Interest rate rise, treasury note jump won’t soon help with Fort Smith’s LOPFI woes

It’s not likely that rising interest rates following the surprise general election results will have a significant short-term impact on city of Fort Smith’s investments, nor the struggling LOPFI retirement pension fund for local police and firefighters.

A turbulent Presidential campaign — and surprising election outcome — have received much of the credit for volatile leaps in the 10-Year U.S. Treasury Note interest rate since Nov. 1.

Interest rates on a 10-Year Note rose to 2.23% Tuesday (Nov. 15) from 1.83% on Nov. 1 — an overall increase of 22%. Following that same path to President-elect Donald Trump’s inauguration day, the rate could crest at 3.21%. But this short-term jump tells only half the story. Going further back to Sept. 6, the 10-Year rate was at 1.55%. Despite a few day-to-day dips, the overall rate increase to present has been 44% in just over two months.

HOW IT AFFECTS CITY, LOPFI
Fort Smith’s general contribution to the LOPFI – Local Police and Fire pension – fund is made annually as determined by LOPFI’s Board of Trustees. While the system is paid for, retirees prior to 1983 who were brought in via the old plans caused a shortfall that must be funded with the city’s internal accounts. At present, the city must make $2.5 million in additional annual contributions on top of the general requirement to cover this shortfall, but it has been unable to do so without the threat of insolvency.

Last year, the additional contribution was $700,000, which pushed the insolvency date from 2019 to 2021. The amount this year will be determined by the Fort Smith Board of Directors upon approval of a final budget and won’t be known until after the hearings on Nov. 29 and Dec. 1.

Discussing how the 10-Year Treasury Note rate increases might help ease some of these pains, Fort Smith Finance Director Jennifer Walker told Talk Business & Politics that it’s something the city will look in to after the budget is confirmed.

“It’s not going to be a substantial dollar amount, but it will probably help some. We have been focused on budget preparations,” she said. “We do invest funds, so if we’re earning more interest, then that’s going to help us. But we’re not investing that much money. We have $91 million in our investment funds for the whole city, and most of that is reserved.”

The amount Fort Smith could dedicate to LOPFI would be approximately $5.5 million, Walker added, so a 2.23% rate would only “theoretically” net $122,650 in additional revenue.

“Theoretically,” Walker said, “because that assumes the money just sits in the account for the full year, which it doesn’t. Actual would probably be less than $100,000.” Still, “Interest rates are going up, so as we invest money, we’re going to see some benefit from that.”

Confirming Walker’s outlook, John Taylor, a Fort Smith based financial adviser with Stifel, said a rising rate environment will not immediately help with pension plans, but a rate that stabilizes at a higher level could ease budget woes beyond 2017. Initial help would come through better returns for investment portfolios tied to pension plans. Also, higher interest rates usually allow for lower lump sum payments.

“If you have those (higher interest rates) and they remain higher and stabilize, then investment portfolios will do better and that, obviously, should help,” Taylor said. “Also, and this is not always mentioned … but if a pension plan allows for lump sum payments, the higher interest rate will reduce the lump sum payment.”

Actuarials – the process by which pension payments are estimated – that include lower lump sum payments would reduce how much a city pays into a pension plan, Taylor added.

‘TOO EARLY TO TELL’
On the LOPFI side, investment managers strive to keep a steady assumed rate of return of 7.75% year after year. Going with what Taylor said, if outcomes are better, they require less investment from the employers — in this case, the city of Fort Smith. If they do worse, they require more investment. LOPFI Executive Director David Clark told Talk Business & Politics, “At this point it is too early to tell what the effect will be.”

“One thing it’s helpful to understand about the portfolio for retirement is that you have $1.7 billion in assets across the entire fund, and it’s incredibly diversified across more than just domestic bonds, stocks, notes, and other financial instruments.”

To understand the full impact, one would have to dig down into each allocation within the fund. Clark said LOPFI has many investment managers making those decisions and “it moves daily.”

As far as expense to the city is concerned, the LOPFI Board of Trustees makes determinations on what the upcoming employer contributions are a year in advance. Rates for 2017 are already set for Fort Smith and other participating cities. Any changes for 2017 would be reflected in 2018’s general contribution. LOPFI moves on a calendar year, the same as its participating employers.

“The goal of our retirement system is to keep rates as level as we can from one generation to the next,” Clark said. “The responsibility for funding levels is up to the Board of Trustees for the retirement system. If everyone does what they need to on this side of the equation, that helps mitigate expenses at the city level.”