Will SLO issue a pension obligation bond?

April 17, 2014

By JOSH FRIEDMAN

Chances are growing that the city of San Luis Obispo will issue a pension obligation bond to gain control of its unfunded retirement plan liabilities, which have soared past $100 million.

The city currently has a total of about $123 million of unfunded liabilities in its California Public Employees Retirement System (CalPERS) pension plans, according to a recent city staff report. Unfunded liabilities accrue when city retirement plan payments combined with CalPERS investments total less than the projected amount of money owed to retirees.

Only one member of the city council supports paying down a sizable portion of the pension debt, and city staff has increasingly discussed floating a bond to address the problem. While some cities have used pension bonds to successfully pay down their debt, others have spiraled into bankruptcy after issuing them.

On Tuesday, the council met in a special afternoon session to discuss paying down its unfunded liabilities to CalPERS, as well as to a state legal insurance pool to which the city belongs. The council had previously budgeted $3 million toward paying down the pension and/or legal insurance debt. It opted Tuesday to use $2.065 million to fully pay off its legal liabilities and give the remaining $935,000 to CalPERS.

The council discussed tapping additional funds to make a larger payment to CalPERS, but only Councilman Dan Carpenter advocated paying down more of the debt. City staff recommended against allocating any money for paying down pension debt until CalPERs adopts a new methodology for calculating payments.

San Luis Obispo currently pays CalPERS about $10 million annually. The annual contribution has increased steadily for years, though, and continues to rise. The city is still playing catch-up from the downturn in the stock market during the recent recession, as well as from a council decision in the late 1990s to forego making pension payments when the city had no debt in its retirement plans.

On Tuesday, finance director Wayne Padilla presented the council with two alternatives to a business as usual approach to making CalPERS payments. One option was to make the $935,000 payment.

Padilla’s other alternative was to issue a pension obligation bond to pay down debt the city has in its retirement plan for public safety employees.

In 2007, San Luis Obispo joined other agencies in a pool of public safety retirement plans. At the time, the city had an unfunded liability in its public safety plan, so CalPERS created a standalone debt, known as a side fund, which the city has still not paid down. The San Luis Obispo side fund currently has $24.5 million of unfunded liabilities.

A pension obligation bond or bonds could fully retire the side fund liabilities but would create a new debt with interest that the city would likely pay off over three decades. The average pension obligation bond has an interest rate of 4 percent, according to Padilla’s staff report.

“At sometimes it may make sense to issue a pension obligation bond,” Padilla said Tuesday. “Issuing a pension obligation bond has never been anybody’s preference.”

Padilla’s report indicates that the city would spend $3.2 million more over the next 30 years, if it opts for a bond over making its usual CalPERS payments. If CalPERS changes its compensation formula, though, the bond would cost the city $12 million less over 30 years than the adjusted CalPERS payments would, according to Padilla’s report.

At an upcoming board meeting, CalPERS will consider changing its payment formula from one computed using percentages of agencies’ payrolls to one that consists of fixed annual contributions.

If CalPERS makes the change, the long-term debt, including interest, in the city’s side fund will increase by more than $15 million, according to the staff report.

CalPERS actuary Barbara Mann, however, said the formula change would make very little difference in the amount the city owes.

During Tuesday’s meeting, Carpenter said the city should do what it can to pay down the side fund.

“I would be in favor of putting as much in as possible now and let us ride out this favorable market,” Carpenter said.

Due to an increase in stock prices over the last year, CalPERS investment returns have spiked. When returns are high, extra payments to CalPERS generate more funding in retirement plans than they do when the market is down.

Additionally, contributions to CalPERS that exceed minimum payments reduce the amount of interest agencies pay over time.

Still, no council member other than Carpenter supported using city reserves to pay down unfunded pension liabilities.

Councilman John Ashbaugh said he would like the city to relieve itself of the shadow of its unfunded liabilities. Ashbaugh, though, made the motion to make the $935,000 payment to CalPERS, saying that he trusted it would provide the most bang for the buck.

The council voted 4-1, with Carpenter dissenting, to make the $935,000 payment toward the city’s public safety side fund.

Following the payment, the city’s side fund will have $23.6 million remaining in unfunded liabilities. An additional $32.9 million of unfunded liabilities exist in the city’s pool portion of its public safety plan. The unfunded liabilities in the retirement plan for all other employees total $65.6 million.

San Luis Obispo currently has approximately 20 retirees with pensions above $100,000. Each retiree receives a yearly 3.25 percent cost of living increase.