Borrowing is part of a strategy to manage rising payments to the County’s closed pension plan.
In early December, Grand Traverse County, MI issued a pension obligation bond (POB) that will be used to pay down the County’s $40 million pension debt. This is a major development in a decades-long effort to manage legacy pension liabilities following the County’s decision in 2000 to close its defined benefit plan (DB) to newly hired employees. Since then, most new employees have enrolled in a defined contribution plan (DC), similar to a private sector 401(k).
At the time the plan closure was initiated, it was around 60% funded and the unfunded liability totaled $20 million. While the move to a DC effectively capped the County’s exposure to future investment risk by eliminating any additional liabilities for new employees, the change did not impact the liabilities associated with existing retirees or active employees who chose to stay in the DB. A small subset of the county workforce continued to enroll new hires in the DB until 2016 but the plan is now fully closed. Today, the plan continues to make payments to around 300 retirees while less than 50 active employees are accruing benefits. The County’s annual required contribution is around $6 million—approximately 10% of their revenue.
Under rules set by the Municipal Employees Retirement System (MERS), the entity responsible for managing pension assets on behalf of Grand Traverse County and other local governments in Michigan, closed pension plans are required to pay down pension debt faster than open plans. Also, MERS in recent years has updated various assumptions – including gradual reductions to the critically important assumed rate of return on investment from 8% to 7.75% in 2015 and to 7.35% in 2019. In combination, these MERS policies and assumption changes result in rising contribution requirements for the County that accelerate as the 2034 full funding date approaches.
With these rising pension costs on the horizon, the County proactively began contributing more than the actuarially required amount in 2017. Then, in 2018, finance officials enlisted GovInvest to help analyze the impacts of the supplemental contributions and further develop the funding plan that front loads pension payments in order to smooth budget impacts over time.
“The Total Liability Calculator has been a huge asset,” said Deputy County Administrator Chris Forsyth. “It allows us to quickly assess both the short and long term impacts of different policy decisions and presents the analysis in a form that the County Commissioners can easily understand.”
The supplemental contributions have continued for the past 4 years, including in the midst of the COVID-19 pandemic.
The recent POB issuance is a continuation of this strategy to stabilize contribution rates- and potentially save money. Once the POB is issued, the proceeds will be sent to MERS, credited to the Grand Traverse County account, and invested into the MERS fund. The infusion of assets will eliminate the pension debt and significantly reduce the County’s required contribution to MERS. Debt reduction payments will go away, leaving only the normal cost for the small number of active employees. In place of the payments to MERS, the County will instead make annual debt service payments to repay the principal and 2% interest on the bond.
If all assumptions hold, including investment performance achieving the assumed rate of return, the transaction could save the county around $10 million over the 13 year life of the bond. The primary risk to using POBs is if investment performance in the pension fund falls short of the assumed rate. This would create an unfunded liability that will need to be paid down by the County, in addition to the POB debt service payments. If the investment losses are high enough, this could reduce the $10M savings or even result in a net cost to the County.
With that said, the County is capitalizing on historically low interest rates, which reduces some of the risk of the transaction. And with the Total Liability Calculator, they can monitor the performance of the transaction by analyzing how actual investment performance impacts the total pension and debt service costs over time. This analysis could inform decisions around whether to use excess investment returns in a given year as budget savings or apply those to the pension as a supplemental contribution that could be used against potential losses in the future.
Overall, the Grand Traverse County story illustrates the challenges associated with closing a DB plan- namely that the legacy liabilities remain and must be funded for many years- but also that those challenges are not insurmountable. Twenty years into the closure, the County has a credible plan in place to pay down the existing debt and manage the remaining liability in a responsible manner that ensures pension promises are kept while maintaining budget sustainability.