SLO pension liabilities skyrocketing

June 6, 2013

By JOSH FRIEDMAN

In a span of ten years, the city of San Luis Obispo has gone from having no pension debt to becoming more than $100 million in the red in its retirement benefit plans.

Between fiscal years 2001-2002 and 2010-2011, San Luis Obispo’s annual pension costs rose from $0 to approximately $8 million. By 2020, yearly pension costs are projected to rise to nearly $14 million, which would consume more than 25 percent of the general fund if expenditures remained the same.

President of the Center for Government Analysis Steven Frates authored a report on San Luis Obispo finances in 2005. Fates told CalCoastNews that the rising cost of pensions will leave city officials with a “conundrum” of choosing between cutting services and raising fees if employee salary and benefit structures remain the same.

“San Luis Obispo city councils over the years have awarded very lavish pensions and they have not been prudent paying for the pensions,” Frates said.

The city holds two pension plans with the California Employees’ Retirement System (CalPERS), which manages the retirement benefits. One plan is for the city’s retired police officers and firefighters, known as the safety plan, and the other, called the miscellaneous plan, is for all other retirees. Both plans have defined benefit status, meaning the retirees are guaranteed their pensions for life. About 450 retirees belong to the two plans, as well as about 350 current employees.

Retired San Luis Obispo public safety employees receive annual pensions of up to 90 percent of their highest yearly salary for the remainder of their lives. Their pension formula is 3 percent at 50. Beginning at age 50, public safety retirees receive a percentage of their highest annual salary equal to the number of years they worked multiplied by three. Retired police officers and firefighters who have worked for the city for 30 years receive annual pensions of 90 percent of their peak salaries.

All other retired employees receive an annual percentage of their highest salary equal to the number of years they worked multiplied by 2.7. These retirees, too, receive their pensions for the rest of their lives, but they do not have a cap on the amount of money they can receive.

Each retiree also receives yearly 3.25 percent increases to their pensions as cost of living adjustments.

Currently, 19 San Luis Obispo retirees receive annual pensions exceeding $100,000, according to a CalPERS database. Former city manager Ken Hampian, who retired in 2010, currently receives a pension of nearly $156,000. Four other former employees also receive annual pensions of more than $130,000.

To pay for the pensions, the city makes bi-weekly payments to CalPERS, which invests those funds and distributes pension benefits to retirees belonging to the two plans.

Beginning in 2012, city employees began contributing to the plans as well. Safety employees contribute 9 percent of their annual salaries to their pension plans, and miscellaneous employees pay 8 percent.

Each year CalPERS tallies payment totals that San Luis Obispo makes. In the years 1999-2000 through 2001-2002, San Luis Obispo paid CalPERS $0 annually. When the investment money accumulated in a plan exceeds the amount of benefits owed to retired and current employees, CalPERS does not require the plan holder to make payments.

The 1999 through 2002 period was unusual because they are the only years out of the 25 in which the city did not make any contributions to CalPERS. In 1999-2000 and 2002-2003, San Luis Obispo paid into its safety fund only and not into its miscellaneous account.

By the end of 2011, the two plans accumulated a combined total of $107.3 million of unfunded liabilities. Whereas in 2002 San Luis Obispo had more money in its pension plans than it owed in benefits, in 2011 it owed more than $100 million more than it had invested.

City Manager Katie Lichtig said a variety of factors caused the sharp rise in pension debt. Some contributing factors included investment losses by CaPERS and rising employee salaries.

But, as CalPERS suffered investment losses and employee salaries increased, the city did not proportionally increase its annual payment to offset the rising liability.

In 2002, San Luis Obispo had more than 100 percent funding for both of its plans. By 2011, the money held to benefits owed ratio dropped into the 60 percentile for each plan. The funding level of the safety plan fell to 65.6 percent and the miscellaneous to 61.6 percent.

“Generally speaking, anything below 80 percent is not good and anything below 70 percent is a matter for acute concern,” Frates said.

The lower the level of funding, the more difficult it becomes to pay down the unfunded liabilities, Frates said.

“It’s going to take a tremendous amount of money or a change in benefit structure.”

CalPERS requires plan holders to amortize, or pay off, their unfunded liability over a 30-year period. Thus, as San Luis Obispo’s pension liability has increased, so have its annual payments.

In 2011-2012, the city paid CalPERS a total of $8.4 million. San Luis Obispo is expected to pay CalPERS $9.7 million over 2012-2013 and $10.4 over 2013-2014.

In 2013-2014, the city will owe approximately $200,000 extra because CalPERS lowered its discount rate from 7.75 percent to 7.5 percent. The additional liability will increase as the city’s annual rate increases.

CalPERS also created a new set of standards in April that will accelerate the pace at which plan holders amortize their unfunded liability. Beginning in 2015-2016, municipal members of CalPERS will face five-year rate hikes intended to increase the funding levels of their plans and reduce the risk posed by potential investment losses.

CalPERS currently projects annual payments beyond 2013-2014 only as a percentage of payroll. In 2004-2005, the city’s pension costs, as a percentage of payroll, were 13.7 percent and 29.5 percent for its miscellaneous and safety plans respectively. By 2014-2015, CalPERS projects the city’s contribution rates for its two plans will rise to 25.8 percent and 44 percent. CalPERS projects that by 2019-2020, those rates will increase to 31.3 percent and 55 percent.

Based on a currently projected payroll of $35 million, San Luis Obispo will owe CalPERS $13.7 million for its annual pension contribution in 2019-2020. That total could increase if employee salaries increase or CalPERS investment returns are not as high as projected.

Last year, the city did negotiate reduced salaries and benefits after San Luis Obispo voters passed a pension reform initiative in August 2011. Following the passage of Measure A, San Luis Obispo labor groups accepted agreements with the city that require employee contributions to pensions and a two-tier system for new hires.

Newly hired police officers will receive 2 percent at 50 pensions, new firefighters will receive 3 percent at 55, and all other new hires will receive 2 percent at 60. Both formulas use an average of the highest three years of compensation, as opposed to the single highest year. Employees, however, can convert unused sick leave into additional pay to boost their pensions. Also, employees often work a lot of overtime in the year or years that will determine their pension size.

Frates described San Luis Obispo’s pension reform efforts as “window dressing.” He said the change in pension formulas would create some savings, but several decades would pass before the city would reap the rewards of the two-tier system.

Since the second-tier pension plans only affect new hires, current retirees continue to receive their pensions as initially structured, as will most current employees when they retire.

In 2011-2012, the city had $51 million in general fund expenditures, $40.1 million of which went to staffing costs. While pension costs totaled $8.4 million, CalPERS projections show they will rise to $13.7 million by 2020 with all else constant.

Lichtig did not indicate whether she expects reductions in city services or increases in fees to occur as a result of rising pension costs.