MuniLand– Stop DROP and Roll

Growing up, the local fire department always had an information stand at the county fair where they would teach kids about fire prevention. The thing I remember was “stop, drop and roll.” Well, the City of Dallas Fire Department could take the same advice, stopping, dropping and rolling its defined benefit pension plan into a defined contribution plan. The DROP program, or Deferred Retirement Option Plan, is available to active Dallas police and firefighters. The program allows participants to choose not to retire but start receiving their retirement benefits anyway. The defined benefit stops growing as it would with traditional retirement, but the payout checks go directly into their DROP account. The program’s intention was to keep experienced cops and firefighters on the job after they hit retirement age, which could be as early of 40. In this regard, the program worked. Experienced fire and police officers were enticed to stay on the force while their DROP retirement accounts earned a guaranteed 8% a year. That’s right, a guaranteed 8% a year savings account! Unfortunately, everything has come to a head for the program within the last few months. The low interest rate environment, poor investment decisions by the Dallas pension board and revised pension COLA rules by the City of Dallas have created an unsustainable situation, which has resulted in ratings downgrades of two notches over the last year.  Fire and police officers are fearful their pensions are being mismanaged, and are taking advantage of pension rules that allow for large block withdrawals from their retirement accounts. All along, the City of Dallas has paid its full annual required contribution (ARC) and met its obligations. This situation is different than the usual pension bullet we write, providing a lesson in how the participant pool in a pension plan is an important variable that can drive unfunded pension liabilities. Overall, the City of Dallas, even with its pension problem, is a strong credit. Unlike Chicago or Detroit, Dallas has significant taxing authority, a growing and diverse economy, and significant reserves. Even with the recent downgrades, the City of Dallas should maintain a high investment rating for the foreseeable future.

Source: The Dallas Morning News, NY Times, Wall Street Journal