Dallas Police and Firefighters Pension Funding Crisis–Part 2

In Part 1 we discussed an extremely basic foundation of pension funding. Specifically, why pension plans are not fully funded and why they run into problems with their investments. Let’s take those basics and apply them to the funding problems of the Dallas Police and Firefighters pension.

The foundation of the Dallas, Texas pension funding crisis

To really understand the problem with the Dallas pension you have to understand the function of the pension. Most people consider pensions as an employment benefit gratuitously offered by the employer because the employer cares about the employee’s well-being. As an employment lawyer I know the existence of pensions is more complex. Pensions exist as a method to defer payment of compensation to employees. Instead of paying more wages today the employer can break up payment for today’s work by paying some as wages (and benefits) today and some as pension payments later. The employer gets the work today and then compensates the employee over time for that work. It makes the labor cheaper to the employer because the employer can externalize some of the cost by letting investment on the pension assets pay some of the benefits. (As discussed in Part 1.)

If you’re a Dallas mayor looking at a city with a crime problem that can’t raise police salaries to compete with other cities for qualified candidates but need qualified candidates and to retain staff then you might improve pension benefits as a way to increase compensation without having to pay it today. This is exactly what Dallas did.

DROP and the Dallas, Texas pension

One way Dallas improved the pension benefits was how it structured its DROP. DROP is deferred retirement option plan. Under the pension an officer or firefighter who met twenty years of service could retire and receive a full pension. DROP allows the employee to continue working for Dallas and receive pension payments which are credited to an account with the pension for the employee. When the employee retires he or she gets the pension benefit plus DROP. This allows Dallas to retain veteran officers and firefighters, thereby reducing its need to staff and train new officers and firefighters. It also allowed the plan to delay tangible payments from the pension. DROP accounts are credited with benefit payments but the pension plan retains the funds and continues to invest them. With benefit payments to DROP accounts only make on paper the plan could keep more money invested and try to obtain more returns.

To improve the attractiveness of DROP, the pension plan paid eight to ten percent guaranteed interest on DROP. (Later reduced to six percent.) Most cities in Texas do not pay interest on DROP or pay far less. This made the Dallas plan far more attractive. Now the Dallas pension has to gain returns to cover its currently due benefit payments, interest on bonds that financed the plan, the accruing but unpaid DROP funds and sizable interest on the accrued DROP funds.

If this seems like a high degree of risk then you’re reading this correctly. At the time–early to mid-2000s–investment returns were substantial. Real estate was a rocket and the stock market wasn’t far behind. It may have been possible to cover these liabilities if the markets continued to soar without retracting. We know that didn’t happen. But wait–add mismanagement to the mix.

How Dallas, Texas pension management blew it

In addition to voluntarily creating a swelling pension liability, the pension plan administration fell to a long string of mismanagement that exacerbated the problems created by the 2008 market collapse. Across several mayors it has been alleged that the mayor and Dallas city council failed to exercise proper oversight. This allowed the plan administrator at the time to run amok. He had a preference for real estate investments, allegedly, and made some bad investments. He reportedly oversold the investment returns and valued the investments at their purchase price without regard for changes in market value. The result of these alleged facts is a pension plan deeply underfunded with insufficient returns in illiquid investments while liabilities grew rapidly. Without clear knowledge that the pension was in financial crisis the situation could only continue to sink. By the time it became clear the pension had funding problems there was a race to withdraw DROP funds which created an immediate need for liquidity and a sudden depletion of capital.

In short: bad management, bad investments, bad plan design.

What will happen now to the Dallas, Texas pension

This is all bad news for Dallas. It’s bad news for the police and firefighters especially. Inevitably, as is always the case in these situations, the employees will bear the brunt of bad management. The employees put in the work in exchange for compensation and now Dallas doesn’t want to pay. (The people employed to manage the pension got theirs.) Dallas is in the process of trying to work out a resolution, most of which seems to involve the employees and retirees taking a pay cut. If Dallas cannot work it out on their own then the state government will have to step in. Likely to the same result. At least the employees have some help because they are public employees. The Texas Constitution gives due process rights to pension benefits accrued by public employees; but that does not mean Dallas cannot challenge it. (As it has in the past.)

It doesn’t get better for Dallas residents. As police and firefighters see compensation cut and feel the city doesn’t support them they will look elsewhere for work and Dallas will end up right back where it started fighting to keep qualified police and fire employees. Then expect crime to start to rise again in Dallas.

All this is not just a Dallas problem. Fort Worth has pension funding problems. Many Texas cities have ticking time bombs in their pensions with the same kind of investment problems.

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