Dallas Police and Firefighters Pension Funding Crisis–Part 1

Dallas residents may have discovered over the past several months a financial crisis in their city related to the Dallas Police and Firefighters Pension. Few people really understand pension funding and how pension funding created this billion dollar shortfall for the city. The local news media in DallasFort Worth, Texas has done a fairly good job of discussing current activities to try to resolve the financial crisis; but they have generally done a poor job explaining how pension funding caused this crisis. As a Dallas employment attorney with experience working with large pension plans I can delve into the mysterious web of pension funding. I worked with many of the nation’s largest private pensions through their run of funding problems following the 2008 financial market collapse and see the same problems with the Dallas Police and Firefighters Pension.

My discussion will focus on the actual funding issues rather than the administrative problems in Dallas–although I will touch on them. We’ll talk pension funding basics and then how that fit into this Dallas municipal pension. Then I’ll forecast the future of this funding problem for Dallas, Texas. Today’s post will just get our feet wet with pension funding basics.

Pension Funding Basics in Texas

Pension funding lies at the intersection of life expectancy calculations and investment management. A defined benefit pension like the Dallas Police and Firefighters Pension promises a monthly benefit to retirees based upon a specified formula. The plan’s liability is the total of all payments the plan projects to pay to its present and future retirees based upon their life expectancy. As Dallas hires employees and the employees continue to work the plan’s liability grows. At the same time the plan satisfies part of its liability by paying benefits to retirees. The pension is in a constant state of paying retirees and accruing liability for future payments.

Pension plans are rarely fully funded; meaning they do not hold enough cash to pay all of its present and future liabilities right now. Instead pension plans hold an amount of money then invested so the investment returns pay the pension liabilities over time. If the investment returns do not satisfy the pension liability presently owed then the plan either pays out of the principal or the plan sponsor must pay more money into the plan. (In this case, Dallas tax dollars go to the plan or Dallas issues bonds to finance the pension.) It’s cheaper for the plan sponsor, Dallas, to put up some of the money early on and invest it because the investment returns externalizes the cost of benefits owed by the plan.

An example

Think about it like this. You hire me as your employment attorney in Dallas, Texas and I do $10,000 of work for you. (We will discuss why I agree to delay payment in Part 2.) I agree to delay receipt of payment until one year from today. You could pay me $10,000 out of your pocket; however, a friend tells you if you’ll loan her $5,000 today she’ll give you $10,000 a year from now. If you loan her the money then you can cut your bill to me in half. Do you want to pay me $5,000 or $10,000? Obviously you want to reduce your costs. This is what pension plans do. They raise the $5,000 today and invest it so somebody else owes them the other $5,000.

Investment Issues

So pension plans have these big piles of cash they need to invest. The amount of money in the Dallas pension, like most pensions, is so large that the plan can invest in more exotic investment instruments than common stock or bonds. They can invest in instruments that carry different types of risk. The instruments may be illiquid (not easily liquidated to cash if needed). They may not be as easily priced as punching in a ticker symbol on a broker’s website. There may not even be a definitive value for the investments. Plan administrators have to exercise diligence with investing the plan’s cash reserve.

Now you may ask: why invest Dallas pension funds in these unusual investments if they carry so many risks? Greater potential returns. Remember if the pension’s assets cannot cover its liabilities then Dallas, Texas either has to throw tax dollars at the pension or take out bonds to debt finance it. If an investment collapses or fails to deliver promised returns then the pension still owes all of its liabilities. Benefit payments must still go out. The more the plan externalizes its costs the less Dallas residents pay for police and fire protection. This creates a desire on the part of plan administration to choose risky investments, fail to thoroughly vet investments and to cover up investment failures.

In Part 2 we’ll apply these principles to the Dallas pension; and how these very issues compiled together into a massive funding crisis for the City of Dallas.

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