Madison Heights explores bonding option to address pension legacy costs

By: Andy Kozlowski | Madison - Park News | Published January 27, 2016

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MADISON HEIGHTS — Like most municipalities across the state of Michigan, the city of Madison Heights has its share of unfunded liability — costs that it must pay for past, present and future retirees receiving pension, health care and other benefits.

At present, this is estimated to total nearly $104 million. These costs continue to grow due to a variety of factors, including revised “mortality tables” reflecting ever-increasing life expectancy.

Now the city is trying to get a handle on paying off these benefit liabilities to stabilize future budgets, as per the wishes of City Council in its goals plan for fiscal year 2016-17.

“What we didn’t know when we made the goals plan last fall is there’s been an actuarial change in the mortality table that affects our funding in (fiscal year) 2016-17,” said Madison Heights City Manager Ben Myers. “We’re going to see an increase in our (pension) contribution last year of almost $680,000, and it’s an annual figure on the police and fire side; the (general employees) will be an additional $49,000.”

But trying to address these legacy costs will be a complex undertaking with many elements. During a special meeting the evening of Jan. 18 at the Red Oaks Youth Soccer Complex, City Council focused on the first piece of the puzzle: the pension plan liability of non-police and non-fire general employees.

These individuals remain on the pension plan that was in place prior to 2005, when the city began switching new hires from a defined benefit pension plan and retiree health care benefits, to a new defined contribution plan — like a 401(k), in other words — and a health care savings account.

The last of the non-police, non-fire pension employees are expected to retire within 22 years. Along with the current retirees, they total about $15.7 million in unfunded pension liability.

The city’s yearly required minimum contribution amount to the pension fund for these employees is set by MERS, or the Municipal Employees’ Retirement System.

In general, the contribution amount has been increasing, which places a greater burden on the city’s budget and ability to fund services.

The city contributes the full required contribution each year. In FY 2016, this contribution is about $1.2 million, which will increase to an estimated $2.1 million by FY 2019.

However, Madison Heights Assistant City Manager Melissa Marsh has identified a possible way to improve the situation, funding roughly 98 percent of the obligation — with the 2 percent difference being made up for by a city contribution. 

By selling pension bonds — bonds being money borrowed for a period of time at a fixed rate — and reinvesting the proceeds from the bond sales into the pension fund, the city can pay down much of the liability with improved interest rates and stabilize the budgeted payment for these benefits, which will occur over the next 16 years as the bonds are paid off.

This does not incur any additional liabilities. Rather, it just changes the nature of the existing liability from a pension payment to a bond payment.

Michigan Public Act 329 allows the use of these so-called Pension Obligation Bonds, or POBs, to fund unfunded pension and retiree health care liabilities under certain conditions. Namely:

• The POBs must be issued by the end of 2018.

• The municipality must have a credit rating in the AA category or higher — the city of Madison Heights has a rating of AA-, so it qualifies.

• The plan must be closed to new hires.

• The municipality must notify the public of plans to issue the bonds.

• The municipality must prepare a comprehensive financial plan.

• The municipality must obtain approval from the state treasury.

“We’re not a distressed community, and I think the state recognizes that (POBs) can be a useful tool for communities that want to restructure their obligation and are in a fiscal position to do it, as reflected in the AA category to even be considered for issuing the bond,” Myers said.

“So we want to look ahead to this liability. We don’t want to kick the can down the road. As much as we have in our control right now to look into the situation, this is a viable option.”

Police and fire pension plans are not eligible for bond funding under Public Act 329, since the plans are not closed to new hires. In addition, due to the volatile nature of health care costs, city staff does not advise using POBs for health care. They’re only advising them for the pensions, and only the pensions of non-police/non-fire employees.

Using POBs this way would save the city an estimated $4 million over the next 16 years. However, the savings are dependent on interest rates.

Other jurisdictions that have taken advantage of Michigan Public Act 329 include Allegan County, Bloomfield Hills, Bloomfield Township, Farmington Hills, Holland, Oakland County, Ottawa County, Saginaw County, Shelby Township and West Bloomfield. All of them use POB for pension; West Bloomfield uses them for both pension and health care.

The city has not yet formulated a plan to address the remaining unfunded liabilities: police and fire pension (estimated $31 million), police and fire retiree health care (estimated $34.3 million), and general retiree health care (estimated $22.8 million). But POBs for general employee pension is a viable first step.

“As with a lot of things with investments, timing is everything,” Myers said. “This appears to be good timing for us to consider this.”

That being said, City Council has not yet taken any formal action on whether to use POBs. According to Madison Heights City Councilman Robert Corbett, there will be a series of decisions that council will have to make, beginning in February, authorizing administration to go ahead with the bonding process.

The next step would be the notice of intent in February — the council resolution that formally gives the intent to sell bonds. There’s also a provision in the state act that allows for a petition referendum challenging the city selling the bonds. There’s a 45-day period for the public to do so.

But even if all goes as planned with the POBs, Corbett said it will just bring the city back to where it began: the issue of rising costs and fixed revenues.

“Sixteen years ago, when I started on council, there was never any question whether we’ll get more money year to year, since property values were going up, taxes were rising and inflation wasn’t an issue, so we were always getting (more money) — it was just a matter of 2 percent, or 4 percent, and how we’d portion that,” Corbett said. “But this is a much more complex environment now. Our costs are still going up, but our revenues are not going up enough to match the expense increase. On top of that, we have a number of programs and goals we want to bring online, but have had to put off for years since it’s a tight squeeze and we don’t have the revenue.

“So to do the things we want to do — whether it’s parks improvement, or strengthening the Police Department, or any of these things — we’re going to have to continue to squeeze costs out of the system in order to make room (in the budget),” Corbett said. “That’s a tight fit, because we’ve been cutting for seven years now. While some may think excess funds are available, it’s not there, if you think it through. What some identify as real money is really money not spent.