The use of the word “unsustainable” had a distant echo this month as the League of California Cities issued a study of CalPERS rates, a move to get stronger local options for controlling rising pension costs.
Over the next seven years, the study found, city CalPERS costs will increase more than 50 percent. The annual pension bite for the average city will reach 15.8 percent of the general fund, nearly doubling from 8.3 percent a decade ago.
A key finding of the study by Bartel Associates actuaries, using CalPERS data and survey replies from 229 cities, is that “city pension costs will dramatically increase to unsustainable levels.”
Nearly a decade ago the CalPERS chief actuary then, Ron Seeling, made a similar prediction at a seminar sponsored by the Retirement Journal in August 2009. The CalPERS investment fund had just lost $100 billion during the financial crisis and market crash.
“I don’t want to sugarcoat anything,” Seeling said. “We are facing decades without significant turnarounds in assets, decades of — what I, my personal words, nobody else’s — unsustainable pension costs of between 25 percent of pay for a miscellaneous plan and 40 to 50 percent of pay for a safety plan … unsustainable pension costs. We’ve got to find some other solutions.”
The average CalPERS contribution for local governments in the current fiscal year is approaching Seeling’s “unsustainable” level — miscellaneous 21 percent of pay and safety (police and firefighters) 40.45 percent.
In seven years, the League study expects rising CalPERS employer rates to be well above those mentioned by Seeling. By then a gradual rate increase will be fully phased in, filling the funding gap created by lowering the investment earnings forecast from 7.5 to7 percent.
“In FY 2024–25, half of cities are anticipated to pay over 30.8 percent of their payroll towards miscellaneous employee pension costs, with 25 percent of cities anticipated to pay over 37.7 percent of payroll,” said the study. (see chart)
For safety or police and firefighters: “By FY 2024–25, a majority of these cities are anticipated to pay 54 percent or more of payroll, with 25 percent of cities anticipated to pay over 63.8 percent of payroll.”
A call to “convene the stakeholders” was another similarity between the League study finding of “unsustainable” pension costs and remarks at the seminar in 2009 that followed Seeling’s call for solutions.
“It is our hope that this report today helps inform the discussions that can be used across stakeholders to acknowledge that there is a problem and encourage all of us to come to the table to help forge solutions,” Carolyn Coleman, League executive director, said this month.
At the seminar in 2009 the CalPERS chief executive then, Anne Stausboll, said the CalPERS board had talked about the “cost and sustainability of pension benefits” the previous week and decided that the system should take a “proactive role” on the issue.
“They asked us to formulate a way to convene our stakeholders — employers, labor, legislators and other stakeholders in our system — to convene everybody and start having a constructive dialogue on sustainability of pension benefits,” Stausboll said.
At the League news conference a reporter’s request for a definition of “unsustainability” was answered by Daniel Keen, a former Vallejo city manager with two decades of experience in five cities.
The ability to absorb rising pension costs varies from city to city, Keen said, but one thing unsustainable for all is the erosion of basic services. He said uncertainty causes reluctance to fully staff police, fire departments, and public works maintenance.
As discretionary services such as libraries, parks and recreation are threatened, long-term commitments are less likely. Though the economy is growing and unemployement is low, cities are forced to make tough budget decisions.
“That’s not a good model for sustainability, considering that we will probably see recessions again in the future that will be much more difficult to manage through simply because of these rates,” Keen said.
Managing the scheduled CalPERS employer rate increases over the next seven years will be difficult for many cities, even if a deep recession and plunging stock market does not create the need for additional rate increases.
The League needs to “convene the stakeholders” because the new cost-cutting local options urged in its “Pension Sustainability Principles,” adopted last June, require legislation or a change in the “California rule” court decisions that prevent cuts in the pension offered at hire.
For example, current law prevents cities from negotiating with labor unions to give employees a lower pension for work done in the future, while protecting pension amounts earned in the past.
One of the League sustainability principles calls for converting employees hired before a pension reform on Jan. 1, 2013, (called “classic” by CalPERS) to the lower pension formula given employees hired after the reform.
At a workshop in November on proposed investment allocations that could raise employer rates, representatives of two cities told the CalPERS board their employees are willing to negotiate earning lower pensions in the future but cannot under current law.
“Our ‘classic’ employees, which are about 87 percent of our workforce today, have indicated a willingness to take a reduction prospectively in the benefit package offered if it were allowed,” said the Hanford city manager, Darrel Pyle.
“Many of our employees have signaled that a reduction in the benefit formula going forward would be much more palatable than additional pay reductions or potential reductions in staff,” said the Bencia human resources manager, Kim Imboden.
Cutting pensions earned in the future was the top recommendation of an influential Little Hoover Commission report in 2011 and a key part of a pension reform approved in 2012 by San Jose voters, which was overturned by a superior court.
The League study said “the most prominent source of the pension system’s cost escalation” began with higher pensions granted by state and local governments under legislation around 2000, when CalPERS had a surplus that was said to cover most of the cost.
Other sources of the cost increase, said the study, are investment losses, an actuarial policy that delays payment of debt, demographic change that has pension debt for retirees exceeding the debt for active workers, and automatic pension cost-of-living adjustments.
Another league sustainability principle is a “temporary modification” to COLAs that “are automatically added to a retiree’s pension benefit payment regardless of compensation level or CPI.”
Cities in CalPERS can choose compounding COLAs of 2, 3, 4, or 5 percent, depending on union bargaining. The COLA for teachers in CalSTRS is fixed at 2 percent of the initial monthly payment. COLAs in private-sector pensions are rare.
Last September the CalPERS board was told that a COLA freeze could increase pension funding by up to 18 percent for safety plans and up to 15 percent for miscellaneous plans.
The board rejected a request to analyze the cost savings of COLA suspensions and switching all employees to the lower pension given post-reform hires. The request was backed by cities but opposed by unions.
With the current cost-cutting options, cities that are financially able can pay down debt quickly or set aside money for future pension costs. Some cities have been unable to restore services cut during the recession because rising pension costs eat up improving revenue.
Asking voters to approve tax increases and employees to contribute more toward their pensions also are options. A city that mentioned the possibility of bankruptcy in September, Oroville, did not use the “bankruptcy word” while addressing the CalPERS board in November.
A federal judge ruled in the Stockton bankruptcy that pensions can be cut. But Stockton, like bankrupt San Bernardino, did not try to cut pensions, saying pensions are needed to be competitive in the job market, particularly for police.
The state Supreme Court has agreed to hear appeals of two appeals court rulings that would weaken or eliminate the “California rule,” allowing pension cuts. The high court could make a narrow ruling that does little to alter vested rights precedents.
If the Supreme Court upholds the appellate rulings, cities might have to “convene the stakeholders” to get legislation allowing change. Attempted statewide pension initiatives have struggled with selecting a retirement replacement, funding, and unfavorable ballot summaries.
CalPERS funding, 101 percent in 2007, has not recovered from the huge loss a decade ago, despite a lengthy bull market. Last year the funding was only 68 percent of the projected assets needed to pay future pension obligations, little changed from a low of 61 percent in 2009.
Now CalPERS fears a deep recession or stock market plunge could drop its funding level below 50 percent, a red line some experts warn could be a crippling blow. Critics say the 7 percent earnings forecast is too optimistic.
In December the CalPERS board, as urged by cities, chose a new investment allocation that did not lower the current 7 percent investment earnings forecast, avoiding another large rate increase.
This week the CalPERS board is scheduled to consider a reform shortening payment of new pension debt from 30 to 20 years, triggering a small rate increase. In November some cities opposed the change, saying “the employer pays more option is no longer viable.”
Reporter Ed Mendel covered the Capitol in Sacramento for nearly three decades, most recently for the San Diego Union-Tribune. More stories are at Calpensions.com.