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Economy & competitive position

Michigan's broken legacy:

Oakland County proposes legacy solution

Not long after Robert Daddow came to work for Oakland County 20 years ago, a couple of elected officials suggested the county should stop setting aside money for its retirees’ health insurance. No law required Michigan’s local governments to prefund the health care plans promised to retirees, so why pay for something now that you can put off until tomorrow – or even years from now?

No way, said Daddow, Oakland County’s deputy executive. In fact, he could see that the county needed to set aside more money, not less, to pay for its retirees’ medical insurance.

“By the time I came to the county in 1993, it was apparent to me this was a major problem we were going to have to solve,” he said. “We said, ‘No, we’re not going to accept the idea. We’re going to fully fund the health care.’”

Most local government leaders back then chose a different course, negotiating contracts with their municipal unions that included a promise to pay workers’ pensions and health-care expenses when they retired, without setting aside enough money to cover those so-called legacy costs. They figured the money would be there when the bill came due. If they saw warning signs, most ignored them.

“I can tell you that even if these people did recognize it as a problem, they didn’t have the will to solve it,” Daddow said. “It was a benefit that people believed at the time wasn’t going to be terribly costly.”

That turned out to be wrong. In fact, Michigan’s cities, villages and townships that provide coverage for their retirees have underfunded pensions and retiree health care programs by a staggering $15.7 billion, a recent Michigan State University study found.

With Oakland County’s pension and retiree health care plans fully funded, Daddow has proposed an idea that he said could help many Michigan communities head off a financial crisis. On Oct. 3, Daddow presented a plan to the state House Financial Liability Reform Committee to create a statewide authority that would do for many of Michigan’s municipalities essentially what Oakland County has done for itself.

In 2007, Oakland County borrowed $557 million by issuing certificates of participation, a type of loan instrument, at a 6.2 percent interest rate, and then reinvested the money at a higher rate, using the proceeds to pay down its legacy costs.

In September, the county refinanced the remaining balance on that debt by borrowing $350 million at a lower rate of 3.62 percent. In so doing, Oakland County became the first local government in Michigan to use a new law, Public Act 329, signed by Gov. Rick Snyder last year, allowing local governments to sell bonds to pay off their legacy costs.

Several other local governments have considered borrowing money under Public Act 329, but Oakland County is among the few so far to complete a deal, possibly because the law sets several conditions, making it difficult for some units to qualify. Saginaw County considered a similar bond sale, but put it on hold in August when rising interest rates made it impractical. A handful of other municipal governments, including Farmington, Traverse City and Grand Rapids, are considering borrowing money under the new law; they face a deadline of Dec. 21, 2014.

Daddow’s proposal would allow local governments, generally smaller ones, to join a proposed authority, which would allow them to pool their resources and, in theory, get better interest rates. The authority would issue bonds at a rate of between 3.7 percent and 4.7 percent, investing the proceeds at a higher rate of 7 to 8 percent and using the interest earned to pay down the unfunded pensions and retiree health care plans, Daddow said.

Periodically, those local governments would make payments on the bonds. If one was unable to make its payments, the state treasury would take state revenue sharing the municipality would have received and pass it on to the authority.

Michigan’s most distressed cities, such as Detroit and Flint, would be ineligible to join the authority, because they are under emergency management and unlikely to receive favorable interest rates. But the plan could help others avoid being taken over by emergency managers, Daddow said. The new law also could help these communities maintain high credit ratings, while providing adequate services to their residents and ensuring retirees that their pensions and health benefits would not be cut.

State Rep. Earl Poleski, R-Spring Arbor Township, who chairs the House committee, said Daddow’s plan could help many communities avoid Detroit’s fate.

“I think we’re starting to see what local governments are going to look like if something isn’t done,” he said.

Although he has not yet introduced legislation to create the proposed authority, “we are thinking very hard about it,” said Poleski, a certified public accountant. “I don’t see any downside to it, frankly.”

Such an authority would only help local governments fund agreements made with past workers who are now retired, Daddow said. Each government still would have to begin setting aside money to keep its promises to current employees. Daddow echoed others in calling on government employers to stop promising fully covered medical care to current workers and instead have them enroll in health savings accounts, under which a community’s financial obligation ends the day an employee retires.

“Somehow, the cycle of deferring costs into the future, particularly as costs are increasing, has to be stopped or, at a minimum, mitigated,” Daddow told the House committee.

He later added that “a lot of people ignored the warnings, and look at what happened. You wind up having to pay the retirees’ costs before you put a single police officer on the street.”

Pat Shellenbarger is a freelance writer based in West Michigan. He previously was a reporter and editor at the Detroit News, the St. Petersburg Times and the Grand Rapids Press.

9 comments from Bridge readers.Add mine!

  1. Rob Sisson

    This simply shifts the costs to future taxpayers (those paying taxes during the amortization of the bonds). It does not fix the structural problems. Admittedly, Oakland County is unique in our state. People can’t easily move “out” to escape higher city taxes, because of the density of municipal governments there. And, it is one of the more affluent counties in the state. In 90% of Michigan counties, there would probably be a popular uprising if a muni sought to issue debt to pay legacy costs.

  2. Marcia Robovitsky

    Why do many articles omit Bloomfield Township from the story on unfunded pension debt? They have borrowed $85 million under the Public Act 329 for the 38% of one pension fund currently listed as underfunded. Like many government bodies, this is a satisfaction of debt on paper only. The money borrowed was NOT paid to the company responsible for guaranteed payments, but is being used to invest and try to make money. When I asked the township about the interest rates on the bond sale, the Township Treasurer gave an AVERAGE figure of 4.55 %. I wonder what the range really is? The Township is investing ALL the money into the stock market.. with Gregory Schwartz and Co. but what will that money really earn in the investments? Can it maintain a positive return over the next 20 plus years? At the study session, a suggestion by Prudential, which is the firm that guarantees the pension payments, was to deposit $10 or $20 million of that $80 million into the guaranteed cash account earning interest and they said that would satisfy township payments probably into the year 2020. I asked the board to discuss that suggestion at the study session and was told by the Supervisor that discussion was not going to happen at this meeting. That same night, approval was given to invest all $80 million dollars with Schwartz’s recommendations of all in/ right now/ in the stock market. IF…. we have another economy like 2000 or 2008 … the way I look at this is: The township taxpayers have a $165 million dollars debt instead of a $85 million debt. The Township leadership claims we will have SAVED $60-$80 million dollars over 20 years. I bet in 20 years, they will be asking for more money.

  3. Marcia Robovitsky

    I would like to see the dollar figures of what happened in 2007, when $557 million dollars was borrowed at 6.2 % and then invested at “a higher rate”. With the 2007 economy and beyond giving a big hit to most people invested…. how much did the county really pay down their legacy costs from 2007 to present? Are those figures available?

    Refinancing at 3.62 % was a smart move for the “remaining balance” of $350 million… because the BORROWED DEBT was already existing. How much is still owed to the pension plan?

    Bloomfield Township did not already have “borrowed bond debt” … they had “paper debt”. I don’t believe there was anything in the law that said “underfunded pensions” must be satisfied IMMEDIATELY. However, now the township taxpayers have a BOND debt that is a first obligation debt…. one to be paid each year before any other bill… including salaries to current employees.

    As far as the “proposed authority”… at this point I’d say NO. The words “in theory” and invest borrowed money at 7-8 % are keys to my NO answer. Also this statement: “If one was unable to make its payments, the state treasury would take state revenue sharing the municipality would have received and pass it on to the authority.” A sure way to many future municipal bankruptcies. I think it would be better for municipalities to work very hard on their current budgets and make larger payments to the UNDERFUNDED pensions each year. Whereas, by joining an “authority” the municipality is incurring a first obligation BOND debt. Losing state revenue sharing to pay that debt in any budget year… would be a disaster.

  4. George Ehlert

    State Law should be modified to require municipalities to impose property tax increases whenever a fund drops below 9% funded (to get the plan whole within 10 years). That way, there will be outrage amongst the populace and all elected officials that have neglected their duties to keep communities solvent will be run out of office. There are too many cases where the politicians don’t or won’t make the necessary decisions yet are often re-elected. Then, when the plans become unaffordable, the voter/employees simply become “victims”. There are consequences to voting for weak or ignorant leaders.

  5. Charles Richards

    I am generally an admirer of Mr. Daddow, but not in this case. One reason pension funds are in trouble is because they assumed an unrealistic return on their investments. Anticipating a return of 7 to 8 percent is unrealistic. That is a huge gamble.

  6. William Harris

    This sort of arbitrage is a great deal for the financier, but only exposes the municipalities to greater risk; indeed, it was such a move that got Detroit into its financial crisis. Moreover, there is little evidence that this particular financial strategy actually works, no matter how much the financial sector believes in it. That, and it should have been noted that 2007 was at the flaming last moment of the housing bubble, right before the crash.

    Past results being no guarantee of future performance etc.

    Sadly, one way or another we will be on line for these bills, either with with the further impoverishment of our neighbors or higher taxes, or most likely, both.

  7. Ken Kolk

    The problem that the cities, counties, villages, and, though no one is talking about it, the State of Michigan is having with legacy costs comes from when the Republicans and Governor Engler decided to “buy” votes by cutting taxes. Given the State Constitution requires a balanced budget, they had to find something in the budget that they felt they could not fund to create a surplus. The Constitution requires that public employees (and State Office Holders) pensions must be prefunded and makes the state having unfunded accrued liabilities illegal. However Governor Engler proposed that the state defer funding retiree health care. MEA and other public employee unions took the state to court saying they were violating the Constitution, but the Republican Controlled State Supreme Court ruled that all the state was required to prefund was the pensions not retiree health care. The MEA warned the Legislature that their unfunded accrued liability for retiree health care was increasing every year, but the Republicans kept cutting taxes every year. I’m a retired public school employee and every year the state cuts its share of my health care premium and lowers the quality of my health care, thus cutting my pension. I gave up between 20% and 25% of what my pay would have been to fund these benefits! Some of my career my family was qualified for food stamps, not it seems that rather than raise taxes to pay its bills the state and local governments, all controlled by the Republicans (or Republican appointed “Emergency Managers” want to raid the prefunded pension funds to pay their bills. The block that votes Republican, senior citizens, need to see that even the National Republicans want to raid the funds that are set aside for our pensions in social security to pay its bills! That’s why I became a Democrat and work to defeat the Republican dominance of our state and national government!

    1. Gloria Woods

      Bravo, Mr. Kolk! Finally, someone posts a comment who knows the history and does not ignore it in favor of ideology! I, too, remember the Engler Administration’s decision to reduce our state’s tax base, so that we ended up with a structural deficit-the inability to pay our state’s obligations. They had a plan. The plan was to deconstruct our state government. It worked. And now Michigan retirees, poor children, veterans, workers and the unemployed–we are all paying for it.

  8. Kate Markel

    The fallacy in the plan lies in the reported phrase “invest at a higher rate of 7-8%.” It suggests that there are known safe investments providing a predictable return in this range. As others have eloquently explained, this is not the case. Instead, the hoped for return might be in this range, but the strategies will engender high risk to both return AND principal. (And if I am mistaken and it is currently possible to safely invest at this rate, I should like to know where and join in!)

    Thanks to my fellow Bridge readers for such informed and thoughtful commentary!

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