Municipalities Struggle to Pay Pensions

Cities and counties across California are mirroring the state by going to what some say are extraordinary lengths to pay for generous pension benefits granted in recent years to public employees.

Some localities are restructuring obligations to the state’s pension fund while others are seeking to issue bonds to cover unexpectedly high pension costs. Critics say both moves will ultimately fail to address whether local governments can afford to maintain the costly packages.

The financial crisis reflects pension bonanzas of the late 1990s, when the California economy was booming. Retirement pay for some public employees is now so lucrative that retirees will make more than they did when they were working.

Not all counties and cities are struggling. But at least eight local governments have successfully petitioned the California Public Employees’ Retirement System, the public employee retirement system, to defer a portion of their pension contributions to the state system this year. CalPERS has approved payment deferrals for Santa Clara County, along with the cities of Long Beach, Lemon Grove, Paradise, Pacific Grove, Richmond and South Gate and the Sacramento Metropolitan Fire District.

The deal allows agencies to pay a lower pension rate for fiscal 2004-05, resuming normal contributions the following year. But beginning in July 2007, the agencies will be required to pay back the deferred amount, plus 7.75% interest, in addition to their annual contributions.

Other counties and cities are considering costly borrowing programs to shore up underfunded retirement systems.

State government is facing similar problems. Gov. Arnold Schwarzenegger last month cut a complicated deal that temporarily saves money by delaying new workers’ enrollment in the retirement system. To help pay this year’s bill, he also proposed borrowing $900 million.

Schwarzenegger made the agreement with an employees union with the hope of passing the state budget on time. With the budget now overdue, some of the governor’s side deals have started to look shaky, leading some Sacramento insiders to question whether the pension deal will hold.

Some Republicans have already criticized the pact as too reliant on rosy financial projections. Repeated calls to the governor’s office for comment were not returned.

Many of the local deals assume improving stock market returns and healthier budgets, predictions that could turn out wrong, said Carl DeMaio, a persistent critic of the higher pension benefits.

“Submitting an IOU is not a payment. It is not actuarially sound,” said DeMaio, president of San Diego-based Performance Institute, a group that studies increasing government efficiency. “All you’re doing is pushing back a crisis for two or three years.”

As the city of San Diego has learned, governments risk deepening the spiral of debt by delaying payments, DeMaio said.

After a decade-old restructuring plan failed, San Diego’s retirement fund today is more than $1 billion in debt. The city’s credit ratings have been downgraded, and the FBI and Securities and Exchange Commission have launched investigations. .

Governments gamble when they delay payments in hopes of better budget times, State Sen. Tom McClintock (R-Thousand Oaks) said. “It’s not a prudent bet to take, especially with other people’s money,” said McClintock, who has criticized the pension enhancements as excessive.

San Diego Mayor Dick Murphy last week proposed a plan that he said would begin to fix the problem. It includes borrowing at least $200 million to beef up the pension system’s funding, paying off debt in 15 years instead of 30 and changing the makeup of the retirement board.

Under the present system, nine of the 13 trustees are current or retired city employees who stand to benefit from the decisions they make. Murphy said a majority of members should be financial professionals not affiliated with the city.

Meanwhile, a CalPERS spokesman said the system’s chief actuary has reviewed each of the local agencies applying for a rate restructure and, in each case, found that delaying payments would not hurt their employees’ retirement plan.

But DeMaio of the Performance Institute said the new policy raises “huge red flags.” He likened it to the “actuarial tricks” that he said led to San Diego’s troubles. “For CalPERS to allow a policy allowing intentional under-funding of a retirement system is to take the same bad policy that San Diego perfected and transport it to every local agency in the state,” he said.

Ray Lane, supervising actuary for CalPERS, disputed that view, maintaining there is no risk of depleting retiree benefits in the long run.

“We have done tests to make sure that it does not put the plan in any actuarial or financial danger,” Lane said. “It’s my understanding that in San Diego, they went beyond what their actuary was recommending.”

Santa Clara County asked for a lowered rate because it was facing a $200-million budget shortfall, said Luke Leung, the county’s human resources director. CalPERS allowed it to postpone $35 million in contributions, a significant amount when every dollar means cuts in jobs and services, Leung said.

Suzanne Mason, deputy city manager in Long Beach, said officials are studying the CalPERS proposal but have not decided whether to go ahead with it. The city, facing a $102-million budget shortfall, also is considering issuing a pension obligation bond, she said.

San Diego County recently issued $450 million in bonds to help pay this year’s $700-million pension bill. It is the second time in recent years the county has had to engage in pension fund borrowing. The city issued a $550-million bond in 2002.

Bryan White, the county’s retirement administrator, said the system does not expect funding problems next year because the stock market is gaining strength and the pension fund’s investments are paying higher dividends.

But other government administrators fear their pension challenges are far from over. In the coming year, cities and counties may have to consider renegotiating employee contracts, lowering benefits for new workers or raising taxes.

“When does it become so dire that we have to consider other options?” asked Mike Killebrew, acting finance director for Long Beach. “We’re there.”

Today’s pension crisis was brewing when Schwarzenegger came to office last fall. Beginning in 1999, Gov. Gray Davis signed an array of union-backed legislation that allowed state and local governments to sweeten retirement packages.

Improvements varied at the state and local levels, but increases of 33% to 50% have been common. In most cases, the increased benefits were made retroactive with employees paying little or none of the extra cost.

Lawmakers approving higher benefits were told that, because retirement trusts were flush with stock market earnings, the improvements wouldn’t cost anything. The market’s tumble erased those gains, however, at precisely the time the tab for higher benefits came due.

The state’s pension bill rose to $2.5 billion for the fiscal year that began July 1, up from $611 million in 2001. Schwarzenegger’s cost-saving plan is estimated to shave $59 million this year, with a total savings of $2.6 billion over 20 years.

His proposal would delay enrolling new state employees in CalPERS for two years. During that time, the employee would contribute 5% of pay to a trust account, but the state would not make any matching contributions.

At the end of the period, employees would cash out their reserves or use them to purchase two years’ credit in the retirement system. Schwarzenegger’s plan assumes that 75% of employees will opt to cash out, saving the state the dollars it would have had to pay out retroactively for the first 24 months.

Jon Coupal, president of the Howard Jarvis Taxpayers Assn., said in return for the unions’ concession, his group agreed to back off a lawsuit challenging the legality of the proposed $900-million pension bond.

Still, Coupal said, Schwarzenegger should have stuck with the broader reforms he envisioned. They called for employees to pay an extra 1% to cover added pension costs and for the state to offer new workers a less-generous and less-costly pension.