PHILADELPHIA — They may not have headline-grabbing white elephant incinerators or sewer systems entangled in incomprehensible derivatives, but many local governments face mounting strain from another, quiet source they all share — workforce costs.
The problem is structural, not cyclical, several experts said at last week’s Bond Buyer Symposium on Distressed Municipalities.
“For almost any turnaround, any distressed municipality must come to terms with workforce costs. This is too big to ignore for any recovery plan,” said Michael Nadol, a managing director of PFM Group Inc.
According to Nadol and Girard Miller, a PFM senior strategist, localities must cope with soaring personnel costs, notably related to pensions and other post-employment benefits, or OPEB.
“If pensions are the tip of the iceberg, then OPEB is under the water,” Miller said.
Nadol and Miller said health care and retiree costs are rising faster than the overall economy. They said challenges include legal limits on management rights and insufficient political will to grasp the problem.
Miller, citing Pew Center on the States data that had pension funding levels nationwide at about 72% — down from the 79% it cited in its landmark April 2011 report — said that level could drop to roughly 60% at the bottom of the next recession. Pew considers 80% an acceptable threshold.
Rating agencies, while acknowledging the heightened awareness of pension burdens, often find it difficult to compare relative burdens by state.
To counter that, Fitch Ratings last week introduced a new metric into its state analysis to enhance comparisons. It combines each state’s net tax-supported debt with the unfunded actuarial accrued liabilities of the major pension systems that are the responsibility of the state. Fitch measures the result against the state’s personal income.
“Debt and pensions are fundamentally different types of obligations, which is why we think it is important to use a combined metric as an addition to, rather than a replacement of, our analysis of bonded debt,” said Fitch senior director Douglas Offerman.
Tim Blake, a managing director at Moody’s Investors Service, said his agency does not rate pension obligations per se, but the levels factor increasingly into ratings.
“Our credit ratings are based on the ability to pay bond debt in full on a timely basis. We view pension benefits as one part of the credit story. It’s one factor in our analysis, but it can drive ratings changes,” he said at the Philadelphia conference.
So far in 2012, Moody’s has downgraded Connecticut and Illinois, two issuers with high-profile pension-funding problems.
Recent multi-notch local downgrades and defaults, Blake said, most commonly reflect tax base erosion and weak demographics, other severe revenue constraints, escalating wage and benefit costs, risks related to outsized government enterprises, and poor fiscal management.
For many cities, employee wages and benefits account for at least two-thirds of general fund spending. The U.S. Government Accountability Office projects that unchecked, budget gaps for the aggregate state and local sector will widen over 50 years.
Legal tools also vary by states and are often limited, according to Nadol and Miller.
In Pennsylvania, for example, the state Supreme Court ruled in December that cities can no longer use their distressed status under the state-sponsored Act 47 program to hold off collective bargaining awards and limit wages for public-sector employees.
The case involved a Scranton firefighters union.
University of Minnesota professor Amy Monahan called on state courts to re-examine pension plan laws.
“The legal regulation of public pension plans leaves much to be desired,” she wrote in 2010. Among other flaws, she said, “The contract-based approach often fails to give states needed flexibility to adapt their plans to changing circumstances.”
According to Ballard Spahr LLP partner Patrick Harvey, management must guard against minimum staffing provisions, inefficient scheduling, no-layoff clauses and inefficient work rules.
“Municipalities are starting to get their acts together, but they’ve been their own worst enemies,” Harvey said. “You all know the problems. We want to get to the solutions.”
Searching for solutions, Rhode Island made big waves last year. With General Treasurer Gina Raimondo running point, the nation’s smallest state passed a law overhauling its public pension plans for state workers effective July 1, though the measure will face court challenges from unions.
Rhode Island stands to follow several other states in putting new employees into a hybrid plan.
According to the Pew Center, it would be the first to incorporate current employees as well.
The far-reaching package creates a hybrid plan merging conventional public defined-benefit pension plans with 401(k)-style plans, and suspends cost-of-living adjustment increases for retirees.
The plan also raises the retirement age for employees not yet eligible for retirement.
Follow-up legislation is in the works this year to allow Rhode Island local governments to modify retirement plans in a similar fashion.
“The biggest question we get is, 'How did you do it?’ ” Raimondo said during a recent visit to The Bond Buyer’s newsroom in New York.
The treasurer took a grass-roots approach, holding town hall meetings, making television appearances and even conducting Internet chats.
“The method worked for us. We focused on the facts, never blaming anyone,” Raimondo said. “We educated the public and put forth a solution.”
In addition, Raimondo worked extensively behind the scenes with other state political leaders.
Raimondo emerged as a national figure after the law passed.
“This Gina Raimondo thing is very interesting. It was not like an election campaign,” former Kansas City, Mo., Mayor Mark Funkhouser said at the Philadelphia conference. “She’s a hometown girl. She’s one of them, one of the family. She leveled with everyone at little town halls, meeting after meeting, They said, 'She’s like my daughter, she’s like my wife.’ They knew she was not going to lie to them.”
In Central Falls, R.I., a city of 18,000 people and an $80 million pension shortfall, receiver Robert Flanders, a retired state Supreme Court justice, said a state law passed last summer that gave bondholders priority in bankruptcy helped set up a Chapter 9 filing that enabled him to rework pension agreements.
Flanders, a partner at Hinckley, Allen & Snyder LLP, recalled asking retirees last July to agree to pension benefit cuts of roughly 50%.
“They looked at me like I had three heads. It was a very unfriendly meeting,” he said of the get-together at Central Falls High School.
Flanders then filed for bankruptcy on behalf of the city on Aug. 1.
“The savings the city needed to realize began to kick in the day we filed. We found out we could blow up any contract we didn’t like,” he said.
Four months later the city and retirees agreed on 55% benefit reductions.