Most of Rhode Island’s local pension plans are floundering

IGNORING WARNING SIGNS? A sign bearing the name of Johnston Mayor Joseph M. Polisena is seen at the town's high school. Johnston in 2013 settled a lawsuit with R.I. Resource Recovery Corp. and received $3 million. But unlike East Providence and North Providence, local lawmakers decided to spend the sudden influx of cash on a new athletic complex, named for the mayor, instead of its ailing pension system. / PBN PHOTO/MICHAEL SALERNO
IGNORING WARNING SIGNS? A sign bearing the name of Johnston Mayor Joseph M. Polisena is seen at the town's high school. Johnston in 2013 settled a lawsuit with R.I. Resource Recovery Corp. and received $3 million. But unlike East Providence and North Providence, local lawmakers decided to spend the sudden influx of cash on a new athletic complex, named for the mayor, instead of its ailing pension system. / PBN PHOTO/MICHAEL SALERNO

(Updated, July 1, 5:05 p.m.)

Editor’s note: This is the second of a four-part series exploring how well Rhode Island cities and towns are funding municipal pension and benefit plans and the public-policy ramifications.

Detective James Brady sits outside a coffee shop on Atwood Avenue in Johnston when a man approaches to say hello.

“How’s retirement?” Brady asks.

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“Love it,” the man laughs. “Not many people can say they retired at age 44.”

The two exchange pleasantries before the man jumps into a pickup truck and drives away.

“He’s a retired firefighter from [Johnston]. He’s in the same pension as we are,” Brady explains. “You see the attitude? Happy-go-lucky, not a care in the world. He knows the trouble it’s in. But that seems to be the norm around here: Don’t worry about it until it explodes.”

Brady, who’s served as a police officer since 1979, joined the Johnston Police Department in 1998 and subsequently the International Brotherhood of Police Officers Local 307. Elected union president in 2011, Brady has since focused much of his advocacy efforts on the town’s locally administered police pension plan, which combined with the local firefighters’ plan has an unfunded liability totaling $125.4 million as of fiscal 2015, the most recent year available. That’s about 66 percent more than the entire $75.5 million tax levy the town proposed for fiscal 2017.

The unfunded liability in Johnston has risen each year since at least 2009, which dates back to when the R.I. Division of Municipal Finance started collecting relevant data. Johnston last year paid $5.4 million toward its police and fire plan, which is $7.5 million less than what it was supposed to contribute – a problem shared by local pension plans throughout the state.

The total unfunded liability for 33 local pension plans in 24 Rhode Island municipalities (the other 15 Rhode Island communities don’t have locally administered plans) totaled $2.3 billion. That’s according to data from the most recent municipal audit reports through 2015 researched by Providence Business News.

The debt weighs heavily on cities and towns trying to play catch-up after years of underfunding. Providence alone last year doled out $66.9 million as a minimum payment, totaling 19 percent of the entire tax levy for fiscal 2016.

In best-case scenarios, towns are beginning to close funding gaps created by years of poor financial management. In worst-case scenarios, communities are failing to make minimum required payments, predicting overly optimistic rates of return in the market and watching as ballooning unfunded liabilities cripple municipal budgets.

“The very simple fact is that we haven’t put away enough money for all of our promises,” said Michael G. Riley, founding and managing member of Narragansett-based Coastal Management Group LLC and Beach Street Financial Services. “Largely it’s not solvable without a reduction [in promised benefits], so somebody’s not going to get their money.”

BUDGET SQUEEZE

Not all local pension plans are floundering, but the majority are.

A state-run commission, active from 2011-14, calculated that 22 of the then-34 local pension plans were in “critical status,” meaning the “funded ratio” – the amount of money set aside to pay off the financial obligations – for each plan fell below 60 percent.

An analysis of the most recent audit reports available through the R.I. Division of Municipal Finance shows 19 plans remain in critical status and another five are between 60-70 percent, according to PBN research.

The worst-funded plan is Coventry police, at just 14.6 percent. The overall plan is relatively small in Rhode Island, and its unfunded liability of $62.4 million pales in comparison to some other, larger municipalities, such as the $894.5 million unfunded liability in Providence. But the amount is nonetheless daunting, as it more than doubles Coventry’s entire $29 million proposed operating budget for fiscal 2017.

The town also has two other underfunded plans: a town plan and a school plan, funded at 36.3 percent and 34.8 percent, respectively, which exacerbates the financial burden of pension costs each year.

“Basically, what happened was that pension commitments were made by the municipality through collective-bargaining agreements, and town councils in the past did not fully fund the annual required contribution,” said Robert Thibeault, Coventry finance director.

The annual required contribution, or ARC, is the minimum amount a municipality is supposed to pay each year toward its pension system for both current and future retirees. Most municipal finance professionals agree: Funding 100 percent of the ARC each year will eventually pull a plan out of critical status.

Nonetheless, eight municipalities failed to make 100 percent of the ARC for nine local plans as of fiscal 2015, according to research. Of the laggards, Smithfield Fire contributed the least at 41.3 percent and West Warwick’s town plan contributed the most at 99.5 percent.

Coventry has been able to grow its funded level from a low of 9.9 percent in 2012 and this fiscal year says it’s paying 100 percent of its ARC for the first time “in anyone’s memory,” Thibeault said.

But funding 100 percent of the ARC – in most municipalities – consumes a healthy portion of each fiscal budget. And when it comes down to deciding whether to fund a future obligation versus a current pothole, municipal leaders often choose the latter. In Coventry, Thibeault says it’s come at the expense of other local initiatives.

“The [town] had to sacrifice to fund other projects, or do other things, to make these payments,” Thibeault said. “The town has really had to come up with a lot of additional money to get to 100 percent funded, so much so that we’ve not funded any other projects … funding the pensions was priority one.”

Earlier this year the town ordered a freeze on all departmental equipment purchasing to ensure no overspending for the fiscal year that ended June 30, according to Coventry Town Council President Glenford Shibley.

“We’ve been putting off purchases on new equipment because of funds that need to be used toward the ARC,” Shibley said. “We want to get to at least 60 percent funded and the goal would be to get higher than that in the long range, but it takes time. You have to be frugal, and I think our council knows that.”

The majority of municipalities with local pension plans still have a long way to go before achieving fiscal stability, but some are already there. The North Providence police plan is among the few, funded at 95.9 percent. But even that success is largely due to external forces. In 2013 the municipality – facing a pension shortfall of about $21 million – was awarded $20.6 million through a settlement with Google Inc. The town had assisted a federal investigation into the company’s distribution of illegal prescription drug ads. North Providence put the full $20.6 million toward its pension plan.

“You could get very foolish with that kind of money,” said Charles A. Lombardi, North Providence mayor, when asked about the decision. “You could really want to build buildings and put your name on them, but that’s not the right thing to do.”

East Providence also benefited from the Google forfeiture and put $49.2 million toward its police and fire plan, cutting its unfunded liability nearly in half. That plan is now funded just above critical status at 61.4 percent.

The Google money freed up about $2 million for East Providence and $860,000 for North Providence per year. The money would have otherwise needed to be spent on pension contributions.

But other communities have shown different priorities.

Johnston in 2013 settled a lawsuit with R.I. Resource Recovery Corp. and received $3 million. But unlike East Providence and North Providence, local lawmakers decided to spend the funds on a new athletic complex instead of its ailing pension system.

“[The mayor] knows there’s a huge problem in the pension and he doesn’t put one penny of the settlement into the pension to correct the problem. Not even a good-faith gesture,” Brady said.

Mayor Joseph M. Polisena, who receives a pension as a retiree of the Johnston Fire Department, did not respond to several requests for comment. Town Council President Robert Russo also could not be reached for comment.

“The good news is that they named the stadium after [Polisena] … that’s a nice touch,” Brady added.

‘THREE-CARD MONTE’

In the wake of the 2011 overhaul of state pensions, Rhode Island mandated each community with a plan in critical status to design a “financial-improvement plan,” or FIP, to show how it would achieve funding above 60 percent by 2033.

Each municipality complied, but the expectations and variables used in those evaluations have added to the debate over pensions, including highly optimistic assumed rate of returns for pension-fund investments. That is, the expected return one would anticipate for pension money invested in the market.

High assumed rates of return, such as 8.5 percent for Smithfield police and 8.25 percent for Providence, have raised eyebrows among some investors, as next-to-zero interest rates and sluggish economic growth have hampered the once-predictable return on pension investment funds.

“The 8.25 percent return is probably not obtainable in the next several years, which means you’re going to have shortfalls that you’re going to need to address,” said John C. Simmons, executive director of the Rhode Island Public Expenditure Council.

The lowest assumed rate of return for local pension plans is 5.75 percent in Central Falls, a municipality that knows firsthand what it means to undervalue pension costs. In 2011, the city filed for receivership after it projected major budgetary shortfalls. Its unfunded liability for pensions and other post-employment benefits, known as OPEBs, totaled about $80 million.

Today, Central Falls’ police and fire plan still carries an unfunded liability totaling $25.2 million and is funded at just 21.7 percent. As the community fights for its economic resurgence, pensioners under the pre-bankruptcy plan only receive about 75 percent of the pensions they agreed to when signing up to work for the city.

“One way or another you’re going to have to pay for the lack of return,” Simmons said.

In 1995, pension investment funds allocated wholly in bonds had an expected rate of return of 7.5 percent, according to Callan Associates Inc. research published June 1 in The Wall Street Journal.

Today, achieving that same 7.5 percent return would require a much riskier allocation and putting the majority of the fund into domestic and foreign equity markets (leaving only 12 percent in bonds), thus increasing the standard deviation – or estimated range of volatility – to 17.2 percent, from 6 percent in 1995.

What it means for Rhode Island municipalities is that once-predictable returns for pension funds are less predictable, suggesting a more conservative assumption may be prudent, according to Robert S. Hull, director of the R.I. Department of Revenue.

“If you have facts and data that the rate should be ‘x,’ then you should be listening,” said Hull, whose department has some oversight of local pension plans through its Division of Municipal Finance. “But it’s hard because it changes your ARC dynamic and your budget,” he added.

Indeed, to lower the assumed rate of return translates into a less favorable discount rate over time, which increases a plan’s unfunded liability and adds to how much municipalities must pay each year toward funding local pension plans.

Higher yearly costs mean less money for other operations, such as new equipment and infrastructure improvements, and could demand larger tax increases to keep municipalities away from running deficits.

The state’s $7.5 billion pension fund in 2011 lowered its assumed rate of return from 8.25 percent to 7.5 percent, which it still struggles to meet. Last year, the state ended with a 2.2 percent gain and the calendar year with a 0.3 percent loss. The State Investment Commission in May decided it was time to review the investment and its asset allocation. An experience study – which could impact how the assumed rate of return is set in the future – is expected to begin next spring.

Rhode Island is hardly alone, of course, in struggling to manage the burgeoning pension crisis. Underestimating pension liabilities is a problem around the world, and a large part of it has to do with who’s in charge of counting.

California in March re-estimated its pension liability using a different accounting measure and found its total liability of $64 billion amounted to $20 billion more than previously estimated. Citigroup Inc. recently reported that 20 countries that belong to the Organization for Economic Cooperation and Development greatly underestimate their combined $78 trillion in promises to retirees, which nearly doubles the $44 trillion combined national debt for those same 20 countries.

“Everyone is kind of hiding or playing three-card monte with costs,” Riley said. “It’s unethical, it’s not honest, and it’s misleading.”

THE FALLOUT

“There are a series of sticks and carrots here, but for the most part they are pretty limited,” said Hull, describing the state’s oversight authority over municipalities when it comes to funding pension systems.

The 14-member Local Pension & OPEB Study Commission, formed in the wake of Rhode Island’s 2011 pension reform for state-administered plans, recessed indefinitely last January after giving a host of recommendations to Gov. Gina M. Raimondo and the General Assembly.

In a letter to Raimondo, House Speaker Nicholas A. Mattiello and Senate President M. Teresa Paiva-Weed, former revenue director Rosemary Booth Gallogly wrote, “After many months of education, meetings, reviewing data, reports and testimony, the time has come to provide you with recommendations, among them the need for continued long-term oversight.”

Top recommendations included establishing an oversight board, requiring annual funding notices and continuing to fund a state municipal incentive aid program. The latter, a three-year $5 million incentive program, went to municipalities that followed FIPs, but dried up last year and wasn’t included in the fiscal 2017 budget. Johnston was the only Rhode Island municipality not to receive any aid in the last year of the program.

Currently, the Division of Municipal Finance and the Office of the Auditor General are the state entities responsible for overseeing local pension systems. The division keeps track of key indicators, such as funding levels and unfunded liabilities, and the auditor general is in charge of informing municipalities running a risk from a budgetary standpoint.

But legislation providing clear guidelines for municipalities to adopt and follow are limited and a far cry from the sweeping reform created at the state level in 2011.

Hull, who left the private sector earlier this year to take over as revenue director, says there’s currently no evidence he has seen that a municipality faces insolvency. But he does acknowledge that unfunded pension liabilities need to be addressed.

“We need to get more work done, there’s no doubt,” he said.

He doesn’t believe, however, that the state needs a second study commission. “Doing the same thing and expecting a different outcome is generally the definition of insanity,” he said.

Rather, he says, the administration should collaborate with the General Assembly to create some type of regulatory framework. But what that might look like is still pretty vague.

“Legislative suggestions need to be our next agenda, so let’s get those in front of the General Assembly,” he said.

Sen. Ryan W. Pearson, a Cumberland Democrat, sponsored legislation that passed the General Assembly last month, creating a five-member advisory council to oversee local pensions systems. Chaired by the general treasurer, the council will submit yearly reports to the governor and General Assembly with opinions regarding the sustainability of each plan, highlighting any potential area of concern. The Division of Municipal Finance already does some of this work and publishes its work online. While the new law doesn’t provide any guidance on how municipalities might be punished if they don’t adequately fund the pension systems, Pearson hopes the yearly opinion will help nudge communities toward acting more fiscally responsible.

“If the general treasurer comes out and says [a municipality] has a significant problem in not funding its pension liability, that will either be enough to begin the conversation about how cities and towns should behave, or highlight the need for [legal repercussions],” he said.

Simmons believes the state would have benefited from the continuation of the Local Pension & OPEB Study Commission, because just having a group publicly monitoring the performance of local pension plans forced municipalities to act more fiscally responsible, he said. And since its disbandment, some municipalities have already begun to underfund pension plans.

Back in Johnston, Brady fears it may already be too late to close the pension gap.

“The hole is so deep, I don’t think there’s a backhoe big enough to fill it,” he said. •

An earlier version of this story reported an incorrect figure for the investment returns for the state investment fund in 2015. The correct returns for fiscal 2015 and calendar 2015 are included in the story now.

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