Reference no: EM133044860

Case: The City in Red Houston is among a number of cities that are facing major issues in funding their employee pension benefits. With oil prices falling over the past few years, the city's coffers have been negatively affected. Voters recently approved a cap on property taxes in Texas' largest city. This means that city officials will have difficulty in raising enough revenue to pay all of the costs of running the city. Houston's problems are echoed in Dallas, which has similar issues.

City employees, firefighters, and police officers are all members of various labor unions with collective bargaining agreements that include substantial defined benefit retirement payments. Making any changes to the benefit structure requires negotiating with the labor unions and agreement of the membership. Since the benefits have been a part of employee compensation schemes for many years, it can be difficult to obtain their agreement on lowering their pension payments.

Houston and Dallas city officials have not made payments to their pension funds at a sufficient level to adequately fund employee pension obligations. Houston underfunded its pension over the past few years by nearly $100 million. Dallas is a smaller city than Houston, and the government tried to issue bonds and reduce benefits to cover its shortfall. But employees and their union representatives rejected that approach. Houston city officials were able to strike a deal that included employees contributing to the pension plan and accepting lower benefits. The inevitability of a financial crisis in the city of Houston allowed city leaders to obtain an agreement for sharing the burden of getting the pension plan in reasonable financial condition.

Since pension obligations are so extensive, these two Texas cities have found it difficult to hire police officers, repair potholes, and carry out other routine operations in the city. In addition to the ballooning obligation, investment returns have fallen short of expectations. In recent years, most investment funds have earned far below the 8 percent that is built into funding plans. This increases the gap between funds available and benefits promised. For instance, Chicago city officials' inability to address their pension funding gap means that the city can pay for only one-quarter of the benefits it has promised. Therefore, Houston and Dallas can see what will come next if they are unable to address their funding gap in public pensions.*

Questions

How would you address this pension funding crisis if you were a city official in Houston or Dallas? How would you address this problem if you were a member of one of the public unions?

What might city residents/citizens do to prevent such problems from occurring? What are the potential challenges associated with your strategy?