The proposed OPEB trust

In our last column, we phrased the issue facing Council as it decides whether to approve new public safety union contracts this way:  Is the “partial solution” proposed by outgoing City Manager John Russo to the “Other Post-Employment Benefits” problem worth the financial consequences for the City those contracts will cause during their six-year term?

We focused last time on the second part of that question:  the financial impact of the contracts.  Today, we’ll look at the first part:  the establishment of a new “OPEB trust.”

Unfortunately, assessing the financial impact of the trust proposal isn’t an easy task.  Even as sophisticated a financial analyst as Councilman Jim Oddie (B.A., Finance, Indiana University; M.B.A., Loyola University) got it publicly wrong, writing in Thursday’s Alameda Sun that “the city’s $91 million OPEB liability will be reduced by $47 million over the next 30 years. . . .”

In fact, according to Interim City Manager Liz Warmerdam, the City’s actuarial consultant, Bartel & Associates, has not estimated the amount by which the trust proposal will reduce the City’s unfunded OPEB liability.  As Ms. Warmerdam explained to us, the proposal is designed to offset the City’s annual “pay-as-you-go” cost for OPEB rather than to fund its accrued OPEB liability.

What we think Mr. Oddie meant to say is that the trust proposal will lower the City’s annual OPEB payments from 2019 through 2045.  That statement would be true.

But the trust proposal will not have any impact whatsoever on the City’s OPEB liability to current retirees, and it will not reduce the City’s OPEB liability to current employees when they retire by anywhere near $47 million.  Indeed, even after the proposal has been implemented for 30 years, the City still will have $252.6 million in unfunded OPEB liability.  No wonder that Mr. Russo carefully used the phrase “partial solution.”

The argument can be made – and is being made – that any reduction in OPEB liability is better than none.  But we reject – and we urge Council to reject – such a simpleminded view.  Instead, the deciders (to use Councilman Oddie’s term) should understand exactly what financial advantages the proposal confers.  Then, they can determine whether those advantages are worth the price the City is being asked to pay.

At the April 16 Council meeting, City Treasurer Kevin Kennedy said it better than we could:

There is some discussion out there in the public that, gee, isn’t it better to do something on this issue than do nothing?  The decision you [i.e., Council members] face is being framed as, Well, you’ve been telling us for years and years we need to address this, don’t we just need to address it?  I would tell you that, really, there isn’t any question that we need to do something about this.  The question is, Is this what we need to do?

So now let’s take a closer look at the OPEB trust proposal.  (Warning:  A lot of numbers to follow).  Based on the staff reports and information provided to us by Ms. Warmerdam, we understand that the OPEB trust will work this way:

  • In January 2016, the City will fund the trust with a contribution of $5 million. For the next 10 years, the City will contribute $250,000 per year.
  • The same month, public safety workers will begin paying into the trust. (The staff report says that the rates are 4% for employees hired before June 2011 and 2% for employees hired thereafter, but Ms. Warmerdam confirmed that in fact the payment schedule is graduated: 2% in 2016, 3% in 2017, and 4% in 2018 and thereafter for the former group; 1% in 2016 and 2% in 2017 and thereafter for the latter group).
  • Until January 2019, the City will pay all of the annual OPEB costs out of the General Fund.
  • Beginning in January 2019, the trust will start paying the cost of benefits provided to public safety employees who retire after that date; the City will continue picking up the tab for benefits provided to employees who retired before then.
  • The trust will run out of money by 2035 – i.e., it no longer will be able to pay OPEB costs for anyone.
  • Thereafter, the City will resume paying benefit costs for public safety employees who retired after January 2019 (as well as continuing to pay benefit costs for pre-January 2019 retirees).  Ongoing employee contributions, rather than going into the defunct trust, will be used to “assist with” – Ms. Warmerdam’s phrase – payment of these costs.

Now for the analysis of the financial impact.  As we see it, the trust proposal affects the City’s unfunded OPEB liability this way:

  • As of January 2013, the City’s “actuarial accrued liability” for OPEB for public safety retirees was $91.2 million.  All of it was “unfunded.”  (We use the quoted terms deliberately, since they are the ones used by actuaries like Bartel.  According to a Bartel report provided to us by Ms. Warmerdam, as of January 2013 the present value of all of the retiree health benefits owed by the City was $130.9 million).
  • According to the Bartel report, this unfunded OPEB liability breaks down into $53 million owed for benefits to public safety employees who already have retired and $38 million owed for benefits to current employees when they retire.
  • By design, none of the money going into the OPEB trust will be used to pay benefits to current retirees.  The trust thus will have absolutely no impact on the $53 million OPEB liability to that group.
  • By design, the OPEB trust will make payments only to current employees who retire after January 2019.  The trust thus will have no impact on the OPEB liability to current employees who retire before that date.
  • The OPEB trust will defray some, but not all, of the City’s OPEB liability to public safety employees who retire after January 2019.

How much of an offset will the trust proposal provide?  Ms. Warmerdam was kind enough to provide us with a table prepared by Bartel showing estimated OPEB costs from 2015 through 2045.  The table shows that, beginning in 2019 and continuing for 16 years, the trust will pay all of the OPEB costs for public safety employees who retire after January 2019.  Through 2034 these payments total $35 million.  Even so, as of January 2034 the remaining unfunded OPEB liability to post-January 2019 retirees will be $122 million (and the total unfunded OPEB liability will be $165.6 million).

The trust will have run out of money by 2035, and it will make no further payments – to anyone.  So what happens after 2035?  The City will be responsible for paying the OPEB costs for both pre- and post-January 2019 retirees, but the proposal assumes that the payroll deduction for OPEB will continue even though the trust is gone.  These employee contributions will be used to subsidize the City’s costs.  As Ms. Warmerdam explained,

[A]fter the trust runs out of money in 2035, benefits for post-January 2019 retirees will be paid by the City (employee contributions are intended to assist with – not supplant the city’s obligation).  And assuming we have not bargained something different, ongoing employee contributions would continue to contribute to that benefit.

Based on the data in the Bartel table, estimated OPEB costs from 2035 through 2045 (for all retirees) are $87.8 million.  If we’re reading the table correctly, the ongoing employee contributions will provide $12.2 million worth of “assistance” to the City during these 11 years.  At the end of the period, the remaining unfunded OPEB liability will be $252.6 million.

(You can now see where the staff report got the $47 million figure misinterpreted by Mr. Oddie.  It is the sum of payments from the trust between 2019 and 2034 and employee “assistance” provided from 2035 through 2045).

So we’ve now come to the end of the analysis – right?  Councilman Oddie and IAFF Local 689 president Jeff DelBono undoubtedly would say so.  (Incidentally, Mr. Oddie’s op-ed in the Sun shows that the IAFF Local 689 PAC is getting every penny’s worth of the $11,799.57 it spent to get him elected to Council).  The trust proposal surely saves some money.  The firefighters surely deserve another guaranteed series of raises.  What’s more to consider?

At the Merry-Go-Round, we think there’s quite a bit.  Two points in particular stand out.

First, we have no doubt that the numbers presented in the Bartel studies represent good-faith estimates of the annual amounts of OPEB payments to be made to retirees; the annual amounts of contributions to be made by employees, and the running balance of funds in the OPEB trust.  But we’re sure that even Mr. Bartel would admit that those estimates are based on a host of assumptions about the future.  The Bartel studies describe some, but not all, of those assumptions.

So what?  For one thing, if all of the assumptions used in the studies were known, an independent expert could evaluate the reasonableness of each of them.  Take one example:  Bartel assumes that the funds contributed to the trust will earn a 6.25% annual return.  The last time we looked, the yield on 30-year Treasury bonds was only 2.50%.  It couldn’t hurt to get a second opinion about whether the trust really can expect a risk-free return one-and-half times greater than Treasuries.

In addition, if the underlying assumptions were known, it would be possible to perform a “stress test” on the Bartel estimates.  Suppose, for example, there are more post-January 2019 retirees or higher retiree health benefits than the proposal assumes.  For how long will the trust be able to cover the greater liability?  Or suppose fewer employees contribute, or their salaries are lower, than the proposal assumes.  Will the trust exhaust its assets even sooner than 2035?

We don’t know.  And neither does Council.  It is by no means an insult to staff or to Bartel to suggest that Council ought to consult an independent expert about these valuation issues before it signs off on the new public safety contracts incorporating the trust proposal.  We’d pose the following question to Mr. Oddie and his colleagues:  If you were buying a used car, wouldn’t you check the Kelly Blue Book to see whether the car is worth what the seller says it is?  If so, why wouldn’t you solicit an opinion from a neutral source when you’re being asked to spend the City’s money to create an OPEB trust?

The other issue that a prudent Council would want to address is this:  Does the trust proposal create any implied legal obligations that would preclude the City from taking other, possibly more effective steps in the future to reduce its unfunded OPEB liability?

City Treasurer Kennedy expressed concern about this issue at the April 16 Council meeting.  He posed the hypothetical of a 30-year-old firefighter who pays into the trust every year for 20 years – only to find out, when she retires, that the trust has run out of money.  “If I’m an employee, I’m kinda wondering, geez, I put money in for 20 years, it came right out of my paycheck, I saw it on my stub, what do you mean there’s nothing there?”  Mr. Kennedy said.  “There might be some legal ramifications of doing it this way.”

Indeed there might.  As we discussed two weeks ago, the California Supreme Court has held that a governmental employer can create vested rights to retirement benefits “by implication,” even if the contract itself is silent on the issue.  Now consider Mr. Kennedy’s hypothetical case of the 30-year-old firefighter.  The Treasurer told Council “it doesn’t sit well with me” for her to get nothing from the trust to which she faithfully contributed for 20 years.  It might not sit well with a judge, either.  And if not, the judge could decide that, by taking money out of the employee’s paycheck to fund payment of benefits to current retirees, the City “impliedly” promised that she would be entitled to the same benefits when she retired – forever.

(Since we keep reading misstatements of the law by friends of the firefighters’ union, we feel compelled to add that the courts also have made it clear that, absent an express or implied promise to provide a retirement benefit in perpetuity, a governmental employer can modify, or even eliminate, that benefit).

If a judge finds that current employees who pay into the trust acquire an “implied” right to receive the same OPEB benefits that were provided while they were making their contributions, the list of options available to the City for really solving the problem of unfunded OPEB liability gets shorter.  Forget about the recommendation made by the majority of the Pension/OPEB Task Force to negotiate down the total liability.  Forget about the suggestion we’ve made – and appellate courts have approved – to cap the amount paid for retiree health insurance.  Once the right to a specific benefit becomes “vested,” it lasts forever.

There is, of course, no way to know for sure how a judge might rule.  But Mr. Kennedy, for one, would like Council to get an expert legal analysis of that issue before it approves the contracts incorporating the trust proposal.  “We need to know what this [i.e., the trust proposal] does to our future ability to deal with this problem, particularly if this is not a solution to the problem long run,” he told Council on the 16th.  “If this limits, if this ties our hands at all, that’s something really serious to consider.”  Retaining a lawyer with expertise in retirement benefits would be more than just money well spent, he said.  “Getting some sort of third-party opinion is absolutely a fiduciary responsibility before you embark on something like this.”

Hear, hear.  (And we’re not just saying that to generate business for lawyers).

If the recent spate of op-ed pieces in the Alamedan and the Sun is any indication, the firefighters’ union is putting on a full-court press to get Council to approve the new public safety union contracts on the 29th.  And who can blame them?  It’s their job to get the most lucrative deal they can for their membership.  But we hope that those elected to Council see their job slightly differently.  What’s good for General Motors wasn’t necessarily good for the country.  And what’s good for the firefighters may not be good for the City.  In this decision, as in others, “Alamedans first” is not just a campaign slogan.

In any event, we remain puzzled by the insistence that Council act now to approve the new MOUs.  Where’s the fire?  If the trust proposal truly makes significant progress toward solving the OPEB problem without imposing adverse financial consequences, presumably it would be heartily endorsed by independent actuarial and legal experts.  Why not wait a few weeks to find out?

Sources:

April 29, 2015 staff report: 2015-04-29 staff report re IAFF contracts

Bartel “Alternative Funding Study”: 2015-04-29 Ex. 5 to staff report – Bartel Associates OPEB Safety Alternative Actuarial Study Report

Bartel January 1, 2013 GASB 45 actuarial valuation: OPEB Final Report

Bartel “Thirty Year Projections”: OPEB savings

About Robert Sullwold

Partner, Sullwold & Hughes Specializes in investment litigation
This entry was posted in Budget, City Council, Firefighters, Pensions and tagged , , , , , , , . Bookmark the permalink.

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