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Explaining What’s at Stake as Dallas Works to Solve $3.3 Billion Pension Shortfall

The city and the pension system for police and firefighters need to hammer out a plan for solvency by November. Sources say there's much they can agree on, but one thing has stymied negotiations.
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The Dallas Police and Fire Pension has a $3.3 billion hole that the city and the system are trying to plug. dallashabitatphotos/Flickr (CC BY-NC-ND 2.0)

The hang-up between the city of Dallas and the Police and Fire Pension Fund appears to be a cost-of-living adjustment that was removed in 2017 as the pension inched perilously close to not having enough money to fulfill its obligations.

Multiple sources say the city and the pension are at loggerheads over adding some sort of increase to offset inflation for its beneficiaries. The retirees have filed a motion to appeal a prior suit, which, if they win, could spell doom for the pension’s liquidity. Meantime, the state has given the entities a November deadline to reach an agreement to shore up a more than $3 billion shortfall and create a path to sustainable solvency.

But how did we get here?

The total bill is about $3.3 billion, a hole that was precipitated by the pension’s near collapse in 2016. The Texas Legislature in 2017 mandated several things, including that the pension and the city devise a plan to become solvent by 2055. That is what the two must submit in the next six months or the state will dictate its own plan, which will likely be just as painful as the immediate fix from 2017.

On Thursday afternoon, the City Council’s Ad Hoc Committee on Pensions will be briefed on the progress of those negotiations. The meeting was delayed for “additional time to seek consensus” on the funding plan, which sources interpreted to mean that there are still disagreements to work through.

Pensions are funded by calculating the life expectancy of its members and then managing the fund’s investments and city contributions to keep pace. The pension pays retired Dallas cops and firefighters a monthly check. Its liability is the total of all payments it expects to send to current and future retirees based on how long they are expected to live.

If investment returns don’t generate enough revenue to pay current retirees, then it is forced to dip into the principal, or the city must increase its contribution. The former is the worst-case scenario as it reduces the amount of money the pension fund has to invest, thus inhibiting its growth. 

The total bill is about $3.3 billion, which was precipitated by the pension’s near collapse in 2016.

In the years preceding the 2016 near-collapse, the fund had invested in high-risk real estate and land purchases that, if successful, would have had a higher rate of return. But they were not successful, and the fund plunged into a disastrous situation exacerbated by an unusual, two-track pension product. 

Until 2016, the system’s 9,300 firefighters and police officers could pay into two different programs. They had a full pension program and a deferred retirement option plan, known as DROP. If an officer or firefighter reached 20 years of employment, they were eligible to receive their full pension. But if they wanted to continue to work, they could place their pension payments into DROP. When they finally retired, they would receive their pension payment in addition to the DROP payments, which guaranteed an unheard-of interest of 8 to 10 percent. 

“Dallas had the lowest funded ratio, the highest share of assets allocated to alternatives, and the highest ratio of DROP assets to total assets of any plan in the state,” Alicia Munell, director of Boston College’s Center for Retirement Research, said in a 2017 analysis. “Dallas is unique in Texas.”

When the stock market collapsed in 2008, the system had spent years investing in riskier prospects, like Museum Tower and hundreds of acres of land in Arizona. By 2014, more than half of the fund’s assets were in those types of investments, which drastically underperformed. By August 2016, the pension announced that the shortfall had grown so large that it needed to cut benefits. Retirees quickly began withdrawing their DROP contributions. The run on the pension hemorrhaged about $500 million in a flash, leaving it with about $728 million in liquid assets—close to the $600 million it considered to be the bare minimum. If the pension fails, the city is on the hook for its liabilities.

Dallas stopped enrollment in DROP. Eventually, DROP payments were made in annuities instead of lump-sum withdrawals. The Texas Legislature passed House Bill 3158 in 2017, which, in addition to plugging immediate holes, gave the city and the pension seven years to agree to a plan for long-term solvency.

Cost-of-living adjustments also ceased during this process. 

Nobody was happy with the temporary solution, but the city’s current retirees—who had paid into the pension for years—were furious. A group of retirees led by Larry Eddington, the architect of DROP in Dallas, sued to reinstate the provisions the pension offered prior to the legislative intervention. The lawsuit argued to reinstate the DROP payments, and argued that cost of living increases were constitutionally protected. It wound its way through the court system, and ultimately the Texas Supreme Court sided with the pension in 2019.

But that doesn’t mean the legal battle is over. In an update posted to the Dallas Police Retired Officers Association in January, David Elliston, the association’s president, told members that its lawyers filed a motion in January asking the full court of appeals to reconsider reinstating the pre-2017 cost-of-living increases. Elliston also told members that they had hired former state Supreme Court justice Eva Guzman and her firm at Wright, Close & Barger. (That update has since been moved to a members-only section of the website, but can be seen in web archives here.)

The legal motion has affected negotiations between the pension and the city. In an email to city officials last month, which was obtained by D Magazine, the pension’s general counsel, Joshua Mond, urged the city to consider making an offer to the retirees who would “immediately begin receiving an assured COLA,” an acronym for cost-of-living adjustment. In return, Mond said, the retirees had promised to drop their lawsuit. 

The association representing the retirees would not comment directly about that claim but did acknowledge media reports about the negotiations. The organization “follows those reports with interest but is not a participant in those discussions,” the statement said.

In an interview last week, Mond said he was concerned that if the court suddenly found for the retirees, the resulting ruling could collapse the pension.

“Yes, we won in district court. Yes, we won at the court of appeals. And yes, we believe we have a very solid legal position. But at the end of the day, there is no sure thing in life, and we would like to take that potential risk off the table,” he said. “It’s a very large risk—$1.4 billion is the rough calculation.”

In the email presenting the proposal, Mond estimated the price tag for the adjustment to be $160 million to $180 million. “It would be very unfortunate for an adverse ruling to put us back to square one when a resolution of the matter is at hand,” he wrote. The suit, on the other hand, could increase the pension’s liabilities to the breaking point. The motion for the rehearing asks the court to consider reinstating the annual 4 percent increase.

The pension cannot agree to a settlement with the retirees, Mond said last week, without receiving assurance from the city that it will be funded. 

“If we did reach an agreement with the retirees, it would be up to the city to agree to the terms as part of the bigger plan,” he said. “It’s just a small piece, frankly, of the whole funding of the plan aspect that we’re trying to reach an agreement on.”

Council members will be briefed on the status of pensions and cost-of-living provisions at Thursday’s committee meeting. Consultants are expected to explain what retirees were receiving from the pension prior to 2017 and why they haven’t seen a cost-of-living increase since. According to city documents, the pension must be more than 70 percent funded to afford such a benefit. Documentation from the Pension Review Board’s May meeting indicates that the system’s funding level is somewhere between 34 and 39 percent.

Untangling its bad investments has decreased the pension system’s funding level from 41 percent in January 2022 to 34 percent in January 2023. Without any changes, it would take 82 years for the fund to reach solvency. The Legislature wants it solvent in 30.

In 2022, Kelly Gottschalk, the executive director of the police and fire pension, told the Council that the riskier investments were still hamstringing progress. “We are doing our best to get out of them,” she said. “I don’t know what the thinking was at that time.” Sources familiar with the negotiations between the city and the pension system say some of those investments are still part of the system’s portfolio.

Interim City Manager Kimberly Bizor Tolbert said bluntly that reinstating the old cost-of-living adjustment would “gut” the pension.

“The pension is first and foremost about retirement for our employees, both in and out of uniform,” she said. “But the numbers have to add up. And a requirement to reinstate pre-2017 COLA for the police and fire pension fund— which the City does not support—would gut it.”

Jeff Patterson and Jaime Castro, the presidents of the Dallas Fire Fighters Association and the Dallas Police Association, say they understand the city’s dilemma. But they argue that their members need an increase that attempts to cover the rate of inflation since 2017.

“These retirees haven’t had any sort of increase since 2017, and we all know how inflation is and the dollar doesn’t go as far as it did,” Patterson said. “Obviously the first thing was getting this pension secured and funded, but then it should be finding some money somewhere to at least get these retirees a COLA.”

Castro says the DPA believes the two sides will come to an agreement, but that any resolution without a cost-of-living adjustment is “unacceptable.”

“[W]ith today’s historic rate of inflation, we cannot accept a plan that doesn’t provide a COLA where we can live on,” he said in a statement. “Currently, Dallas Police Officers will not receive a COLA until the pension is 70 percent funded, this is projected to be in 2046.”

“These retirees haven’t had any sort of increase since 2017, and we all know how inflation is and the dollar doesn’t go as far as it did.”

Jeff Patterson, president of the Dallas Fire Fighters Association

Sources in City Hall, the fire and police departments, and the pension describe near-daily discussions about the pension and the city’s options. Negotiations have been presented to the public as ongoing and congenial, but fissures have been appearing since at least January, when city and pension officials appeared before the state Pension Review Board to provide an update.

That meeting included Gottschalk, the head of the police and fire pension; Nicholas Merrick, the board’s chairman; and Jack Ireland, the city’s chief financial officer. Two consultants from the actuary firm Cheiron, which the review board hired to craft a plan to bring the two funds to solvency, were also in Austin that day.

Keith Brainard, the chair of the review board’s actuarial committee, reminded the board that the issues with the pension “are the result of years of poor governance and poor decisions made by multiple entities, including the legislature, the city, and the pension fund.”

He also reminded city and pension officials that they need to work together. 

“If you are unable to come to an agreement to fix the problem, the legislature will do the job,” Brainard said.

The pension sought to clarify who had final say over the plan around the same time, Mond said. In a memo from the pension’s outside counsel, also obtained by D Magazine, the pension insisted that its board “has exclusive authority to adopt a pension plan.” City Attorney Tammy Palomino disagreed, writing earlier this month that state law required the pension system and the city to work together. Either way, funding the plan requires the City Council to approve the expenditure.

Mond concedes that the memo, without context, probably didn’t land well at City Hall. But he also says that the cost-of-living adjustment has always been a sticking point.

“The letter was written because things were never really humming along,” he said. “You know, Kelly (Gottschalk) for years and years has been saying publicly that there remains an issue, and it was known in 2017…and that’s why the parties instituted this sort of ‘OK’ mechanism knowing that in seven years we would be back to the table. That’s always been known.

“The pension system is not saying that we will likely have the final say—we are realistic and know that if there’s no agreement, the legislature will have the final say,” he said.

Tolbert didn’t use emphatically positive terms to describe the negotiations, either.

“From where I sit, the negotiations are going as can be expected,” she said. “We agree on some elements but still have a way to go. The city is committed to getting this done. The math has to work. That’s where we are.”

Both sides agree that having the state legislature make a decision about the pension would not be an ideal outcome. 

“We should be able to come to an agreement and address it here at home,” Tolbert said. “That is the expectation from the city’s perspective, as well as the expectation of the Texas Pension Review Board in Austin. This is a local issue, and we are committed to solving it locally.”

Mond says that he, Gottschalk, and the pension board are aware that any plan presented to the pension board is a three-legged race: no plan can be implemented without city money. That means it must secure the Council’s tacit approval to obtain those funds.

In January, Ireland, the city’s CFO, told D that Dallas’ options come down to “the math—we either need more money coming in or less money going out.” He said that the city does not favor increasing the amount employees contribute to the pension because “they would be paying more for a benefit than what it is going to be worth.”

Dallas must balance its ongoing needs—like services to residents and employee salaries—with paying for its pension obligations.

“How quickly can we increase our annual amount from the $180 million or so that we’re already paying—at least on the police and fire side?” he said. “How soon can I get that to $220 and $240 and $260, and for that to continue on how for the next 30 years?”

A plan has emerged to gradually increase those payments over the next five years, and then move to an actuarially determined contribution, or ADC, a rate that combines the cost for benefits that year and the unfunded liabilities from any funding shortfall over time.

Tolbert says that plan hasn’t changed. “We have always been committed to meet the 30-year funding plan,” she said. “Any unplanned or additional expenses could change the funding structure and that would impact taxpayers.”

Mond said that even with the ongoing negotiations regarding cost-of-living increases, he thinks the public can feel confident that any plan the city and the pension hammers out will be successful.

“I don’t really have any interest in talking about what transpired in the past because it’s a lot of things and it wasn’t just one thing—it was a zillion things,” he said. “We’re just looking to move forward. Since 2017 the board—which has had a majority of mayoral appointees—has done a phenomenal job running the system.”

In January, then-City Manager T.C. Broadnax seemed to second that.

“I think they’re much further along in their fiduciary understandings of what’s going to make sure that their funds perform and do well, and we feel a lot more comfortable than we did five years ago,” he said.

Patterson, who was more willing to address the past, agreed with their assessments. 

“The previous board was probably not making the best choice as far as investments, maybe being a little too aggressive with some unorthodox investments, that’s no secret,” he said. “The whole board makeup was changed with the legislation in 2017, and we have professional money managers who are volunteering their time to help get this thing back on track, and they’ve been doing a great job.

“They just need more money.”

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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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