Two cities that took control of retiree costs

They are the exceptions, but leaders in a handful of Michigan cities and towns foresaw the financial crisis that would overwhelm their communities if they didn’t begin setting aside enough money to pay the pensions and health insurance they promised workers when they retired.

“It took about 10 years to figure this out,” said Eric Scorsone, a Michigan State University economics professor, who estimates that 311 of the state’s cities, villages and townships collectively underfunded their so-called legacy costs by $15.7 billion.

“A lot of people at the time were saying, ‘This is going to be big,’” Scorsone said. “It turned out to be bigger than anyone thought.”

Many Michigan municipalities have done a pretty good job over the years setting aside at least some money for their employees’ pensions while they were still working. But most saved nothing in advance for their retirees’ health care, opting instead to pay for their medical care only once their workers retired. This put put cities at the mercy of unpredictable medical costs.

The City of Kentwood, south of Grand Rapids, is among the few in Michigan that began paying for its retirees’ health care while workers were still on the job.

But even Kentwood did not begin to tackle this problem until 2003. Before then, the city had no money set aside, so it was not earning interest that could have helped cover retirees’ health care costs, which began spiraling out of control.

“What happened was we saw the issue developing,” said Tom Chase, Kentwood’s finance director, who joined the city in 1993, “and we found that it made sense to start advance funding it.”

Kentwood also trimmed down the health benefits it offered newly hired employees, setting a flat dollar amount based on years of service. The city has since covered its liability, earmarking 121 percent, more than enough to cover the expected cost for retirees’ health care.

The city has also taken control of another “legacy” cost that has bedeviled other towns – employee pensions. Before 2001, most Kentwood workers were enrolled in a “defined benefit” plan, in which the city promised to pay workers a certain amount each month after workers retired, no matter how long they lived.

In 2001, Kentwood began enrolling new employees in a “defined contribution” plan, under which a portion of workers’ own paychecks are invested for retirement, similar to 401(k) plans many private sector employers provide their workers, with Kentwood offering a match. When these new workers retire, Kentwood’s liability ends. The city’s overall pension obligations are now 88 percent funded, according to the MSU study, more than most cities in the state.

“I was looking for predictability,” Chase said of the changes. “I feel like we’re on track to meet our obligations to our employees. I think a lot of other units of government have challenges ahead.”

Kentwood, with a population of about 49,000, had an advantage over Michigan’s older, industrial cities. Founded in 1967, it did not have a long history of collective bargaining agreements requiring it to pay high legacy costs well into the future.

Another path

Muskegon didn’t share that advantage. As an older city, it had a long history of union contracts, and an economy built on industry and chemical manufacturing that have since gone into decline, leaving the city with high unemployment and a struggling outlook.

But while leaders in other cities failed to set aside money for retiree health insurance, Muskegon began prefunding its program 30 years ago, according to Tim Paul, the city’s finance director. In recent years, it has been appropriating about $700,000 annually toward retiree health care, with a goal of fully funding that obligation over the next 30 years, an indication of the size of the obligation it had to tackle. The city’s leaders expect to fully fund pensions by 2030, Paul said.

Since 2005, Muskegon’s administrators also negotiated leaner contracts with its unions and, like Kentwood, switched new hires to a defined contribution pension plan. It also stopped offering to pay for workers’ health insurance when they retire; replacing it with a health savings account that the city stops paying into the day an employee retires.

None of those changes have been easy for Muskegon or its employees.

“We never took the easy way out and said, ‘Let’s not fund our retirees’ health care,’” Paul said, referring to the path taken by some other Michigan cities.

Muskegon still has financial problems. In 2009, Sappi Paper, which once employed more than 1,200 in the city, closed its mill after 109 years of operation, costing Muskegon $300,000 to $400,000 a year in property taxes. And Consumers Energy announced it will close its B.C Cobb generating plant by 2016, idling some 130 workers and costing another $800,000 a year in property taxes.

But unlike other Michigan cities, Muskegon’s fiscal challenges are not compounded by years of failing to fund pensions and retiree health care.

“I feel vindicated that we made the right move,” Paul said. “If you wait until the last minute, you’re going to have problems.”