The Public Eye: Pension promises threaten California cities, counties

preese@sacbee.com

Published Sunday, Apr. 11, 2010 - Sacramento Bee

This year, the city of Roseville will spend about as much to fund its pension plan as it does on parks and recreation.

San Luis Obispo County will spend five times as much on pensions as it does prosecuting criminals.

And Stanislaus County's pension costs will be nearly double its $23.5 million general fund budget deficit.

The initial logic of increasing retirement benefits to retain quality employees has been turned on its head: Paying for those benefits is forcing local governments to lay off employees – and cut programs.

"The old joke is that General Motors is just a health insurance company that makes cars on the side," San Luis Obispo County Supervisor Adam Hill said during a pension presentation at a recent board meeting. "My concern is that the county government is becoming a pension provider that provides government services on the side."

Yet today's escalating annual pension payments barely touch the looming shortfall: $28 billion in unfunded liabilities – the difference between what pension systems have and the pension benefits their employees have earned – at the 80 largest city and county governments in California, according to an extensive Sacramento Bee review of pension plan valuation reports.

On top of that, those cities and counties owe about $8 billion in pension-related bond debt – all in a time of shrinking budgets. In many areas, the total pension shortfall is more than the annual payroll; in some, it is more than the general fund budget.

Spread that debt evenly, and it comes out to about $4,000 per household in those cities and counties.

Already, Californians feel the impact of the rising costs. Local governments are cutting unrelated programs – everything from parks to public safety – to help pay for pension plans. Downsizing likely will continue both because pension contributions often are legal mandates, and, even with a recovering economy, because much damage already has been done.

A very few places are whispering about the nuclear option: bankruptcy. The Bay Area port city of Vallejo already went this route, largely to break its agreements with its employees.

It wasn't supposed to turn out this way.

When local governments passed enhanced retirement benefits at the turn of the millennium, the stock market was humming. Government leaders could just sit back, watch their employees smile and let the market do the heavy lifting.

"We're not creating an unfunded liability," then-Fresno County administrative officer Linzie L. Daniel vowed in 2000, when the county approved better retirement benefits to be offset by expected investment returns.

Since then, unfunded liabilities have increased from less than $100 million to $800 million in Fresno County.

'Five-year pain plan'

San Luis Obispo County's chief number cruncher, Assistant County Administrator Dan Buckshi, fiddled with his PowerPoint presentation a few months ago and warned his listeners that what he was about to show them was only the third year in the county's "five-year pain plan."

The county supervisors in front of him chuckled feebly. They were well aware of the pain the county had endured.

They had watched their work force dwindle by nearly 13 percent, from 2,700 in 2002-03 to an expected 2,350 later this year. They had instituted a hiring freeze, consolidated jobs, encouraged early retirement, scaled back capital projects and amortized losses over 10 years instead of five.

They also limited health care access for the poor by cutting community health clinic funding.

And they knew it wasn't enough. The county still had a 2010-11 projected budget deficit of $19 million and an annual pension bill that ate 11.2 percent of the total budget.

"I wish I had something comforting to say," county Supervisor Frank Mecham told the San Luis Obispo Tribune last month. "If you sit there and watch the (stock) market every day, it will drive you to drink."

That pain is being felt all over.

Northeast of the state Capitol in Roseville, officials have cut 150 of 1,150 staff positions during the last year – more than 10 percent of its work force. The $18 million the city must legally pay in pension contributions this year could have preserved those jobs plus several new hires.

The south Placer County city faces $111 million in unfunded pension liabilities, double the figure from just five years ago. As it stands now, the city will be able to cover just 75 percent of its future pension expenses. An 80 percent funded ratio is generally considered healthy.

"Roseville has built a retirement compensation system that was based on an old model of revenues," said city Finance Director Russ Branson. "Clearly, that is a driver of costs."

And, down in the San Joaquin Valley, unfunded liabilities have quadrupled during the past five years in Fresno County. The county also has about $550 million in outstanding pension obligation bonds.

Fresno County expects to pay more than $140 million into its pension system next fiscal year – up 13 percent from this year. According to a recent report, that contribution requirement is likely to grow during the next four years.

With revenue also falling, services are affected. The total number of Fresno County employees dropped by 700, or 10 percent, from 2008 to 2009, financial audits show. The county drastically cut its mental heath services budget, reducing care for the homeless and indigent, and, like many other places, it released a slew of jail inmates.

The worst-case scenario for these local governments isn't more cuts – it's bankruptcy, a step that most insist is unlikely.

"Last time I checked, government is not going out of business; Merced County is not going out of business," said county CEO Larry Combs.

Even places like Merced County that can cover just 65 percent or 70 percent of their future liabilities are doing amazingly well, given the depth of the recession, according to Dave Low, chairman of Californians for Health Care and Retirement Security, which represents more than a million public employees on pension, health care and labor issues.

"The very worst are still probably in very good condition," Low said.

Still, a decade ago, few would have predicted that Vallejo would go under. Today, the city remains hung up in court, trying to cancel provisions in its labor agreements that promised benefits it no longer can afford to pay.

As of its bankruptcy filing in 2008, Vallejo had roughly $88 million in unfunded pension liabilities. Those liabilities equaled about 112 percent of the city's annual general fund budget.

Combs' own county, Merced, is slipping toward that figure: Its pension bonds and unfunded liabilities equal about 85 percent of its annual general fund budget.

San Luis Obispo's situation is worse, with pension obligations now equal to roughly 119 percent of its general fund.

How it came to this

About 85 former members of the Sacramento Metropolitan Fire District earn annual pension benefits of more than $100,000, including former chief Donald Mette, who makes almost $241,000 a year in retirement, according to a list obtained from CalPERS by advocacy group California Pension Reform.

In Roseville, 17 former employees earn north of $100,000. In Merced County, it's 37. In Stanislaus County, it's 50.

All of them can thank former Gov. Gray Davis.

In 1999, Davis and the state Legislature passed a generous set of pension upgrades. Most public safety officers came out on top, eventually receiving 3 percent of their salary per year of service for life, after reaching age 50. The improvements were heavily supported by labor unions, which had contributed large sums to Davis' election war chest.

Nearly all California cities and counties followed Davis' lead, often passing clauses that mandated better pay or benefits if a neighboring jurisdiction received them.

While those "me too" enhancements get the most ink, they're only one factor – and probably not the largest one at that – behind the pension morass facing cities and counties. The other three factors:

• Faulty assumptions about the stock market.

• Bad advice from some professional advisers.

• Hiring followed by a plethora of raises.

It's a simple calculus: The more money government employees make, the more they'll get in retirement.

Average pay at all California local governments rose 40 percent from $46,073 in 2000 to $64,284 in 2008 – a much faster rate of growth than inflation, according to the U.S. Census Bureau. To keep up with inflation, those employees would have needed just a 25 percent raise.

Unions pushed heavily for the raises, saying public employees had been ignored during previous, leaner years.

In the city of Sacramento, the average pay of public safety employees grew 50 percent during that time frame, to $82,897, according to the city's latest valuation report. In Oakland, average pay for police and fire employees has tripled to $114,741 since 2000.

Combined with enhanced retirement plans, the salary jumps caused startling leaps in pension payouts.

Using the same cities for comparison, in Sacramento, the average annual benefit to former public safety employees who took a service retirement during the past five years was $64,521, up 58 percent from a decade ago, valuation reports show. In Oakland, the average annual benefit for recently retired public safety employees has more than tripled since 2000 to $83,946 today.

While payroll and benefits packages are largely within the control of city leaders, other influences on pension costs are not.

Roughly three-fourths of benefits are typically paid with returns on investments. Once the recession hit and dragged down the stock market, the burden fell to local governments to pick up the slack.

Local governments generally have counted on about an 8 percent annual return on their investments. Between 2007 and 2008, many instead saw declines of 15 percent or more.

In Stanislaus County, for example, officials watched their retirement portfolio lose more than $400 million – 30 percent – between early 2008 and mid-2009. About half of those losses have been erased by recent stock market gains.

On top of all this, many counties were getting bad advice about the costs of their pension plans – advice that haunts them in today's budget talks.

Governments hire actuaries to make educated guesses about how much a plan will need to meets its obligation to retirees over two or three decades. Their assumptions are based on everything from when the average employee will retire to how long they will live and how the market will perform.

A recent audit in Stanislaus County found that its former actuarial firm had made mistakes in predicting how many employees would draw pension benefits. The actuary assumed that more employees would opt for retirement cashouts, which are cheaper to fund, instead of monthly benefits. Based largely on those predictions, the county seriously underfunded its plan.

Fresno County claims its actuary had employees paying a share of pension obligations that should have been covered by the county. The county eventually had to cough up millions.

Just as damaging, actuaries told local governments during the boom years that they didn't need to put any money into the retirement system because the market was performing so well. That wasn't a mandate; local governments could still sock money away, but few did.

"Most of the cities took pension holidays," said Low, the public employee advocate. "That is a pretty big reason for all this."

Search for solutions

At a glance, the city of Fresno looks to be in far better shape than Fresno County. Its pension plan is fully funded, and its annual contributions to that plan are relatively small.

Dig deeper, though, and some of that advantage is an illusion, conjured up by pension obligation bonds. One-third of pension plans are well-funded – they can meet 90 percent of their future obligations – but half of those well-funded plans are saddled with bonds.

They've borrowed to buy down debt, offloading the bill to future taxpayers.

Having already deeply cut services and being wary of raising taxes, many local governments hope to pass pension costs on to employees by making them pay a larger share of their pension contributions.

The most dramatic version of this approach follows Gov. Arnold Schwarzenegger's lead and tries to repeal many of the enhanced benefits approved during the Davis regime.

In Merced County, Combs – the county chief executive – and the current board of supervisors favor a plan in which new employees would receive a scaled back annual pension equal to 2 percent of their yearly salary multiplied by their years of employment. Merced's current plan is 3 percent at age 50 for safety workers, and 3 percent at age 60 for others.

Such shifts sound minuscule, but they would make a significant difference. A 55-year-old Merced County sheriff's deputy with a final annual salary of $75,000 and 30 years of service gets an annual pension of about $68,000 currently, but would get only $45,000 under the new plan.

"I have to believe everyone understands that pension costs are going to break all of the local governments in California," said Vito Chiesa, a supervisor in Stanislaus County, which soon will negotiate for similar reductions in benefits. "I think everyone will see it is unsustainable."

That's likely too optimistic. Stanislaus County, for example, has closed its sheriff's deputy training academy for the coming year, saying the market is flooded with laid-off candidates. Yet the local union still argues that the benefits are essential for attracting and retaining employees.

"The retirement benefit is a huge hiring point," said Vince Bizzini, president of the Stanislaus Sworn Deputies Association.

This month, Stanislaus County leaders reversed the enhanced benefits they gave to workers in 2002, but only for workers who are hired after the end of this year and who aren't represented by unions. The county has 413 unrepresented workers, mostly managers and elected officials.

Low, the employee advocate, predicted that unions will bargain on pension issues in good faith. But, he said, it's unfair to view them as the linchpin for fixing local government finance problems.

Regardless, asking employees to pay down a city's pension obligations is a little like trying to cut down a tree with a knife.

About one-third of the 80 cities and counties examined by The Bee – including Merced, Orange and Fresno counties – now have unfunded liabilities that equal or exceed the size of their annual payroll. So even if governments told their workers, "Sorry, but your entire salary will be diverted to pay off pension debt for the next year," there would be debt to spare.

That leaves taxpayers. The pension bill facing them likely will balloon in years to come.

Currently, 15 percent to 30 percent of local governments' annual payroll goes into their pension system – a quarter or so for every dollar spent on paychecks.

That adds up. Together, all local governments in the state paid $11 billion into their pension plans during 2008, or about $900 per California household, according to U.S. Census Bureau data. Millions more went toward paying off pension bonds.

Dwight Stenbakken, deputy executive director of the League of California Cities, predicts that contribution rates will expand to about 30 percent or 40 percent of payroll in most places. CalPERS officials partially agree, saying that, due to retirement and market projections, contributions will rise for the next decade.

It's a hard sell – cutting fat pension checks while cutting government services – that has exhausted many local government leaders.

"We're trying to maintain credibility with taxpayers," Stenbakken said, "but, right now, I'm not sure this is defensible."

ABOUT THIS REPORT

This story was a collaboration among The McClatchy Co.'s five California newspapers. Contributing reporting were: Brad Branan, Fresno Bee; Ken Carlson, Modesto Bee; Bob Cuddy, San Luis Obispo Tribune; Danielle Gaines, Merced Sun-Star; and Phillip Reese, The Sacramento Bee. Reese, who did the data analysis and wrote the front-page story, also watched hours of video recordings of local government meetings where pensions were discussed.

Reese pulled data from the most recent available actuarial valuation reports for pension plans of most of the state's 40 largest cities and 40 largest counties. In almost all cases, these reports covered fiscal 2009 or 2008. In a few cases, data came from a local government's comprehensive annual financial report.

Cities and counties included in the analysis were selected based on U.S. census and CalPERS data about the size of their work force. Every household's share of local government pension debt was determined by adding unfunded liabilities and bond debt at the 40 largest city governments and the 40 largest counties, then dividing them by the number of households.