April 14 (Bloomberg) -- Memphis has underfunded its city-run pension plan since 2009, putting the cash toward its budget. Tennessee lawmakers want to attach a cost to that kind of scrimping on retirement expenses.
Legislators are poised to take up a bill this week requiring cities, school districts, utilities and other entities with their own pension plans to contribute 100 percent of what actuaries say is needed to meet annual obligations. If they don’t, Tennessee will do it for them, diverting tax revenue the state disburses to municipalities.
The measure may mean hard times in the home of the blues. Memphis, the state’s most-populous city, has been paying less than 25 percent of the actuarial guidelines. It would be responsible for an additional $70 million yearly -- equivalent to 11 percent of its budget, or half the annual cost of its fire department. Moody’s Investors Service lowered its outlook on the city to negative in December, partly because of the strain from retirement benefits.
The proposed law “gives us a sense of urgency,” said George Little, chief administrative officer for the city of 655,000 along the Mississippi River. “We know that we have to deal with the situation sooner rather than later.”
Almost five years after the recession, the former home of Elvis Presley joins cities nationwide weighing payments to retirees against the cost of providing services to residents. The gap between the payments that states and localities have promised and available funds exceeded $1 trillion as of fiscal 2012, according to the Pew Charitable Trusts.
Keith Brainard, director of research in Georgetown, Texas, at the National Association of State Retirement Administrators, said he hadn’t heard of a measure like the Tennessee proposal that includes a provision for the state to intercept tax dollars to support pension funds outside of its control.
“This is a fantastic idea,” said Adam Weigold, who manages a $38.5 million Tennessee muni fund at Boston-based Eaton Vance Corp. “There are some issues that come up when you are forcing a muni to make a payment it can’t afford. But, properly implemented, this is good news for bondholders. These are required payments.”
Independent local pension systems make up 94 percent of the nation’s 3,418 state and local plans and about 10 percent of membership, according to Census data. They exist in all but seven states, and in many of the biggest cities, including New York, Los Angeles and Chicago.
The Tennessee measure would take effect next year and be phased in over five years. The Senate passed the bill unanimously in February, and it’s on this week’s agenda for the House of Representatives.
The bill was championed by Treasurer David Lillard, a former county commissioner who said he understands the pressure on local governments to use pension contributions to patch budget holes. Lillard’s spokesman, Blake Fontenay, said he expects the house to approve the measure.
“The hallmark of just about every distressed pension plan in the country is that they at one time or another reduced their annual payments,” Lillard said.
While the minority of Tennessee systems are independent, they include the state’s biggest cities and counties. There are 487 local governments and 118 school agencies in the Tennessee Consolidated Retirement System. In contrast to plans run by municipalities such as Memphis, the governments in the state system have been required to make full payments for decades.
At least 31 entities run their own plans and will be subject to the new law, according to a report by Lillard.
Thirteen of those didn’t make their full contribution in 2012, according to the report. They paid a combined $86.4 million less than was actuarially required and had a combined $1.5 billion in unfunded pension liabilities.
The combined funding ratio for those plans was 65 percent, where an 80 percent level is considered optimal for funds to be able to pay future claims. In comparison, the 18 systems that paid their full amount were 80 percent funded, and the three state plans were 89 percent to 96 percent funded.
Memphis, which paid about $20 million of a required $90 million, ranked second-worst in terms of its actuarially required payment in 2012. A school district in Dyersburg, in northwest Tennessee, paid nothing.
Chattanooga, Knoxville and Nashville pensions had lower funding percentages than Memphis.
Moody’s kept its negative outlook on Memphis in February, saying it will monitor the city’s ability to fund the contribution increases that could be required.
“The budgetary burden of funding these obligations is the reason that large unfunded liabilities are seen as negative,” Tom Aaron, an analyst for New York-based Moody’s, said in an e-mail. The company grades Memphis Aa2, third-highest.
The larger contributions will result “in some pretty draconian cuts,” including changes in pension and health benefits and reduced services, said Little, the city administrative officer.
In a bond offer last month, Memphis sold 30-year general obligations with a 5 percent coupon to yield 4.19 percent, or about 0.33 percentage point above benchmark munis, data compiled by Bloomberg show.
A mandatory timeline for full payments would mean the municipalities have a plan for managing the burden, said John Sugden, senior director of the state and local-government group at New York-based Standard & Poor’s.
“You want them to fully fund” their actuarially required payments, he said. “You also have to balance it with the whole. You want to make a plan that’s manageable.”
Fitch Ratings in a March report said the state law benefits Memphis. The law will reinforce the city’s resolve to address chronic pension issues, said Barbara Rosenberg, Fitch’s public-finance director in New York.
The city has more flexibility to pay for the obligations because it no longer has to make an annual payment to city schools after they were merged with a county system, she said.
“We consider this positive for the credit,” Rosenberg said of the new law. “It could really motivate Memphis to step up.”
The timeframe for compliance gives jurisdictions budget flexibility, while the threat of losing state dollars gives them an incentive to act, said Weigold at Eaton Vance.
Support for the bill is widespread enough that the Tennessee Municipal League, which lobbies for cities at the legislature, doesn’t oppose it in its current form.
“We always believe in local control in our cities,” said Executive Director Margaret Mahery. “But I guess, just like all of us, sometimes we maybe needed a little push.”
The shift provides officials with political cover for unpopular cuts, said Memphis Councilman Lee Harris.
“The state is going to constrain our ability to maneuver with respect to pensions and wages and other things that are driven by politics,” Harris said. “That kind of forces us to get this right even though the political will to get it right might not be there.”
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