City of Birmingham

A Hole in the Balance Sheet: Birmingham’s Impending Pension Crisis

Birmingham Mayor Randall Woodfin’s transition report, “The Woodfin Way,” features assessments of most major issues facing the city’s nascent administration. But during the March 15 presentation of those findings, one issue in particular drew murmurs of alarm from the crowd: the Transparent and Efficient Government Committee’s finding that the city has been underfunding its city employee pension plan for more than 15 years, leaving a pension liability of $750 million.

“On the surface, the (city’s) finances don’t seem so bad,” said the committee’s co-chair, Daniel Coleman, during the presentation. “We’re close to a balanced budget, we’ve had small deficits, but we’re able to cover those. But if you look back at the next level, we’re creating new deficits, big deficits that won’t go away — holes in our balance sheet.”

The nature of the presentation meant that Coleman was unable to address the pension liability issue with any real depth, drawing cries of frustration from the audience, a large portion of which consisted of city employees.

“You want to break that down?” yelled an audience member at the end of Coleman’s presentation. But by that point, Woodfin was moving on to the findings of the next transition committee, leaving open the question of just how dire the pension issue is and what can be done to fix it.

Breaking It Down

The City of Birmingham Retirement and Relief System Retirement Plan requires membership from all city employees except for appointed and elected employees, for whom it is optional. Funding for the plan comes from required contributions by employees, contributions by the city and returns on investments such as U.S. Treasury bonds and notes.

Because of the variables involved in calculating these contributions — interest rates of the fund’s investments, for instance, can fluctuate wildly — the status of pension funds can sometimes be unpredictable. For instance, the recession that began in 2008 drove down interest rates, meaning that the fund’s investments were not contributing as much to the pension plan as had been assumed.

Birmingham Mayor Randall Woodfin makes his “The One Hundred” presentation. (Source: Sam Prickett)

This unpredictability means that the prognosis for the city’s pension fund can vary. The $750 million liability cited in The Woodfin Way, for example, is based on estimates from the Governmental Accounting Standards Board, which generally bases its assumptions on a pessimistic outlook. A pension fund’s actuarial liability, typically determined by outside consulting firms, is usually less dire.

As Coleman stated in his transition committee’s presentation, a large part of the existing liability is due to Birmingham underfunding its pension fund for more than 15 years. Having an underfunded pension fund means the city doesn’t have money set aside for pensions that will come due in the future.

According to the city’s finance department, Birmingham began underfunding its retirement and relief pension system in 2002, during the tenure of Mayor Bernard Kincaid. By the end of Kincaid’s tenure in 2007, the city’s actuarial unfunded liability hovered at just more than $40 million. In 2016, close to the end of Mayor William Bell’s seven-year administration, the unfunded actuarial liability had leveled off at about $330 million.

That means that, to fully fund Birmingham’s pension plan, the city would need to contribute an additional $10 million to $15 million annually — money that would likely need to be reappropriated from other parts of its $428 million budget.

That’s no small number. To compare, the city’s FY 2018 operating budget allocates just more than $11 million to public transit and just more than $15 million to public libraries.

A Future “Fiscal Calamity?”

Birmingham is far from the only American governmental body coming to terms with unfunded pension liabilities. A 2016 Reuters report highlighted how common the problem is for state and local governments across the country. “A small minority face dire circumstances, but many jurisdictions appear to have their costs under control,” the report read.

A 2016 MarketWatch article estimated that U.S. state and local employee pension plans are unfunded by a total of $6 trillion. “Every year (pension plans) are in deeper trouble,” wrote MarketWatch’s Ed Bartholomew and Jeremy Gold. “Many taxpayers are aware that state and local government pension plans are underfunded. They generally aren’t aware just how dire the situation is.”

Most assessments of the problem range from alarmed to apocalyptic. The American Legislative Economic Council, a right-leaning nonprofit dedicated to drafting conservative fiscal legislation, released a study in December describing the issue as a “scourge” that, without reform, “will continue to grow and threaten the financial security of state retiree and taxpayers alike. The fiscal calamity could be far deeper and prolonged than the Great Recession.”

The Boiling Frog

How long does Birmingham have until its unfunded pension liabilities become a significant problem? It’s hard to tell, Coleman said. He compares the situation to a frog boiling in water — the ramifications will be hard to notice until the situation is dire.

“It’s hard to estimate that critical point, and I would hate to test it,” he said.

One “clear sign that pensions are a problem,” he said, is the city’s recent downgrade by Fitch Ratings, one of the “Big Three” credit ratings agency. Fitch recently changed the city’s rating from AA, indicating a stable outlook,  to AA-, indicating a negative outlook, citing the city’s underfunded pension liability as the primary reason.

“When these agencies downgrade us, it becomes slightly more expensive for us to borrow money,” Coleman said. “And then at some point, if the downgrades continue, it becomes impossible.”

S&P and Moody’s, the other two “Big Three” agencies, currently rate Birmingham’s outlook as stable.

The city’s strategy for addressing that problem remains an ongoing discussion. In March, Woodfin told BirminghamWatch that he is awaiting Coleman’s recommendations on how to address the problem, though he hopes that cost-saving measures resulting from the city’s ongoing performance audit will free up funds to go toward the pension.

“There’s no question, if we want to address this issue, we’re going to have to move more money into the pension fund — at a minimum, the amount that’s actuarially recommended,” Coleman said. “That’s going to take money out of the general budget of the city. Our ability to help the city reengineer itself and save money can enable us to do this, we hope, without taking money from other resources — but that means a lot of work and very good execution.”

Coleman, who stressed that he was not speaking for Woodfin or his leadership team, said the city would likely need to compare the expense of its benefits “to other municipalities and similar cities, both around the country and around the state.”

Taking an aggressive stance on the issue, Coleman said, will also serve to “separate the city of Birmingham from any other cities who are kicking (similar problems) down the road.”

“Dealing with it in a significant way sends a positive message to anyone who interacts with the city, especially people lending the city money and ratings agencies,” he said. “If it’s an issue that we address head-on and quickly, I really think we can turn it from a negative issue to a positive issue.”