(Feb. 22,2013) With employee benefits having been a hot political topic over the past two years – and already acknowledged to be the key issue in the current contract negotiations between the city and its public safety unions – actuarial reports of the city’s retiree pension and health care funds for the final quarter of 2012 indicate that some of the anticipated benefits and drawbacks of recent plan changes may already be coming to fruition.
Consultants from Morgan Stanley, which manages the investment of the city’s employee benefits trust funds, presented the city’s Board of Pension Trustees with their quadrennial report this week, indicating a strong showing for the city’s investments over the past year.
The general employees’ fund gained 9.72 percent over the year, and the public safety employees’ fund 9.64 percent. The employee healthcare fund gained 8.91 percent, and gains for the current year are on target.
“The markets are really off to a great start and your portfolio is participating in that fully,” said Morgan Stanley’s Michael Holycross.
Since 1991, the city’s public safety employees have had a separate fund from the city’s general employees, due to the different retirement norms for public safety work. General employees pay five percent of their salary each week into the pension fund, with an identical match from the city. After 30 years of service, they become fully vested, meaning they will receive the maximum post-retirement benefit of 50 percent of their salary. Retiring earlier provides a somewhat lower payout.
For public safety employees, the vesting term is 25 years, and the benefit is 60 percent of salary, but they must contribute 8 percent of their pay while they work.
Despite this year’s excellent performance, none of the three plans have enough funding to fully cover their projected expenses in pension and insurance payouts – few municipal govern-
ments’ plans are fully funded.
Much of the reason for this is that the future value projections for the funds assume an investment return of 7.5 percent. While this was a normal – or even somewhat low – average rate at the time the plans were designed, the recent economic recession has reversed that dramatically.
Further, no new employees are paying into the funds, since they were controversially closed out two years ago in favor of individual 401(a) packages.
Even with this year’s excellent performances factored in, the average rate of gain over the past five years has only been 1.83 percent for the general employees’ fund, and 1.84 percent for the public safety fund.
The medical benefits fund has fared better, but only because it was conceived later; the Government Accounting Standards Board only began to require a separate retiree health benefits fund in 2009. As such, the health fund has made 7.4 percent since inception, but still only covers about 20 to 25 percent of its projected future costs.
Ocean City currently pays 80 percent of retiree health premiums, with the former employees themselves paying 20 percent. Spousal coverage is not offered.
In all cases, the city routinely bolsters its funds with additional capital, on top of what it normally pays in per employee paycheck, amortized over a period of 25 years to reach full funding.
This scenario may soon become more urgent, however, as the GASB has become more conservative in its recent rule revisions involving asset smoothing and gain assumptions.
Estimated gains or losses of the funds’ value are phased in over five-year periods, to keep the contributions levels from fluctuating wildly. But this also masks, according to the GASB, investment market drops that may not be fully accounted for by the time the fund money is needed to pay for retirements.
Additionally, with a long, slow economic recovery looming, investment return rate assumptions have been lowered from 7.5 to 7 percent, and may be required to drop further. With a large percentage of Ocean City’s workforce nearing retirement age, the city may be paying out of a pot whose paper value is overstated.
Fortunately, however, the city has already been able to reduce some of its medical liability through plan changes. Last spring, the council voted to introduce a high-deductible health plan — as opposed to more expansive PPO plans — that would also come with a city-incentivized Health Savings Account. It also decided to cap any increase to the city’s insurance premium contribution at three percent, to guard against the town taking the lion’s share of future rate increases.
“The reason why the costs are going down is because you made those plan changes for new hires,” Kay Moran of Bolton Partners, the city’s insurance advisor, told the trustees. “Instead of estimating based on market trend, you’re using a flat three percent, and that eliminates any potential fluctuation.”
The city’s premiums have also been going down, due to its insurers suffering fewer claims from town employees.
“There were a lot of reasons for that, mainly because we’ve been altering plan designs and we put in the high-deductible health plan,” Moran said.
At the same time, one of the arguments made by city officials and employees against the plan changes – that providing more individual and less group benefits would jeopardize employee retention – seems to also be occurring. While the number of current general employees eligible for post-employment benefits dropped by 30, the number of retirees using the plan did not correspondingly increase. In fact, it decreased by two.
“Which suggests,” Moran said. “that the older, longer service – and more expensive – employees stayed, and the younger employees were the ones that left.”
On the public safety side, active eligibility increased by 42 employees, and retirees by eight.
“So you added more public safety, and they’re under that new rule,” Moran said. “That increased your liability, but not as much as would’ve been if you hadn’t made that plan change.”