Bloomberg News

Fairfax Reveals No. 1 Relative as Liabilities Soar: Muni Credit

October 17, 2012

Fairfax County, Virginia, credits Bridgewater Associates LP, the world’s largest hedge fund, with helping it generate a 19.3 percent annual return since 2009, the best performance among the biggest U.S. public pension systems.

Even so, the second-richest U.S. county is coming up short in funding its retirement promises. Fairfax County, home to 10 Fortune 500 companies, has seen its pension gap more than double since 2005, underscoring how even the most affluent communities are struggling to keep pace with retiree obligations.

At issue is how much the county allocates for pensions. Over the past three years, its contributions were about $120 million below the amount recommended by Governmental Accounting Standards Board formulas, according to a 2011 annual report. County officials say the deficit started to grow in 2003 after they adopted an approach that reduced the volatility of annual payments.

“What’s been so frustrating to me is that we do very well on the investment side and we still have this funding gap,” said Robert Mears, executive director of the Fairfax County Retirement Administration Agency. “But we’re wrestling with very difficult budget times and a lot of austerity, so the county is trying to address limited revenues and a tremendous amount of needs.”

Double Challenge

States and localities are grappling with the challenge of mending their finances after the recession that ended in 2009 while also keeping up with retirement promises. Those obligations were made more difficult by the Standard & Poor’s (SPX) 500 Index’s 48 percent slide from October 2007 to March 2009.

In 2011 more than 30 states had less than 80 percent of the assets needed to meet pension obligations, data compiled by Bloomberg show. That left them short of the threshold for sustainable retirement plans.

Fairfax, with the highest credit grades from the three major rating companies, borders the nation’s capital and is home to 1.1 million people as well as Northrop Grumman Corp. and General Dynamics Corp. Both are among the top five U.S. defense contractors, leaving the region among those vulnerable to $1.2 trillion of possible federal spending cuts set to start in January unless Congress acts.

Matching Rally

Investors have yet to penalize Fairfax debt, which is keeping pace with a rally in AAA municipal bonds. A 10-year county bond yielded 1.67 percent in trading last week, about even with a benchmark of nationwide AAAs, data compiled by Bloomberg show. The county also achieved yields in line with the AAA benchmark when it issued the securities in January.

The county, across the Potomac River from Washington, had unfunded obligations to its almost 27,700 government, police and fire employees and retirees of $1.7 billion as of July 1, 2010, up from about $700 million in 2005, according to county filings. It also had a deficit of about $560 million in a separate retirement system for about 32,000 teachers and school retirees.

“The county has consistently funded at a rate determined by our actuary,” said Mears, who is based in the city of Fairfax. “We always fund what it is, though that is not in accordance with GASB standards.”

‘Full Contribution’

By eschewing the GASB approach, “they’ve not been paying their full contribution,” said Keith Brainard, chief of research for the National Association of State Retirement Administrators, based in Essex, Connecticut. “That adds up to hundreds of millions of dollars over the years when you include the compounding effect.”

Fairfax County’s funding gap would be larger if not for the success of its pension investments.

The $3.6 billion Fairfax County Employees Retirement Fund, the county’s main fund, averaged a 19.3 percent annual return in the three years through June 30, said Chief Investment Officer Larry Swartz. That topped 62 other public pension funds with more than $1 billion in assets, according to Bank of New York Mellon Corp.

Fairfax relies on outside managers selected by Swartz and agency boards. He credits Bridgewater, the Westport, Connecticut-based fund started by Ray Dalio that manages about $130 billion, for boosting returns. Bridgewater’s Enhanced TIPS Index fund and Enhanced Multi-Asset Real Return fund managed a combined 21 percent of the fund’s assets as of June 30, 2011.

Asset Shift

Bridgewater declined to comment, said Russell Sherman at Prosek Partners, a New York public relations company that represents the money manager.

Fairfax County in 2004 started shifting from stocks to bonds and alternative investments, Swartz said. Fixed-income in July 2011 comprised 43 percent of assets, to 26 percent for equities, while real-estate securities, commodity futures and absolute-return funds made up a combined 25 percent, according to a county filing.

Nationally, corporate and public pensions had 44 percent in stocks, 31 percent in bonds and 25 percent in alternative investments, according to a January 2012 study by Towers Watson & Co. (TW:US), a benefits consultant based in New York.

County supervisors this year agreed to boost the funding ratio to 91 percent over the next 15 years from about 70 percent now. To close the gap, Fairfax County is counting on investment results rather than bigger contributions.

“We have confidence the market will sustain our funding level over the long term,” Mears said.

Longer Lives

The county’s funding gap worsened because pension costs for its employees are proving more costly than estimated, said Gene Kalwarski, chief executive officer in McLean, Virginia, for Cheiron Inc., the actuarial consultant that advises Fairfax County. The higher costs stem partly from retirees living longer than expected and limited turnover, he said. Longer-serving employees typically raise pension costs.

After growing at 15 percent annually from 2002 to 2007, property values peaked in 2009, then declined 10 percent in 2010, Moody’s Investors Service said in a January 2011 report.

Fairfax County responded by raising property taxes in 2009 and 2010, cutting 481 positions and freezing pay, according to Moody’s. Last month, the county capped sick pay and boosted its retirement age to 55 from 50 for workers hired after July 1, 2012, said Sharon Bulova, chairwoman of the county’s Board of Supervisors.

The county had median household income of about $106,000 in 2011, trailing only neighboring Loudon County, and double the national average of $50,054, according to U.S. Census Bureau data. The unemployment rate was 4 percent in August, compared with 8.1 percent nationally.

Pension Feasibility

Fairfax County decided this year against more extensive pension changes, including converting to a 401(k)-style defined- contribution plan, Bulova said.

The county will eventually revisit the issue because traditional pension plans aren’t feasible, said Pat Herrity, a Republican county supervisor.

“If you don’t deal with the underfunding today, it becomes a bigger issue that you have to deal with,” said Herrity, chief financial officer of Gap Solutions Inc., a Reston, Virginia, staffing company. “I’d rather have a plan that is sustainable so we can keep our promises to our employees.”

In the $3.7 trillion muni market yesterday, yields on benchmark 10-year tax-exempts were little changed at about 1.65 percent, a Bloomberg index shows. The index dropped to 1.63 percent on July 27, the lowest since it began in January 2009.

Following are pending sales:

DALLAS-FORT WORTH INTERNATIONAL AIRPORT plans to sell $301 million of revenue bonds as soon as tomorrow, data compiled by Bloomberg show. Proceeds will refund debt. (Added Oct. 17)

CALIFORNIA plans to sell about $550 million in general- obligation refunding bonds as soon as Oct. 23, according to the state treasurer’s website. The debt will be sold via auction. (Added Oct. 15)

To contact the reporter on this story: David Mildenberg in Austin, Texas, at dmildenberg@bloomberg.net

To contact the editor responsible for this story: Stephen Merelman at smerelman@bloomberg.net


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