Cities stuck on the pension escalator have few ways to slow the rapidly climbing cost, among them: cut staff and services, lower pensions for new hires, get unionized employees to pay more for their pensions, or cut salaries and hope to remain competitive in the job market.
What the Little Hoover Commission and some reformers say could quickly curb runaway costs — cut pension amounts earned by current workers in the future — awaits state Supreme Court action on two unanimous appellate court decisions allowing the change.
Pay earned by current California public employees in the future can be cut. But the pension amounts current workers earn in the future, based on their pay and years of service, can’t be cut under a series of state court rulings known as the “California rule.”
In the search to slow the growth of pension costs, Newport Beach has been a leader in an option that moved into the spotlight this month when Gov. Brown proposed borrowing $6 billion from a state cash-flow fund to make an extra CalPERS payment for state workers.
The extra payment could save the state an estimated $11 billion over the next two decades, assuming pension fund investment earnings and interest rates remain on target. Legislative Analyst Mac Taylor urged the Legislature to go slow and take a hard look.
Some think the proposal by Brown and state Treasurer John Chiang, manager of the cash-flow fund, may have been sparked by a presentation to the CalPERS education forum last year by the Newport Beach finance director, Dan Matusiewicz.
Working with a CalPERS actuary, Kerry Worgan, he outlined a way to make the case to local government officials about the potential for extra payments to cut pension costs, including showing the reduction in interest payments.
Newport Beach plans to pay an extra $9.1 million to the California Public Employees Retirement System in the new fiscal year that begins July 1. The total city payment would be about $43 million.
“We believe this is the best way to handle the debt, is to pay it down… as quickly as you can,” Mayor Kevin Muldoon said last week, the Orange County Register reported. “If we do this in a disciplined manner, we’ll protect our city from escalating debt for many more years.”
A member of the League of California Cities pension task force said “he is hearing that many cities are facing bankruptcy over rising pension costs,” the Modesto Bee reported last week, quoting Joe Lopez, Modesto acting city manager.
Lopez said he is “pretty sure we can stave that off.” Newport Beach, with its boat-filled harbor and a big-wave surfing area, has smoother financial sailing than most California cities.
“We have the luxury of being a financially prosperous city,” said the city manager, Dave Kiff, the Register reported. “What cities like us are doing this (making extra pension payments)? The answer is not many, but many should.”
California has no solvency requirement for pensions. In New York, state law requires that state pension systems quickly pay down debt or “unfunded liability,” mainly created when pension fund investments earn less than expected.
New York state pension systems were 98 percent funded two years ago while California state systems were 74 percent funded, the Pew Charitable Trusts reported last month, using the latest available data. CalPERS currently is about 65 percent funded.
Well-managed public pensions funds in the Netherlands are required to be 105 percent funded to avoid passing debt to future generations. To keep pensions fully funded, the Dutch systems can raise employer-employee contributions and, if needed, cut the pensions of retirees.
Pensions have a structural problem. The time when new money from employer rate increases may be most profitably invested, at the bottom of an economic downturn, may also be the time when shrinking government budgets make rate increases the most difficult.
In 2007 CalPERS was 101 percent funded with an investment portfolio valued at $260 billion. Then a $100 billion loss during the financial crisis dropped funding to 61 percent in 2009.
A phase-in of four successive employer rate increases did not begin until 2012. The second rate increase, approved in 2013, was a reform of the actuarial method that changed two things that could delay rate increases: “smoothing” and “rolling” amortization.
CalPERS had been smoothing the gains and losses of the investment fund over a 15-year period. The nation’s largest public pension fund ($323.5 billion last week) was a lone outlier, well beyond the big pension fund standard of three to five years.
Smoothing is intended to reduce employer rate shock as investment earnings rise and fall from year to year, while presumably rising in the long run at an average currently assumed to be 7 percent.
The CalPERS earnings forecast was lowered from 7.75 to 7.5 percent in 2012, then to 7 percent last December. Employer rates were raised to fill the hole left by assuming lower earnings from investments, which are expected to pay nearly two-thirds of future pensions.
Critics say a 7 percent earnings forecast is still too optimistic, concealing massive debt and the need for even more rate increases. Experts told the CalPERS board last year that its investment portfolio was likely to earn only 6.2 percent during the next decade.
The 15-year smoothing period adopted by CalPERS in 2005 was replaced by phasing in 20 or 30-year rate increases over five years and phasing them out over five years. The change in CalPERS actuarial method in 2013 also ended rolling amortization.
Rolling amortization was used by CalPERS, and some other public pension funds, to pay off debt or unfunded liabilities over 30 years. The debt was refinanced each year and might never be paid off, unless booming investment markets produce a period of full funding.
The change in 2013 switched from using an actuarial to a market value of assets to set contribution rates. The annual CalPERS financial report, using both ways to value assets, had been listing two versions of the unfunded liability, often quite different.
CalPERS provides pensions for 1,521 local government agencies (not counting school districts), many with a wide range of funding levels. Their annual valuations show potential savings from choosing to pay off unfunded liability in less than 30 years.
Newport Beach is paying off its unfunded liability in 19 years. That’s one reason its CalPERS rate is high: 65.6 percent of pay for safety employees next fiscal year, up from 60.3 percent this year, and 29.7 percent of pay for miscellaneous employees, up from 27.6 percent.
One of the cities that some worry may be bound for bankruptcy, Richmond, has much lower CalPERS rates: 40 percent of pay for safety employees next fiscal year, up from 36.7 percent this year, and 27.9 percent of pay for miscellaneous employees, up from 24.7 percent.
Brown’s plan to cut long-term state worker pension costs with a $6 billion extra payment, doubling the nearly $6 billion payment required by CalPERS, also puts the spotlight on another cause of underfunded pensions: delaying payment of pension debt.
Add it to a CalPERS list that includes near zero employer contributions during a market boom in the late 1990s, sponsoring SB 400 in 1999 that led to generous police and firefighter pensions critics say are unsustainable, overly optimistic investment earnings forecasts, and an investment portfolio laden with stocks and other risky and unpredictable investments.