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Lexington, Ky., and Unions Reach Consensus on Pension Plan Reform

BRADENTON, Fla. – In Lexington, Ky., elected officials and union representatives may have set the stage for a new level of dialogue on how to solve unfunded pension liabilities.

By all accounts, a recent agreement to restructure the city’s nearly 40-year-old police and fire pension system wasn’t an easy task.

But city leaders and union representatives say the consensual agreement worked out through an unusual public process is based on compromise and shared sacrifice that produced changes that will lead to a defined-benefit pension plan sustainable for both parties.

It wasn’t an easy road.

It took more than five years and two task forces with as many as 40 members. Ultimately a pact was nailed down in the last three months after Public Financial Management Inc. was hired and a small group of negotiators came to agreement through consensus.

The consensual agreement was approved by the entire task force nearly two weeks ago, and police and fire union members are now voting on it. Those results should be known by the end of next week.

The Kentucky General Assembly will be asked to approve the plan in this year’s session, which is under way through the end of March. City officials say they were asked to tackle the long-running underfunding problem by legislative leaders.

The task force approved a plan that immediately cuts the city’s unfunded liability by approximately 45%, and adjusts benefits for members of the Policemen’s and Firefighters’ Retirement Fund.

Lexington officials agreed to increase their annual payments and bind themselves to pay down the unfunded liability over 30 years through a change in state law.

The deal also eliminates the need for the city to issue $34 million of pension obligation bonds this year to cover the city’s minimum required payment. Lexington had issued $136 million of POBs since 2009 to cover annual required contributions, but officials said that didn’t work because the plan required fundamental changes.

Union representatives agreed to lower annual cost-of-living adjustments, increased contributions from active and future employees, reduced disability payments, and a revised plan for new hires.

“What is so unique about this is we protected a defined-benefit pension,” said Mike Sweeney, president of the Bluegrass Fraternal Order of Police. “I think it’s a good compromise even though there might be pensioners and members of the public who do not agree. I’m glad we reached a consensus with the city.”

There were sleepless nights, and not a lot of public sympathy, Sweeney said, adding, “We were just asking for a sustainable pension plan that we paid into.”

For the unions, he said, an important factor underpinning the deal was that the city’s does not participate in Social Security, he said. That means retirees receive only a portion of Social Security benefits.

Adding to the complexity of negotiations were underlying assumptions and requirements in state law that increased the city’s liabilities.

Lexington, population 300,000, is the only city in Kentucky that has its own police and fire pension plan, as an outcome of Lexington and Fayette County merging in 1974. As a result of the merger, the state retained control over the benefits that were offered, while the city was required to fund them.

For Mayor Jim Gray, who led the smaller team of negotiators with his staff and PFM, a new model had to be created because the city could not afford to continue paying for pensions on the current path.

“We saw in 12 years the ratio of pension costs as a percent of the general fund rise from 7% to 22% last year,” said Gray. “It was just not sustainable. It’s why a new model had to be created.”

Developing trust among negotiators and the public was critical to moving ahead, he said. The city kept the public apprised of developments, and continues to do so, on its website.

“From the beginning, we knew we had a tall order with this overall project, and also developing trust,” Gray said. “That was what this negotiating team really did illustrate in a remarkable way.”

Negotiations were not casual. There were “nose-to-nose” debates but they were “characterized by a level of trust that you don’t often see,” he said.

Hiring an expert consultant was essential to the process, said Gray, who worked in his family’s nationally ranked construction business before becoming vice mayor in 2006 and mayor in 2010.

PFM was hired after a competitive selection process in November. The firm’s fees were paid by the city, the Greater Lexington Chamber of Commerce, and the Lexington Industrial Foundation.

Vijay Kapoor, the director of PFM’s Workforce Consulting practice who worked on Lexington’s plan, said the city was only required to pay what he described as “the normal cost plus interest each year on the unfunded liability.”

Historically, the city made contributions of about $11 million a year, he said, though costs were rising to the point where the city needed to contribute $29 million a year.

Pension bonds were sold in recent years in an attempt to address the actuarially required contribution and nearly $300 million unfunded liability.

City officials said POBs were not addressing the problem, and that the bond deals were beginning to cause the city to bump up against its debt capacity and financing ability for capital expenses.

The new pension plan cuts the unfunded liability to about $134 million, and requires the city to contribute no less than $20 million a year, Kapoor said.

“This was done with increased contributions by the city to the plan as well as benefit changes for retirees, for active police and fire, and new hires,” he said.

Kapoor said the task force of city officials, legislators, union representatives, and local business interests made it clear from day one that they “wanted to fix the problem.” That included ensuring people receiving pensions under $40,000 retained 2% cost of living adjustments.

In a presentation to the task force Jan. 18, Kapoor outlined the problem and the solution.

Though there was determination among the task force to resolve the long-term funding problem, he said the public process used was very different from traditional pension negotiations, and helped the group reach consensus.

“The way that the process worked in Lexington was different than any place else I’ve worked,” he said. “This really broke the mold in terms of how these issues are usually addressed [by using] a task force and consensus.”

Kapoor said he believes Lexington’s approach can be used by employers across the country.

“It’s hard to overstate how rare it is to reach a consensus on a comprehensive solution that deals with an unfunded plan,” he said. “I’m not aware of it being used in any other place but hope it serves as a model for other cities and states.”

Mayor Gray agreed, and said Lexington’s experience could be valuable to other local governments struggling with controversy over unfunded pension obligations.

“It requires a plan, it requires determination, and it requires the best talent at the table,” he said.

The best possible deal was negotiated under the circumstances, said Sweeney, the police union representative.

“This isn’t perfect but if you look at other departments around the country they are seeking cuts and having to work longer,” Sweeney said. “This was a necessity we had to do.”

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