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Explainer: The City’s Police and Fire Pension Shortfall May Not Be the Calamity It Was In 2016

The Dallas Police and Fire Pension System's status is still a concern, and it will need the city to increase its contribution to improve its odds. But it's not quite at the verge of collapse, as it was in 2016.
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Tuesday’s news of the Dallas Police and Fire Pension System’s $3 billion shortfall in funding made many worry that the system was reverting back to 2016 —insolvent and headed rapidly toward complete collapse.

But the current $3 billion is not like the $1.1 billion the system needed six years ago to stay afloat. For one, this $3 billion is meant to be disbursed over time, in monthly payments to pensioners. In 2016, the pension was dangerously close to being immediately out of money. This time, the pension system wants the city to increase its funding by 35 percent—which would be roughly $58 million.

Pension administrator Kelly Gottschalk told the council’s Government Performance and Financial Management committee this week that the system couldn’t make any more cuts to benefits, nor could it expect officers and firefighters to pay into it at a higher rate. “The only viable solution is additional substantial funding from the City,” she said.

As it stands, in addition to the city increasing its funding share, retirees will likely not see a cost of living adjustment in their benefits for another 51 years. At the current rate of investment returns and new enrollees, the pension won’t be fully funded until 2090. The state legislature is expecting it to be fully funded by 2055.

But to understand why this isn’t the same situation, we’ll need to review a few things.

How the pension works

Funding a pension is a balance of calculating life expectancy and managing the fund’s investments. A fund like the Dallas Police and Fire Pension, which will be referred to as DPFPS pays a monthly benefit to retirees, and its liability is the total of all payments it expects to pay current and future retirees based on how long they are expected to live.

As it pays monthly benefits to retirees, new employees (who will also eventually retire) are hired and begin to pay in. Those funds are then invested. The pension has a perpetual cycle that pays retirees while gaining future retirees who will need to be paid. To do that, the fund will invest those payments, and ideally, said investments increase the amount of money the fund can pay out or reinvest.

If the investment returns aren’t enough to pay current retirees, then it has to dip into the principal, or the sponsor (in this case, the city) has to pay in more money. Neither scenario is ideal, but the former is less so because it not only reduces the amount available to invest but it also inhibits further growth of the fund.

The board has to weigh that the more unorthodox investments have a higher rate of return but also increased risk. If those investments do not pay off, a fund can see itself in the kind of trouble that put DPFPS in a disastrous situation in 2016.

What happened in 2016, and why that matters now

Part of the reason the fund was precipitously close to bankruptcy in 2016 had a lot to do with the way it was structured. The DPFPS had two programs that could be paid into—the full pension and a deferred retirement option plan, called DROP. 

If an officer or firefighter reached 20 years, they were eligible to get their full pension. If they wanted to continue working past that date, their pension payments could be placed into DROP. That meant that when the officer or firefighter finally retired, they would receive their pension payment, plus DROP, which guaranteed 8 to 10 percent interest. 

That guarantee left the fund under the gun to produce, which in turn led to high-risk investments that had higher yields in a bid to meet that guaranteed return and keep the overall fund healthy. 

A lot of those investments were in luxury real estate developments that didn’t perform as expected, leaving the pension holding the bag. We wrote about all this in 2016.

“We are doing our best to get out of them,” Gottschalk said Tuesday. “I don’t know what the thinking was at that time.”

When the stock market collapsed in 2008, the system had been increasing its investments in riskier prospects for about four years. By 2014, more than 56 percent of the fund’s assets were invested in those higher-risk prospects, which drastically underperformed. When the pension system said in August 2016 that the shortfall was so bad that benefits would need to be cut, retirees began withdrawing their DROP contributions to the tune of about $500 million, ultimately leaving the system with about $729 million in liquid assets—very close to the bare minimum of $600 million it said it needed to keep on hand.

The city stopped enrollment in DROP and suspended new enrollments into the program. Eventually, the move was made to make DROP payments annuities instead of lump-sum withdrawals. In 2017, the Texas Legislature passed House Bill 3158, which saved the pension for a time, but didn’t necessarily fix it. 

Instead, it gave the city and the system about seven years to come up with a plan to return the fund to solvency and keep it at a healthy funding level. In 2024, the pension system will need to demonstrate that it can achieve full funding within 30 years, and submit a plan before the 2025 legislative session.  

So how bad is it, really?

It’s an issue, but it’s not the crisis it was in 2016. One city official we spoke to on background noted that much has changed since then, which is true. The folks in charge of the investments have turned over. The fund’s leadership is different. The board is different. None of what was in Tuesday’s report, the official said, was a surprise. The city has always known it was operating with a deadline, and Tuesday’s presentation was a problem but not a crisis. 

Much of the outlook for the fund is predicated on how the economy performs. The fund’s portfolio has recently underperformed, and currently, more than a third of its assets are not liquid, compared to the 15 percent target the fund has set for itself. That doesn’t mean the fund is nearly broke; it means it doesn’t have a large cushion of cash on hand. It also means that if the economy improves, its valuation improves. 

The city still has a year to work on a solution, and Mayor Johnson has assembled a study group led by Bill Quinn and Rob Walters (both have served on the DPFPS board) to examine how to actually fix the system and keep it solvent in future decades. The city does have at least a couple of options, especially since its current bond rating outlooks are better than they were in 2016. In 2005, Dallas used $535 million in pension obligation bonds to keep the Employee Retirement Fund afloat. 

Bonds come with their own set of problems, though—threading the needle to make sure that the interest rates on those bonds don’t negate the gains from investments made in a volatile market can be precarious, too. The city will soon begin issuing bonds for the new Kay Bailey Hutchison Convention Center and Fair Park renovations, too, which may mean it would find the prospect of pension obligation bonds to be unattractive.

Tl;dr

Although at first blush, it might appear that the pension is in a similar level of crisis as it was in 2016, that’s not the case. The system is still dealing with significant issues related to the pension’s previous mismanagement, but there is a plan in place to make it solvent for future retirees, and unlike six years ago, it is not on the verge of collapse.

Author

Bethany Erickson

Bethany Erickson

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Bethany Erickson is the senior digital editor for D Magazine. She's written about real estate, education policy, the stock market, and crime throughout her career, and sometimes all at the same time. She hates lima beans and 5 a.m. and takes SAT practice tests for fun.

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