Yesterday, Standard & Poor’s Rating Service downgraded the City of Omaha’s bond rating a notch from AAA to AA+, signaling serious fiscal troubles for Nebraska’s largest city. This downgrade came in spite of Mayor Jean Stothert’s desperate trip to Chicago to convince the bond agency otherwise. Despite her pleas, Standard & Poors cited “the city’s high net direct debt and underfunded pension obligations” as justification for the downgrade. To be specific, Omaha currently owes more than $700 million in unfunded pension liabilities, putting at risk the city’s fiscal survival and thousands of civil servants’ retirement.
As the Platte Institute pointed out in a May study about Nebraska’s unfunded liabilities, the root of the city’s pension problems is its unrealistic assumptions in accounting. The Omaha Police and Retirement System assumes an annual return of 8% on its investments “which is among the highest in the nation” according to the report’s author Andrew Biggs. But since the value of the system’s investments fluctuate with the market, it regularly receives a rate of return much less than that – more like 3.5% in recent years. As Biggs explains, “Under current GASB accounting rules, a plan can call itself ‘fully funded’ even if it has only around a 50-50 chance of being able to pay what it owes in full. Yet the plan, under state law, has a 100 percent obligation to make those payments.”
While adopting more realistic assumptions about the pension system’s rate of return is a necessary first step in returning fiscal sanity to Omaha, much more must be done.
Any public pension system has inherent risks because of its defined benefits, legally obliging the government to pay a fixed amount of money to each retiree regardless of its finances. Instead, Omaha should look to the defined contribution model favored by the private sector to stabilize its finances and secure its retirees’ future.
Under defined contribution, each employee chooses how much of their paycheck they wish to contribute to their retirement fund and where to invest the savings. The employer then matches the employee’s contributions up to a certain rate (usually 3-4%). In this manner, the employer assumes no unfunded liabilities whatsoever – a godsend solution for local governments like Omaha that are downing in debt. Instead of sucking up to bond agencies that are simply relaying the fiscal facts, Mayor Stothert and the Omaha City Council should roll up their sleeves and solve the city’s pension crisis by enacting market-based reforms like a defined contribution retirement system.