Rising interest rates have thrown a monkey wrench into Providence’s plan to borrow $500 million to ease its deepening pension problems, and some say there’s not enough time to wait for lower rates.
Issuing a $500 million pension obligation bond was the best option to address the city’s gaping $1.3 billion unfunded liability and curb the rising annual contributions needed to keep the pension fund solvent, according to a working group tasked with finding solutions.
But the plan approved by state lawmakers and city voters states the bond could only be issued if the interest rate was capped at 4.9%.
Now that rates have broken through that ceiling, officials aren’t in agreement about what to do next.
The city’s pension woes are worsening quickly. On top of the $1.3 billion unfunded liability, the required annual contributions are rising much faster than city revenue. The annual payment is forecast to reach $120 million by fiscal 2027, which would eat up 21% of the city’s general fund revenue. If nothing is done, the contribution is expected to swell to $230 million by fiscal 2040, according to a January 2022 report.
Brett Smiley, the presumed incoming mayor after winning the Democratic primary on Sept. 13, suggested during the campaign that he was in favor of transitioning the city’s independently controlled pension fund to state management.
This would eliminate the fees the city pays advisers to oversee its investments, while preventing potential mismanagement from city administrators that has created the problems in previous years, Smiley said.
Mark Tracy, a former member of the Providence Board of Investment Commissioners, says the state’s risk-adjusted investment strategy, which relies less on equity, could improve returns for the city pension fund.
But that still doesn’t solve the unfunded liability, much of which stems from fixed payments to retirees that cannot be renegotiated.
As for waiting for interest rates to fall?
“I don’t think that’s a great strategy,” Tracy said. “We don’t know where rates are going in the future, but it seems like we are moving into an inflationary environment, which may last for some time.”
State Sen. Samuel Zurier, D-Providence, also wasn’t in favor of waiting it out.
“The longer we wait, the bigger hole we will have to climb out of,” he said.
Zurier, a former city councilman who served on the pension working group, suggests that the state should allow the city-owned Providence Water Supply Board to profit on the water it sells to other municipalities since the infrastructure around the Scituate Reservoir was built and paid for entirely by the city 100 years ago with no reimbursement.
“I don’t know about feasibility, but from a fairness lens, it makes sense,” said Zurier, who said the water supply board was the only public utility in the state in which the owner did not receive a rate of return.
In 2018, Mayor Jorge O. Elorza sought to privatize the Providence Water Supply Board and use the money to shore up the city pension fund, but he failed to persuade state lawmakers to allow it.
Elorza later pitched a pension obligation bond in 2021, when interest rates were at historic lows, but again he was stymied by legislators concerned about the borrowing proposal.
Elorza then appointed a group of fiscal experts and community leaders to study the city’s options, only to have the working group recommend the same idea, except at a lower amount and with more safeguards. The $500 million pension obligation bond put forth this year gained legislative approval and the support of voters in a June referendum, with city leaders championing the cause through campaign mailers and Statehouse testimony.
It was disappointing to put in all that work, only to be foiled by interest-rate hikes, says Michael DiBiase, co-chairman of the pension working group and president of the Rhode Island Public Expenditure Council.
But DiBiase didn’t think the bond would be a “silver bullet” to end the city’s pension woes.
“If it was successful, it would give the city some breathing room with respect to its annual pension obligation, but it wasn’t going to deal with all the issues,” DiBiase said.
In fact, DiBiase initially opposed the pension bond and still supports other options, such as increasing residential tax rates and creating a fund from employee contributions to pay for other post-employment benefits.
Smiley was not available to comment, but Elorza isn’t sold on either of those ideas. Raising the residential tax rate would not bring in enough additional money to cover the annual pension contributions, and establishing a special fund with employee contributions would siphon away cash that the city can’t afford to give up right now, he says.
Whatever Smiley decides to do, Elorza expects the pension problem will continue to plague the city for decades to come.
“Even if Brett was to balance every budget, my sense is that finances are going to be a challenge,” he said. “To truly fix the city finances is going to take about five good, responsible mayors in a row.”
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