Needed: $1.2B. In The Bank: $468M

The city’s pension funds should have over $1 billion in the bank.

They have under $500 million.

That’s a problem. How to fix it?

That new information fueled a continuing discussion Thursday night over one of the biggest questions facing local lawmakers in this budget season: How to tackle perilously fragile pension funds.

The Harp administration has proposed the unusual step of borrowing $250 million to help shore up its underfunded pension funds. Five weeks after public and aldermanic resistance emerged to that idea, city financial staff returned to the alders with nearly the exact same argument as before, but this time bolstered with a wealth of details and a clearer narrative about the current state of the city’s pensions, and about the risks and rewards of taking on more debt to pay down some of its unfunded liabilities.

As wary now as they were over a month ago, alders took in the new information with caution and skepticism, requesting that city staff work harder to reassure the alders and the public that borrowing such a large amount of money to help fill up the pension funds is a worthwhile use of debt.

Such was the focal point of Thursday night’s five-hour budget workshop in the Aldermanic Chambers on the second floor of City Hall, during which Acting Budget Director Michael Gormany and city Controller Daryl Jones came before the Finance Committee to discuss the mayor’s proposed $547.1 million operating budget and $79.6 million capital budget for the fiscal year that starts July 1. 

Jones and Gormany spent most of their testimony defending Appropriating Ordinance #5, described on the 309th page of the proposed budget, which would allow the city to issue up to $250 million in Pension Obligation Bonds (POBs) next fiscal year to help pay down some of the unfunded liabilities in the City Employee Retirement Fund (CERF) and the Police & Fire Pension Fund (P&F).

CERF and P&F are the two defined pension plans that the city pays into each year to cover retirement benefits for city employees. The P&F covers pensions for public safety personnel like police and firefighters; CERF covers pensions for all other unionized city employees.

Jones told the alders that the city pays out around $6 million every month in combined pension benefits to retirees, many of whom earn 60 to 70 percent of their salary in retirement.

He said actuaries estimate that the city needs to have $1.2 billion earning 7.75 percent annual investment returns across the two funds in order to have enough money to pay its pension obligations to retirees over the next 30 years. Jones said the pension funds currently have a combined $468 million: a little over $300 million in P&F and around $165 million in CERF.

“Why do we only have $468 million in the bank?” Jones asked. ​“We didn’t put enough money in the bank over the past 20 years. There was money going into that back account, but not the accurate amount to fund pensions correctly. That’s why they’re shot.”

“To prevent the water from washing away the bridge,” he continued, ​“we must raise the bridge above the water. To prevent the pension from being depleted, we must take some actions to shore it up.”

Jones said that the city already has taken steps to reduce its glaring pension funding gap. He said the city reduced the expected rate of investment return for the two pensions from 8.25 percent to 7.75 percent. He said the boards that manage the two pensions have negotiated with institutional investors like Morgan Stanley to reduce the cost of high investment fees.

And most importantly, he said, the city has committed to funding the pensions each year at a steadily increasing level that helps pay down the unfunded liabilities a little bit every year.

The proposed budget calls for the city to invest $21.9 million in CERF and $34.6 million in P&F next fiscal year. Although those numbers are millions of dollars higher than the annual pension contributions going back just five years, they represent a 0 percent increase over the current fiscal year’s pension contributions.

“We’ve raised the bridge, and lowered the water,” Jones said. ​“But those steps aren’t enough. We’re requesting authorization for Pension Obligation Bonds of $250 million to shore up both the P&F and the CERF.”

At the request of alder leadership, Jones brought with him four key risks associated with borrowing money to pay off outstanding liabilities owed to retirees.

First, he said, there is the risk of borrowing money and then not funding the pension properly, which increases the city’s debt load without decreasing its pension liabilities.

“That is what happened 20 years ago,” he said. He said the current administration has committed to following through on actuarial-recommended ARC payments, or annual required contributions that financial experts hired by the city say must be paid in order to fill up the pension funds.

The second major risk is if the interest rate on the bond is higher than the pension funds’ actual returns. That would mean that the city would be paying more in debt service than they would be making back in investments.

Jones said the current interest rates set by the Federal Reserve are around 4.7 percent, and that the city’s pension fund investments have averaged a rate of return of 7 to 10 percent over the past 30 years. He said he would not consider issuing POBs if the interest rate climbs to 5.7 or 5.8 percent, but that for now, 4.7 percent was a pretty attractive interest rate at which to borrow money, especially considering the city’s average rate of return.

Third, he said, financial ratings agencies like Standard & Poor’s (S&P) and Moody’s may disapprove of a city issuing POBs if it doesn’t also have a long-term financial plan in place.

“If you don’t have a fiscal plan, a strategy, then things get out of stray,” he said. ​“You have to have a plan going forward, some kind of roadmap.”

He said the state Office of Policy and Management (OPM) requires that city’s present at least a three-year financial plan before they issue POBs, and that therefore this process of borrowing money for the pension funds could help spur city government to develop a longer-term financial vision for the city.

“The last risk,” he said, ​“is the lack of policy reforms to change long-term liability costs. You have to be able to have policy reforms that mitigate those liabilities.”

He said POBs would work best if coupled with structural reforms to future employee benefit packages, so that the city would not owe as much to future retirees as it does to its current pensioners.

“You don’t just borrow money if you don’t also change things to help lower the liability,” he said.

Ultimately, he said, borrowing the $250 million would increase the P&F’s funding level to 54 percent and CERF’s funding level to 70 percent. According to a June 2016 valuation, P&F is funded at around 43 percent and CERF at around 33 percent.

Jones also argued that issuing POBs would reduce the amount of money that the city would have to put into the pension funds each year, thereby saving between $1.9 million and $2.7 million each year for the General Fund.

“Back It Up”

Finance Committee alders largely balked at what they portrayed as an overly optimistic spin on a plan that would increase the city’s debt load without guaranteeing a successful paying down of the pension liabilities.

West River Alder and Board of Alders President Tyisha Walker-Myers asked Jones to give a few examples of cities that are comparable to New Haven in size and number of people who receive pensions, and that have also issued POBs to help cover up pension fund gaps.

When Jones said he could get that information to the alders after the meeting, Walker-Myers said she was surprised that city staff didn’t have examples readily on hand.

“If we’re proposing to do something as risky as this,” she said, ​“we should have supportive information to actually back it up.” She asked Jones to share with the alders the three-year financial plan that the city would need to prepare for OPM if the alders approve the appropriating ordinance and if Jones then decided to issue the bonds.

Hill Alder Dave Reyes asked Jones if the same people who were involved in the poor planning that led to the current underfunded pension funds are still involved in overseeing the funds.

Jones said that a variety of players are involved in what happens to each pension, including actuaries, financial advisers, and the boards of trustees that actually make decisions about invesments.

“What happened in the past, I don’t know what happened in the past,” he said. ​“Were financial advisers fired? I made sure of that when I got in.”

He also said the CERF board of trustees just last month passed the pension fund board’s very first set of bylaws, and that the P&F board will be doing the same next month. Before the passage of these bylaws, Jones said, the boards for these funds have had no guiding formats or principles for processes as consequential as how to interview investment companies.

Westville Alder Adam Marchand said he was most concerned about the city borrowing money a significant amount of money under the assumption that all will be well if the average rate of return outpaces the fixed interest rate on the bonds over the course of two or three decades.

“There’s going to be volatility,” he said. ​“It could be feast or famine. And for the purposes of budget planning, if you have a good year and a bad year, the bad year could really hammer us unless if you have some plan to take some of the bounty from the good years and put it aside as a reserve to shield us from the bad years. You should not just plan based on the average, but plan based on the volatility.”

After the meeting, Mohit Agrawal, the chair of the independent Financial Review & Audit Commission (FRAC), said he was less concerned with the rationale behind the city’s pitch for issuing POBs, and more concerned by the assumptions the city is using to justify that pitch.

He said the city should model the potential impact of the POBs based on a more realistic average rate of return of 5.75 to 6.75 percent, rather than 7 to 10 percent. He also said a downturn in the stock market early on in the life of the POBs would hurt the city a lot more than a downturn later on, since that would limit the initial size of the principal on which interest would accrue over the decades.

Medical Benefits Explanation Left For Another Day

A curious lack of public attention was paid by alders and city staffers alike to the city’s proposal to flat fund the medical benefits line item of next year’s budget at $76.6 million, even though the city is on track to spend $90 million on medical this year.

FRAC’s Agrawal said that cities and companies throughout the country are looking at 5 to 8 percent annual inflation of their medical costs, and that the city should expect to have to pay $93 million to $98 million next year on medical. He said Hartford Mayor Luke Bronin’s recently released budget assumes that the capital city’s medical costs will grow by 7 percent next year.

During March’s Finance Committee meeting, Alder Adam Marchand even told Gormany and Jones that they had ​“some pretty high bars to hit between now and the April 19 meeting,” particularly in coming up with an explanation for the lack of an increase to the city’s medical costs.

Before the hour-long conversation about pensions during Thursday night’s meeting, Jones spent five minutes reading a pre-written, carefully-worded statement about the city’s continued work to ensure that medical costs do not increase next year.

“At this point city officials are continuing to work with major partners in the city, state officials, and in concert with the Board of Alders leadership to address the medical self-insurance fund,” Jones read. ​“There are several proposals under discussion simultaneously but there are not enough details and the talks aren’t far enough along to describe a formal proposal to you tonight. We remain extremely confident that there’s a pathway forward in this regard to maintain the proposed flat funding in this line item, and a potential reducing of the mill rate increase.”

Jones did go into a bit more detail about two specific medical cost saving items: the city’s discontinuation of its stop-loss insurance policy and its research into moving retirees away from a current supplement retiree medical plan and onto a Medicare Advantage plan. But, Jones admitted, those two items would only save between $1 million to $2 million each year: not insignificant, but not enough to completely counteract the $5 million or $6 million annual projected inflation according to FRAC’s data.

Walker-Myers said after the meeting that she and her colleagues are still very concerned about the city’s medical budget, but that there is only so hard they can push if the city says they are not yet ready to share details on potentially sensitive ongoing negotiations.

“I made a comment some weeks ago that having a budget that flat funds medical benefits from one year to the next seems a very bold, bold move,” Marchand told Jones and Gormany, ​“and it’s not something that’s easily accomplished.”

“I understand that there are conversations that are at an early stage,” he continued. ​“I think it’s very important to see how quickly those conversations can advance so that leadership can be briefed, so that this committee can be briefed, and the public can know what is in the works and what can be realized. I’m excited by the possibility of something really powerful, but you don’t know it will work until you see the numbers and you have the details, and those details aren’t here yet. We have this challenging situation where the conversations are in the early stages, and the budget process is in advanced stages, so we’re under some pressure to see those conversations advance.”

The Board of Alders must approve a final version of the budget by the first week of June.

The next and last public budget hearing, during which the Finance Committee will listen to public testimony about the budget, is on Wednesday, May 9, at 6 p.m. in the Aldermanic Chambers on the second floor of City Hall.