence, that point towards the root causes of the liability.
1. Lifetime pension benefits for retirees are set at financially unsustainable levels, far above what is needed to attract and retain a quality public safety workforce.
2. The estimated cost for providing enhanced pension benefits in 2001 was severely miscalculated and misrepresented to taxpayers over multiple years. The PFPF was consistently underfunded as a result of underestimated retiree life expectancies and deeply flawed discount rates for valuing pension liabilities.
3. Reporting on the Fund’s performance and long-term viability is proactively infrequent, opaque, and inaccessible to citizens, preventing regular external oversight.
Let’s address each claim in turn.
Claim #1: Lifetime pension benefits for retirees were set at financially unsustainable levels, far above what is needed to attract and retain a quality public safety workforce.
The most recent changes to pension benefits occurred in 2001. The 2001 changes impacted the size and growth of a retiree’s pension for current employees. These changes were also made on a retroactive basis for those already retired.
In effect, retirees received a large raise. For those retiring after 20 years, the first pension payment increased from 56% of an officer’s final salary to 60%. Annual cost of living adjustments (COLAs) were previously zero for the first five years of a pension, then directly tied to the rate of inflation. While inflation has averaged in the 2.0 to 2.5% range over the past decade, pension COLAs are fixed at 3%. This arrangement is prohibitively expensive to taxpayers when compounded over decades of a retirement. In 2013, inflation was only 1.5%. But PFPF retirees will still receive a 3% increase to their pension, which is in effect a 1.5% raise funded by taxpayers.
Are retiree benefits too high? That’s a judgment call for citizens and their elected officials to make, based on their assessment. We believe the answer is “yes” and offer two pieces of evidence.
Chart 1 of this report is our first piece of evidence. A standard police officer retiring after 20 years and his survivor can expect to collect over $3.4 million in pension benefits during their lifetimes, starting at age 43. This is over three times the $1.1 million in total salary the officer earned during his 20 years on the force. In total, the officer will receive a combined $4.5 million of salary and pension for 20 years of service, over $220,000 per year. A senior leader in the department making $100,000 will collect nearly $5 million in pension benefits, in addition to about $2 million in salary while working. Spread across the entire police and fire departments, this sums to billions upon billions of pensions.
Do taxpayers need to fund a multi-million dollar retirement to every member of the police and fire department to attract and retain a high quality workforce? Our judgment says “No.” But we wanted to make a comparison of Jacksonville police benefits to another profession with a similar risk profile. As a result, we looked at the pension plan for current members of the U.S. Military. Similarly, members of the armed forces are able to retire and receive pensions after 20 years. How do the pension benefits of men and women in the Armed Forces compare?
Chart 2 below compares total estimated pensions and survivor benefits received over a lifetime if both a service member and a Jacksonville policeman or firefighter retired at the same age of 43 with the same ending salary.
Chart 2 - Comparison of the Value of Military vs. PFPF pension benefits with Same Ending Salary
Members of the U.S. Military have a lower base pension benefit, a lower annual COLA, and a lower surviving spouse benefit. Using our example of a police officer who retires after 20 years with an ending salary of $62,476, he and his survivor would receive a total of $3.4 million of pension benefits over their lifetime. This is 80%, or about $1.5 million, higher than the $1.9 million in pension benefits that a member of the U.S. Military would receive. It must be noted that a member of the PFPF does have $80,000 deducted from their salary over the course of 20 years of service, which is invested in their pension benefit. This does partially reduce the disparity. But the difference between the estimated total pension benefits of the PFPF versus a U.S. Military retiree still remains expansive.
Thus, we conclude that lifetime pension benefits for PFPF retirees have been set at financially unsustainable levels, far above what is needed to attract and retain a quality public safety workforce.
It is critical to note that in presenting the above examples, we do not wish to diminish the value police and fire department employees provide to Jacksonville. The services we count on every day are essential to Jacksonville’s quality of life. We deeply respect and appreciate the commitment and service of our police officers and firefighters. However, we believe setting pension compensation at multi- million dollar levels – significantly above the U.S. Military, for whom we also carry a deep respect – is not necessary to attract and retain a high quality public safety workforce. While it is a guiding principle that retirees should have a pension that provides a base peace of mind, a multi-million dollar benefit is not what we had in mind. This level of benefits is unsustainable and comes at the long-term citizen expense of uncompetitive tax rates or shrinking city services.
Claim #2: The estimated cost for providing enhanced pension benefits in 2001 was severely miscalculated and misrepresented to taxpayers over multiple years. The PFPF was consistently underfunded as a result of underestimated retiree life expectancies and deeply flawed discount rates for valuing pension liabilities.
As noted earlier, the city elected to significantly enhance future pension benefits for employees and also retroactively boost pension to then-current retirees in 2001. How could such a financial decision have been justified, given the additional millions of dollars involved?
There are two items in the claim. First, retiree life expectancies were underestimated by the Fund and later updated. How does this affect the Fund and its liability? Once again, take the example of our officer. If he and his spouse live for two more years versus what we modeled in our example, taxpayers would pay out an additional $250,000 in pension benefits. Across 5,000 employees and retirees, that’s an extra $1.25 billion of pension benefits to be funded! The 3% COLA on pensions makes any upward adjustments to retiree life expectancy very, very expensive.
At present, the Fund is using the “RP-2000 Combined Healthy Mortality Table” to estimate the life expectancies of employees and the duration they and their spouse will receive retirement benefits. We do not proclaim to be experts on mortality tables, but it does give us pause that billions of dollars of liabilities are being estimated off of forecasts created over 10 years ago. Is the $1.7 billion unfunded liability even higher today because most current life expectancies are not incorporated in pension liability estimates?
The second item in the claim relates to deeply flawed discount rates for valuing pension liabilities. Let’s illustrate this with an example. Suppose you bought a house with a unique mortgage. You pay nothing up front, but simply owe the bank $200,000 in exactly 20 years for the house. If you do not come up with the $200,000 in 20 years, your home will be foreclosed.
If you are to pay the bank $200,000 in 20 years, how should you value the liability on your personal balance sheet today? $200,000? Something else? Based on the accounting of the PFPF from the 2000s, the PFPF would have valued the liability today at only $39,123. Why $39,123? Because the PFPF assumed that its investments would grow by 8.5% per year. So, they could take $39,000 of taxpayer and employee contributions to the PFPF, invest it in a portfolio of stocks and bonds, assume they will earn 8.5% per year and then have the $200,000 to pay the bank in 20 years. According to the PFPF, the above scenario would be in perfect balance, by assuming that the $39,000 will grow by 8.5% per year for 20 years.
That’s a very liberal way to value a major liability like a mortgage – or a retiree pension. What if the 8.5% rate is not reached every year? What would happen then? Today, the assumed rate of return has been reduced to a more conservative rate of 7%. The same $200,000 liability in 20 years would now instead be valued at just under $52,000. As a result, the homeowner would need to fund an additional
$13,000 – or an additional 33% over the original estimate – for his assets and liabilities to be “balanced.”
If the homeowner did not fund the difference immediately, it would be booked as an unfunded liability. It is adjustments like these, applied over billions of dollars of pension liabilities, which have added hundreds upon hundreds of millions of dollars to the PFPF’s unfunded pension liability.
According to the PFPF, the current value of all future pension liabilities is $2.8 billion. The $2.8 billion is the result after discounting all projected liabilities at a 7% rate, which is the present anticipated (but not guaranteed) rate of return on the Fund’s investments. But is discounting liabilities by 7% the right amount? Most financial experts would say that 7% is still too aggressive and should be reduced further, which would further increase the unfunded liability and the threat to Jacksonville’s long-term finances. Overall, there is general consensus among the financial community that the appropriate rate for valuing pension liabilities is separate from the question of what pension funds are hoping to earn on their investments.
The City of Jacksonville and the PFPF have been systematically miscalculating and misrepresenting the value of pension benefit liabilities. Pension liabilities had been incorrectly valued for numerous years. Later upward adjustments to the value of liabilities have in turn added to the PFPF’s unfunded liability. Pension liabilities arguably are still undervalued today with a 7% discount rate on liabilities and potentially outdated life expectancy assumptions for retirees.
This has led to consistently insufficient funding policies and the gravely erroneous belief that benefits can be greater, city services can be greater, or taxes lower while still funding benefits securely. As a result, 13 years after pension benefits were enhanced, we are now faced with a $1.7 billion unfunded liability to address.
But couldn’t citizens have uncovered this problem sooner and enacted reforms before the problem became so large? This leads us to claim #3.
Claim #3: Reporting on the Fund’s performance and long-term viability is proactively infrequent, opaque, and inaccessible to citizens, preventing regular external oversight.
In preparing this analysis, we were surprised at the dearth of publicly available information on the PFPF. With such a large liability looming over the taxpayers of Jacksonville, we consider it an absolute must to have online access to the Fund’s two most critical documents: its comprehensive annual financial report (CAFR) and its actuarial valuation report. Neither is presently available online. In addition, given the billions of dollars involved in the PFPF, we are surprised the Fund would order an actuarial valuation report only every three years. Three years is an eternity in finance. No reputable financial advisor would recommend going three years without reviewing one’s personal savings and plan. Yet that has been the practice of the PFPF. In every released actuarial valuation report in the past decade, the size of the PFPF’s unfunded liability was calculated to markedly increase by hundreds of millions of dollars.
At present, we must be certain that all benefit assumptions are current and stakeholders have the latest information on the viability of the Fund, including any potential changes (good or bad) in assets and unfunded liabilities. So why does the PFPF fail to place its actuarial valuation and detailed annual report online for review and inspection? Why does the PFPF not mandate an actuarial review annually? We can only speculate on the reason, but the consistent lack of transparency has been a contributor to the growth of the $1.7 billion unfunded liability, as citizen oversight has been restricted.
Part 5 – Freeze & 40: Piecing Together a Joint Pension Reform Solution
In our opinion, the City and the Jacksonville Police and Fire Pension Fund have severely underperformed both politically and financially in managing and overseeing the Fund, placing a $1.7 billion liability at the feet of citizens to address. The need for comprehensive reform is evident and urgently needed.
We have aligned the following reform proposals with six guiding principles in mind:
1.) a 50-50 joint responsibility for the $1.7 billion unfunded liability between taxpayers and all fund members;
2.) no new taxes of any kind;
3.) preserve retiree peace of mind;
4.) continue to attract and retain top quality public safety talent;
5.) provide clear transparency of retiree benefits to all citizens; and
6.) guarantee that another pension financial calamity will never happen again
The reform plan is called “Freeze & 40,” and contains two sister components related to the Fund’s investment management fees and annual pension cost of living adjustments, titled “Fee Chopper” and “Diet COLA,” respectively.
The net financial effect of the plan is to reduce the PFPF’s unfunded liability to a point where taxpayers contribute $56 million of “annual amortized cost” per year towards the unfunded liability, plus fund management expenses. (Today, taxpayers pay 100% of the cost, about $112 million).
After a change to the retirement structure of current employees, the city will save $56 million per year, which equates to around 1.25 mills of property taxes. We advocate returning at least 0.5 mills back to Jacksonville taxpayers through a property tax cut. This would reduce the millage rate to 10.94 mills, which approximates the tax rates of the late 1990s of the Delaney mayoral administration.
While this is a reduction over the current millage rate of 11.44, it is still 29% higher than the 8.48 millage rate levied in 2008 and 2009. Property taxes would be effectively reset to the period prior to the 2001 pension agreement that began our pension problem and before the real estate bubble that temporarily distorted city revenues and spending.
There will be $25 to $30 million in remaining savings from the Freeze & 40 plan, which can be re- allocated by the City Council to core strategic priorities. We recommend a comprehensive strategic review of present public safety spending and that the top priority of remaining savings be the strengthening of public safety through the addition of new officers and fire stations.
Core Reform Proposal: Freeze & 40
As described across this proposal, the complexity, unpredictability, and opaqueness of defined benefit pensions has been harmful to the City of Jacksonville, resulting in a $1.7 billion undefined benefit that threatens the financial health of our city government and Jacksonville’s quality of life. Jacksonville is not alone in facing this problem. Across the nation, hundreds of states and cities face trillions of dollars of unfunded liabilities, as they have been unable to successfully manage their respective pension funds.
As a result, we advocate that the city get out of the business of funding long-term defined benefit pensions to employees - replacing complexity, unpredictability and opacity with a modern structure of benefits that is simple, reliable and 100% transparent.
We propose the following reform component, named “Freeze & 40.”
First, all defined pension benefits earned by current employees will be frozen at present earned levels. An officer, for example, who has served 15 years would still be eligible to receive a pension at 45% of their last two year’s average salary upon retirement after 20 years. The employee has earned the core value of the defined benefit pension.
Replacing the defined benefit pension, employees will receive a defined contribution via a modern, cutting edge 401k that is designed for the special risk profile of employment as a police officer or firefighter. The city will fund $40 million of defined contributions in year 1. The normal annual taxpayer cost of current pension benefits is presently calculated to be approximately $36 million. In exchange for switching from a defined benefit pension, the new 401k benefit will be robust, portable and immediately vesting.
The city 401k will provide a 12-to-1 match on the first 2% of all employee contributions. With the average employee in the PFPF making an average salary of $60,000, he would contribute $1,200 to his own 401k and receive a city match of $14,400. Presently, there are between 2,700-2,800 total PFPF- qualifying employees across the police and fire departments. Allocating $40 million in defined contributions equally among them is approximately $14,300 to $14,800 per employee. Senior employees will receive a larger match in tandem with the higher salaries they earn. In addition:
- The employee contribution to their 401k to receive a 12-to-1 match is 2%. This is a reduction from the mandatory employee contribution of 7% paid into the PFPF towards a future pension. As a result, employees will be able to keep more of their paycheck. Based on their personal circumstances, an employee has the freedom to put more into their 401k or divert the freed up funds for other personal needs.
- The vesting of defined contributions is immediate (versus 5 years, at present).
- Employees will own their 401k, 100%. It is portable to other jobs, can be borrowed against if needed, and willed to heirs. We consider this component of our plan to be a win-win for both employees and taxpayers, as it aligns with several guiding principles.
- The 401k benefit is robust, just as the current defined benefit pension is robust. Some may argue that the 401k benefit is too rich, but Jacksonville must be certain it remains able to attract and retain top talent in our police and fire departments. This benefit will be especially attractive to new officers, given the immediate vesting of the 401k.
- This modern 401k benefit provides clear transparency of retiree benefits to all citizens. The benefit is simple, 100% predictable, and understandable to all, as numerous Jacksonville citizens have retirement benefits invested in a 401k.
- This structure allows taxpayers to easily monitor and quickly comprehend any potential changes to retirement benefits. Citizens will not need to rely on an actuary’s assumptions in projecting the cost of pension benefit changes – assumptions that can be later changed at significant cost to the taxpayer. Instead, a taxpayer can measure and assess any potential changes on their own with pencil and paper.
- The vesting of defined contributions is immediate (versus 5 years, at present).
- Lastly, the shift to a modern 401k will guarantee to taxpayers that another pension fiscal calamity will never be experienced again in Jacksonville. Taxpayers will never again find themselves on the hook for a billion dollars because of retroactive benefit enhancements or undervalued pension liabilities.
The shift to a modern 401k will reduce the unfunded liability to taxpayers as the DROP (Deferred Retirement Option Program) program for retirees will be abolished. In DROP, after 20 years, an employee can elect to continue to work in the police or fire department, receive their current salary, defer their pension, and receive a guaranteed 8.4% return on deferred pension dollars. DROP, in effect, allows retirement-eligible employees a “triple dip” that is prohibitively expensive to taxpayers. Going forward, police and fire department leadership will need to optimally manage human resources to ensure their departments have appropriate succession plans in place for key leaders and employees, and not instead rely on the expensive “triple dipping” of DROP as a crutch.
Reform Component #2: Fee Chopper
In order to pay for future pension benefits, the PFPF has over $1.1 billion invested in various securities. The PFPF can save over $6 million per year and reduce the $1.7 billion unfunded liability by shifting its current investments from high-cost, high-fee, money management firms to low-cost index funds that closely replicate broader stock and bond indexes. According to an analysis provided to the Jacksonville Pension Reform Task Force, the Fund’s investment strategies are skewed towards active management, with 83% of equity funds actively managed by firms that charge significant fees to the Fund – and by extension, to taxpayers. Despite this strategy, the most recent 10-year investment return of the PFPF underperformed a comparative set of examined pension funds. The Fund paid 74 basis points in fees (0.74% of assets) in 2012 and 78 points in 2013. By comparison, the State of Florida Retirement System paid just 30 points in fees in 2011. Across $1.1 billion in investments, 78 basis points results in $8.6 million in annual management fees. If the Fund replicated the State of Florida’s fees, only $3.3 million in fees would be realized.
We believe that the Fund can shift its investments to reputable index funds which closely replicate the Fund’s portfolio strategy for less than 25 basis points. As a result, the Fund can save over $6 million per year which can be used to pay down the unfunded liability, with no impact on investment returns. These reforms can be enacted and the proceeds realized in a matter of weeks.
Reform Component #3 – Diet COLA
A large portion of the estimated $1.7 billion unfunded liability is a result of the 3% fixed, compounded cost-of-living adjustments (COLAs) to retiree pension payments. Prior to the 2001 pension agreement, no COLAs were enacted in the first five years of a pension. After 5 years, the COLA was the lesser of inflation or 3%. The current practice of 3% annual COLAs is, in our opinion, financially unsustainable and destructive to Jacksonville taxpayers. In contrast, U.S. Military pensioners receive a COLA of “Inflation minus 1%” on their pensions until they reach the age of 62, and then receive a COLA equal to the rate of inflation.
The financial unsustainability of 3% fixed COLAs is especially true for larger pensions in excess of $60,000, where retirees are guaranteed to receive an annual raise of $2,000 or more, per year, every year, for the rest of their lives. In the past 10 years, there were several instances where inflation was less than 2% - yet retirees received their 3% increase to their benefit. This is effectively a raise to retirees, paid by taxpayers. In the long-term, these raises come at the expense of higher tax rates or reduced public services offered by the city.
Later this decade, due to the compounding effect of 3% fixed COLAs, we estimated that the average PFPF retiree will earn more from their pension than the average front-line employee in the police and fire department will earn in salary for performing their job. As a result, we believe that the 3% fixed annual COLA needs to go on a diet.
Adjustments to COLAs are aligned with guiding principles #1 and #3. In order to share the burden of the $1.7 billion unfunded liability equally between taxpayers and all pension fund members, fixed COLAs need to be adjusted downward in a fair manner. However, we must also make sure to preserve retiree peace of mind in the adjustment process.
After taking into account reductions to the unfunded liability as a result of the first two components of our reforms, the balance of the reduction will come from adjustments to COLAs. We propose the maximum COLA offered to retirees going forward be the rate of inflation. Depending on the age of the retiree and the size of the retiree’s benefit, COLAs should be varied. Older retirees with a smaller pension benefit should receive the maximum COLA available. Retirees with a pension in excess of $80,000 per year should receive the smallest annual COLA. The youngest retirees retire in their 40s and 50s and possess who have 10-20+ working years available in their careers should also receive small COLAs.
The below Chart 2 illustrates a range of potential COLAs based on the retiree’s age and the size of their pension benefit. After tabulating the impact of the first two components of our reforms, actuaries can calculate the range of COLA adjustments needed to provide a 50-50 shared responsibility between taxpayers and fund members for the unfunded liability.
A “lowest” COLA, for example, might be the annual prevailing inflation rate minus a fixed percentage of 1.5% or 2%. As a result of these proposed reforms, the aggregate sum of benefits collected by a retiree with a large pension may not approach the $5 million range in lifetime benefits as described in Chart 1. However, the retiree will still certainly retain financial peace of mind in their retirement.
Summary Conclusions
The condition of the Jacksonville Police and Fire Pension Fund is presently the greatest threat to the short- and long-term financial health of our city government and Jacksonville’s future quality of life. While the problem of solving the PFPF’s $1.7 billion liability is incredibly daunting, it is fixable. There is a way forward. We have presented what we believe is a principled and fair solution that preserves financial peace of mind of retirees, limits the burden of taxpayers, and repositions the City of Jacksonville’s finances for success.
At the heart of our reforms is modernizing the system of retirement benefits provided to police and fire employees. The current system is outdated, risky, overly complex, and opaque. It is also prone to manipulation through the political adjustment of key actuarial assumptions that allow expensive and unsustainable pension benefits to be initially presented at a cost to taxpayers that far understates proper financial reality. This pattern has manifested itself across the nation, creating trillions of dollars in unfunded pension liabilities that are threatening the financial future of numerous U.S. state and local governments. To put it mildly, the first cities to truly face the full brunt of their pension problems, such as Detroit and Stockton (California), have not fared well. Jacksonville must take a different path to preserve our quality of life and competitive tax levels which fuel future economic growth.
The solution, in our opinion, requires the shared sacrifice of taxpayers and both PFPF current and future employees and retirees. In our proposal, taxpayers can continue to maintain a limited tax burden, but prevailing property tax rates will remain significantly above levels assessed just 5 years ago. Employees and retirees can continue to plan on retirement with financial peace of mind and security. But those who anticipate collecting millions of dollars of growing pension benefits over 40+ years – levels far above those offered to men and women in the U.S. Military – will need to adjust their expectations. The problem cannot be wholly solved by placing the entire burden for the $1.7 billion unfunded liability on taxpayers. It cannot be wholly solved by current employees and retirees and taking away the financial peace of mind of their retirement. It cannot be wholly solved by slashing the benefits of new policemen and firemen or marring our ability to attract and retain top talent to our public service departments.
We hope our reform proposals positively shape the present pension debate in Jacksonville. Please send any comments to jaxpensionreform@yahoo.com. We would appreciate your feedback to make these reform proposals stronger, as our city’s best thinking will be needed to arrive at the very best solution for Jacksonville.
Jointly, this problem was created. Jointly, it can and will be solved.
Tom Majdanics
Michael Yang
Christopher Owens
Felisa Franklin
Sources:
Details on Jacksonville Police and Fire Pension Fund Finances and Benefits:
• Jacksonville Police and Fire Pension Fund Comprehensive Annual Financial Reports (CAFRs), FY
2008-2012 (not available online);
• Jacksonville Police and Fire Pension Fund Actuarial Valuation Reports for FY 2008, 2011 and
2012 (not available online)
• PFPF Summary Plan Booklet: https://www.coj.net/departments/police---fire-pensionfund/
summary-plan/summary-plan-2012---2014---advisory-update---jan-2.aspx
US Military Pension and Survivor Benefits:
• https://militarypay.defense.gov/Retirement/index.html
• https://militarypay.defense.gov/survivor/sbp/04_cost_spouse.html
Jacksonville Sherriff’s Office – Police Officer Salaries:
• https://www.joinjso.com/careers/police_officers.php
Investment Fees paid by PFPF vs. State of Florida retirement system:
• https://www.coj.net/retirement-reform/docs/oct-29/jt-jacksonville-testimony---oct-29-2013-
(amended).aspx
Current and Historical Jacksonville Property Tax Rates:
• https://www.coj.net/departments/property-appraiser/millage-rates.aspx
• https://www.truthaboutpensions.net/Pension_Burden.html
Historical City Contributions to the PFPF:
• https://www.coj.net/retirement-reform/docs/retirementreform-finance-62713.aspx