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Category 1 - Political / Internal Causes of Financial Distress

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Governance Crisis   
Excessive Personnel Costs           
Past Awards of Unsustainable Retirement BenefitsPoor Morale or Commitment

Overexpansion      

Governance Crisis

A governance crisis is a foremost cause of distress. Governance encompasses the board, management, and approved policies and procedures. Strong governance is needed to confront difficult facts, encourage innovative solutions and adaptive behavior, and hold the organization accountable for the changes needed.

A governance crisis can manifest in various ways and could involve board members, independent elected officials, and/or an elected or appointed chief executive officer or other members of management.

Symptoms
  • Lack of political cooperation. Members of the governing board, the chief executive, and/or other key management staff are consistently unable to work together or make joint decisions.
  • Excessive decentralization. Operating departments have too much independent control over policy and budget decisions such that economies of scale are lost, departmental budgets do not support organization-wide objectives, and coordination is seriously impaired.
  • Multiple power centers. Power is dispersed among multiple, potentially competing authorities within the organization. 
  • Board micromanagement. The board involves itself in administrative issues normally better addressed at a staff level.
  • Ineffective linkage with staff. A chief executive that does not communicate effectively with the board or has trouble developing staff actions to translate the board’s policy into financial stability will hurt financial position.

Excessive Personnel Costs

Labor costs comprise a high proportion of most local governments’ budgets. Excessive compensation costs can severely damage a government’s financial position. Union agreements are often blamed for reducing flexibility or creating compensation plans that are unsustainable. However, excessive personnel costs can have many causes. For example, perhaps the compensation structure is not attracting enough high quality workers such that more people or overtime is needed to do the work. 

 

Symptoms

  • Above-market compensation without a related strategy. Evaluate total compensation (including benefits) that is significantly above the median for comparable positions, given market rates. Is there an explicit human resources strategy that justifies
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    instances of above-market compensation or does the decision rely strictly on the organization’s ability to pay?
  • Lack of a compensation plan. A plan should include ranges (including upper limits) on total compensation (wages plus benefits) for all positions. It should be updated regularly and should be based on market comparisons.
  • Declining pension funded ratios. The pension funded ratio compares accumulated plan assets to the actuarial accrued liability. Consider funded ratio trends over time. What direction has it been heading and at what speed? Increasing decline may indicate excessive employee pension benefits.
  • Falling short of required annual contributions. The annual required contribution (ARC) is designed to recover the cost of pension benefits earned by employees during the period. Full funding of the ARC over time will ensure resources are available to pay benefits when due. Failure to fund the ARC may indicate benefits are beyond the ability of the government to pay.
  • High employee per capita measures. Greater numbers of employees than comparable governments may indicate overstaffing. If employee headcount numbers are high, is the compensation structure low? It may indicate that the organization has a problem of quantity over quality.
  • Excess overtime. Is overtime increasing? Is there more overtime incurred than at comparable governments? 
  • Understaffing. Does a lack of staff require more overtime (or inefficient use of contractors)? 
  • Lack of labor flexibility. Can work be easily directed to the staff that has the capacity to perform it? Or does excessive departmentalization or constraining work rules prevent flexibility.
  • Under-skilled staff.  Are staff not properly trained or qualified to do their jobs? This might require more hours or people to get the work done than is really necessary.

Past Awards of Unsustainable Retirement Benefits

Contributed by Girard Miller 

 

The most common problem underlying post-employment benefit funding challenges today is the legacy of past benefits promises that were never sustainable in the first place.

Unsustainable retirement benefits plans ignore inevitable future costs, and either ignore actuarial methods or manipulate them. In the case of retiree medical benefits, the chief problem has been a multi-decade history of pay-as-you-go financing, long after public pension plans moved away from that model because it was proven to be unsustainable.  In the case of pension plans, specious reasoning and actuarial gimmicks have sometimes been used to justify benefits increases that were unaffordable. 

This is not to say that pension plan administrators and trustees are entirely at fault.  It was all too common for city councils and county commissions to award retroactive unfunded pension increases. Often, these deals were struck to settle collective bargaining agreements, while avoiding an immediate budget appropriation. Similarly, some local governments have offered early retirement programs to fix an immediate budget problem, and thereby increased the liabilities of the pension plan without paying for them. 
 

Symptoms

  • Employer pension contribution rates are in the double digits and keep increasing.
  • The OPEB plan has never been funded actuarially, and no revenues are identifiable to begin making actuarial required contributions (ARC). 
  • Frequent ad hoc cost of living adjustments are made (except in plans with funded ratios of more than 100 percent).
  • There is a history of unfunded retroactive benefits increases.
  • The average lifetime expectancy for new retirees exceeds their career service period (e.g., employees retire before age 58 with less than 30 years of service).
  • Employee contribution rates are low, and the ratio of employee versus employer contributions is low. Combined pension and OPEB plans’ employer contribution rates exceed 200 percent of employee contributions.
  • The pension plan has a payout multiplier of more than 2.5 percent (times years of service times final compensation) coupled with an employee contribution rate of less than 7.5 percent – or, conversely, an employee contribution rate of less than three times the pension multiplier for civilians. (Benchmark with 4x for first responders eligible for retirement before age 60 – 5x for those below the age of 55 – unless funded by a dedicated pension tax.)
  • Early retirement incentives are charged to the pension plan rather than being expensed.
  • Benefit levels exceed the local labor market or surrounding public employers; the employer is consistently out-flanked by labor unions and makes frequent arbitration awards of retirement benefits increases. There is a history of granting retirement benefits increases to obtain union agreements, shifting costs to the future.
  • The OPEB plan has no CPI or hard-dollar benefits ceiling and can “run wild” with future medical cost inflation.
  • Declining constituent population base or stagnant local economy is coupled with generous and unfunded legacy retirement benefits.
  • Operating budget revenue limitations or tax caps are combined with a tendency toward inflationary postretirement benefit increases.
  • Taxpayer groups or media outlets frequently bring attention to abuses and excesses.

Poor Morale and Commitment 

Contributed by James Garnett


During threatened or actual retrenchment, strong employee morale and commitment are most needed but are typically at their lowest.

  • Being left out of the loop by management creates employee anxiety and loss of morale.
  • In the absence of effective communication, rumor mills fill the gap and excessive attention gets devoted to conveying or rebutting these rumors.

 

Symptoms

  • Too much time and effort are spent scuttle-butting about what is happening and when the axe might fall.
  • The blame game heats up adding emotional stress to fiscal stress.
  • Rumors about potential cuts are more numerous—and sometimes more accurate—than official communication.
  • Free-exiting increases. The most valuable employees—those with other job options—jump ship or show declining morale if not respected and not kept in the loop.
  • Employees become paralyzed—not knowing how to act—or try to move in different directions at once.  

Overexpansion

Growth of public services is often attractive to government officials and constituents, but when undertaken without a compelling purpose it can create financial distress later. Expanding programs is particularly dangerous when not supported by an ongoing revenue stream or strong public demand. Overexpansion can also stretch staff resources and distract managerial attention.


Symptoms

  • Financially unsustainable. Temporary or one-time revenues are used to support expansions of ongoing programs.
  • Disconnect from need. Expansion decisions are not connected to a measurement of community need or to a government-wide service priority.
  • Value for money ill-defined. There is no clear outcome, result, or expected return defined for the money spent. 
  • Over-diversification. There is diversification into new functions without good reason. For example, a new program that duplicates services available from the private sector is probably not a proper use of taxpayer dollars.
  • Over-complication. New programs can make the organization more complex, which will compound management difficulties.


Continue to Category 2 – Internal, Economic/Technical cause of distress

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