Denver’s public pensions have been in a state of steady deterioration for years. Welcome to the 2024 edition.
First, some good news. The Denver Employees Retirement Plan’s (DERP) funded level finished 2023 improved from a record-low 57.3% to a slightly-less-than-record low 58.1%. That still doesn’t mean it’s good, but it does mean that for a year, at least, they managed to stem the bleeding.
The problem is in what it took to do that. Employer (i.e. taxpayers) contributions were $153.1 million, up 18% from 2022, which in turn was up 16.1% from 2021. Employee contributions came in at $75.8 million, up 4.6% from 2022. In addition to these large contributions, the plan’s investments returned 9.97%, earning $225.9 million. (In 2022, they had lost $243.8 million, becoming the major reason why the funded level declined from 66.2% funding to 57.3%.)
So consider this: both employees and employers contributed record amounts to the fund, with employers contributing nearly $7 million more than the actuarially determined contribution (ADC), the fund returned just under 10%, and the funded level still barely budged.
A small part of this was a downward adjustment of the expected rate of return, and thus the liability discount rate, from 7.25% to 7.00%. The accounting conservatism at work here is welcome; lowering the discount rate makes the accrued liability larger and closer to what what it probably should actually be. Had the plan left it alone at 7.25%, the estimated funded level would have been more around 59.4%. Doing that would have made the plan’s funded level look better, but at the cost of being misleading about what the plan can actually expect to get on its investments.
The ADC is determined by two things: 1) How much do we need to contribute to pay down the existing unfunded liability over the 20-year amortization period? and 2) How much do we need to contribute to pay the cost of new benefits accrued during the year? Those numbers are calculated based on actuarial expectations of such things as rate of return, inflation, employee raises, and retirement rates for various levels of service credit.
Given that, the contribution requirements have been pushed up by a number of factors. First are the generally low rates of return. Over the last 16 years, they have averaged 5.4% which is abysmal compared to most pension plans. This includes a period from 2009-2012 when they averaged 9.9%, but the employer contribution was consistently less than 90% of the ADC.
Second, beginning a few years ago, DERP moved from a 30-year amortization period for new obligations to a 20-year period. While this has the effect of decreasing the overall apparent pension obligation, it also has the effect of increasing the annual required contribution.
Finally, the current expected annual employee salary increase is 3%, but from 2017-2022 the per-capita salary has increased an average of 5.1% a year, including 9.6% from 2021-2022. Not only are salaries increasing faster, the obligations from those salaries are amortized over a shorter period, requiring higher contributions. It’s also worth pointing out that over the last few years, taxpayer contributions have been increasing faster than employee contributions, reversing an earlier trend.
All three of those factors – lower returns, faster amortization, and rapidly increasing salaries, have conspired to keep the funded level near or below 60% for most of the last nine years, regardless of increasing contributions.
Unlike Colorado’s state public pensions, the Public Employees Retirement Association (PERA), DERP is not a Social Security replacement, nor does it have annual cost of living adjustments (COLAs) to deal with. Employees continue to participate in Social Security, and are expected to make other arrangements for their retirements in addition to the DERP.
Nevertheless, even though the fund isn’t the size of PERA, the sums involved are not trivial. The total amount of investments under management is $2.4 billion, while paying over a quarter-billion dollars in pension benefits in 2023. And those contributions continue to grow as a percentage of the city budget. In 2023, the total contribution to pension and health benefits rose to just under 7% of Denver’s budgeted operating expenses. At some point, unless this situation is addressed, it will begin to crowd out high-priority city spending.
The best possible recommendation is to relieve the city of this burden altogether by converting DERP from a defined benefit (DB) to a defined contribution (DC) plan. DC plans are, by definition, 100% funded, and employees would be responsible for investing and managing their own money. A conversion to a DC plan could take place over the 20-year amortization period of existing obligations.
Barring that, a comprehensive analysis such as the one PERA conducts each year, looking at the likelihood of the plan’s continued viability over the next several decades, is decidedly called for. Denver’s taxpayers are on the hook for this thing, and the City Council has an obligation to them to make sure that the plan stays solvent, before it seriously starts crowding out other priorities.
Joshua Sharf is a senior fellow in fiscal policy at the Independence Institute, a free market think tank in Denver.
