Last week the Kinder Institute at Rice University released a report examining the causes of the growth in Houston’s unfunded pension liabilities. The report also proposed several possible changes to reduce the unfunded liability. The report focuses on the combination of factors over the past 21 years that have contributed to the increase in unfunded liabilities. These factors include the city repeatedly neglecting to pay the full Annual Required Contribution (ARC) for two of the city’s three pension systems.
Houston has three defined benefit pension systems: one for police officers; one for firefighters; and one for municipal employees. All three systems have dealt with the same challenges that other public pension systems across the country have encountered. Investment returns suffered during the Great Recession, which increased unfunded liabilities.
Houston’s pension funds have also dealt with chronic underfunding by the city government. The firefighters’ pension system is an exception here because the city is required by state law to make its full ARC payments to that system each year. For the police officers’ and municipal employees’ pension systems, however, the city has not made anywhere close to its full ARC payment for more than a decade. This has happened to other pension systems as well, including New Jersey, Illinois, and Kentucky. The failure of political leaders to responsibly manage their pension systems is a common cause of underfunding.
The report strongly advocates for the city to make its full ARC payments each year. Otherwise, the unfunded liability will continue to increase. The report also looks at possible changes the city could make to reduce the unfunded liabilities of the pension systems. Currently, Houston’s property taxes are subject to a revenue cap. If city tax revenues exceed a certain limit, then property taxes are capped until revenue is brought back down below that certain level. This obviously constrains the city’s ability to raise revenue to pay for things like fully funding pensions, maintaining roads, and providing other essential city services. According to the report, repealing the revenue cap could raise tens of millions of dollars per year.
The report does consider the possibility of switching new employees to a 401(k)-style defined contribution system, but points out two of the serious flaws of that proposal: first, it does nothing to reduce current unfunded liabilities; and second, it may reduce the city’s competitiveness as an employer. The report does not mention that forcing new employees into a 401(k)-style system creates massive transition costs, as has happened in places like Michigan, which did switch its state employees with disastrous consequences.
Houston Mayor Sylvester Turner has stated publicly that he is committed to sticking with defined benefit pensions for city employees. He is right to do so as pensions remain the most efficient and effective way for state and local governments to provide a secure retirement to their employees. Hopefully the Kinder Institute report will spur serious discussion among all parties in Houston on how best to protect a secure retirement for the city’s police officers, firefighters, and municipal employees.