Bond Issues Funding Pensions

California public agencies borrowed more money this year to cover employee pensions than they have in a decade, underscoring the struggle of governments to keep pace with the spiraling costs of retirement plans.

Borrowing topped $2 billion this year and is expected to continue next year as cities and counties look for ways to cover employee retirement costs without cutting into basic services. Interest on long-term pension bonds will only compound the debt over time.

Officials in Contra Costa, Santa Clara and San Joaquin counties have warned that program cuts may be necessary to deal with increased costs. Salinas will close its libraries next month, and Richmond recently laid off 18 firefighters, citing pension costs as a factor.

Pension costs are rising for two main reasons. Governments have agreed to more generous pension plans over the last few years. The pension plans rely in part on strong performance from the stock market. With market performance weaker than expected, governments must make up the difference in their plans.

Although borrowing to pay off unfunded liabilities is not uncommon, the acceleration in bond issues is “an indicator of illness in the pension system,” said Dan Pellissier, chief of staff for Assemblyman Keith Richman (R-Northridge), who is pushing for pension reform.

Just this year, 13 local governments -- including San Bernardino, San Diego, Sacramento and Fresno counties -- issued $2.2 billion in pension obligation bonds, returning to levels not seen in a decade, according to the state treasurer’s office.

Pension costs in Los Angeles and Ventura counties, by contrast, are rising at a slower pace because officials in those jurisdictions have resisted union pressure to grant improved benefits. Both counties last issued pension obligation bonds in 1994. Orange County also has not issued pension obligation bonds in a decade.

But last week Los Angeles County Supervisor Gloria Molina ordered a study of the county’s pension system because of an unusually high number of firefighters who filed disability claims in the last year before their retirement. Nearly three-quarters of county firefighters who retired in the last three years successfully claimed they were disabled on the job and as a result received increased pension benefits, according to county records. The cost of these extra benefits has jumped from $20 million a decade ago to nearly $50 million last year.

For many municipalities, however, borrowing to cover such costs remains the central issue. By trading one debt for another, governments can reduce current payments -- but they run the risk of paying even more in the long run, Pellissier said.

Richman, who advocates converting all public pensions to 401(k)-style plans, believes the problem with rampant borrowing is that it allows governments to artificially lower annual costs while pushing off debt to future taxpayers.

“In this year alone, local governments have issued over $2.2 billion, which over their lifetime is going to cost somewhere in the range of $5 billion,” Richman said. “That’s money that’s going to meet pension obligations that is not going to public safety, healthcare, libraries or infrastructure investment.”

Riverside County is considering a $350-million pension bond for the coming year while also forming a committee to look at ways to rein in costs. San Diego’s plan to float a $200-million bond issue is on hold while credit-rating agencies await the outcome of state and federal investigations into the city’s troubled pension system.

Analysts say bonds can be a legitimate tool for governments looking to trim retirement costs. With interest rates low, employers can retire an unfunded liability at a lower cost and reduce annual pension contributions, said John Bartel of Bartel Associates, which consults with governments on bond issues.

But borrowers are betting that the lending climate will remain favorable, a risk that can backfire and end up costing governments even more over the long run, Bartel said.

“You are taking a chance, and the question each agency needs to ask is, ‘Is that an appropriate risk to take with the taxpayers’ money?’ ” he said.

Local governments aren’t the only ones turning to pension bonds. The Schwarzenegger administration is hoping to make an $800-million pension bond offer to offset the state’s retirement costs, estimated at $2 billion.

However, the plan was put on hold last week when the Pacific Legal Foundation, a conservative legal group, challenged the constitutionality of the bond sale.

The state is unsure how long it will take to resolve the challenge in court, said H.D. Palmer, a spokesman for the Department of Finance.

After years of decline, pension borrowing began rising in 2000, according to the state treasurer’s figures. Governments turned to bonds to pay off shortfalls in their retirement portfolios created by the stock market’s poor performance, higher benefits granted during flush times, increases in disability-related retirements and increased life expectancies.

For instance, San Bernardino County’s pension system was 84% funded until it borrowed $463 million in June, said Tim Barrett, head of the retirement fund. It’s now at 93%.

San Diego County’s funding level was even lower -- 76% -- even though the Board of Supervisors had approved a $550-million bond issue in 2002. To replenish the system, supervisors approved a $450-million bond issue this year, said Bryon White, director of the county’s retirement system.

Although counties did most of the borrowing, municipal governments also got in the game.

Daly City, Merced, Millbrae, Monterey Park and Riverside banded together on a $197-million pension bond. An official at the agency that arranged the issue, California Statewide Communities Development Authority, said the agency has been contacted by other cities interested in a similar action. Many of the hardest-hit local governments had increased pension benefits by 33% to 50% just as the stock market was starting to slow down. Pellissier, of Richman’s office, argues that those levels are unsustainable in the long run.

But union leaders say the effect of benefit enhancements has been overblown. Most of the downturn in retirement portfolios can be traced to the stock market’s dive in 2001, 2002 and 2003, said Carroll Wills, spokesman for the California Professional Firefighters, an umbrella group representing firefighters’ unions.

Wills also faulted employers for halting pension contributions when trusts were bulging with excess funding in the late 1990s.

“This is the result of the three-year holiday that governments took during the go-go years of the 1990s,” he said.

Many retirement administrators agree that changes are necessary to make pension costs more predictable for governments. The wild funding swings cause instability, they say.

“Everyone who takes their responsibility seriously knows that there are issues that need to be looked at,” said Richard Stensrud, executive director of Sacramento County’s retirement system.

But they worry that the fix will be made with a bludgeon instead of a scalpel.

“It’s a valid point to say we need some pension reform,” said Peter Kutras, chief executive of Santa Clara County. “My concern is that we [not] get pension destruction.”

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Growing debt California public agencies are increasingly going into debt to cover retirement costs. In 2004, local governments issued more than $2.2 billion in pension obligation bonds to cover their underfunded retirement trusts.

Pension obligation bonds

Principal Bonds Debt Year (in millions) issued refinanced* 1994 $2,285 3 $2,285 1995 2,143 9 533 1996 787 4 469 1997 680 5 137 1998 206 3 206 1999 201 3 163 2000 211 1 211 2001 378 3 203 2002 1,279 10 598 2003 1,295 9 920 2004** 2,281 22 644 Total $11,747 72 $6,369 * (in millions) ** Through Oct. 13 *** Bonds issued in 2004 Top issuers / New debt (in millions) San Bernardino County / $464 San Diego County / $454 Sacramento County / $426 Fresno County / $403 California Communities Development Authority** / $197 Solano County / $97 Butte County / $30 Union City / $23 Kings County / $7 ** Pooled bonds issued on behalf of Daly City, Merced, Millbrae, Monterey Park and Riverside. CaliforniaÕs attempt to issue $800 million in pension bonds is being challenged in court.

Sources: California treasurer