Palo Alto to consider options for paying off $296 million in unfunded employee pensions

Marin Independent Journal, 9/16/15

PALO ALTO — City officials hope to have a plan in place by the end of this year to address a $296 million unfunded employee pension liability.

Both the city’s budget director and actuary consultant say the economic downturn is the primary reason the city owes that much money to finance employees’ retirement benefits.

They said a smaller part of the equation was the city’s decision to increase employee pension benefits before the economy soured, when there was a surplus in its pension trust.

Earlier this month, the City Council heard from John Bartel, an actuary with Bartel Associates, about the state of the city’s unfunded liability.

Bartel outlined five options to reduce the unfunded liability during a council study session on Sept. 9.

Walter Rossmann, the city’s Office of Management and Budget director, will work with Bartel, city staff and the Finance Committee to evaluate those options and make a recommendation to council in coming months.

The discussion on pensions likely will be folded into a 10-year general fund forecast the city expects to complete by December.

Among the options, Rossmann said the city should not consider pension obligation bonds because they are too risky.

The other options on the table include borrowing from the general fund or another city fund to make an upfront payment to CalPERS; making a one-time payment if the city has a general fund surplus; requesting a shorter amortization period; or establishing a supplemental pension trust.

In the past, the city diverted the bulk of its general fund surplus to transportation projects. A $4 million surplus in 2013-14 was transferred to the capital improvement fund.

The city estimates it could end this fiscal year with a surplus of $6 million to $8 million, Rossmann said.

If the city creates a separate pension trust — in a sense diversifying its investment portfolio and risks — then it would need seed money, Rossmann said.

Bartel said the option is good for governments that want a degree of annual budget certainty.

For example, if CalPERS gave the city a required contribution next year that is less than the city’s contribution this year of $30 million, then the difference can be placed into the trust. Later, in years where the CalPERS contribution is higher than the set amount, money from the trust can be used to pay CalPERS.

“The challenge with these trusts is you need… a little bit of seed money to pay the unfunded liability,” Bartel said. “It’s not designed to save you in the event that CalPERS goes bankrupt… it’s only designed for contribution volatility.”

The city’s required contribution to CalPERS for 2015-16 is nearly $30 million, with $9.7 million for police and fire employees and $19.5 million for all other employees. As of 2013, the city owes a total of $105.25 million for police and fire employees and $190.3 million for the rest.

One shift in the city’s unfunded liability situation is that the city now has more retirees than active employees. People are also living longer.

In 2013, the city had 184 active police and fire employees and 404 retirees from those fields.

That same year, the city had 789 active non-safety employees and 989 retirees that category.

Vice Mayor Greg Schmid, a retired economist, said city leaders have to be realistic in paying down liabilities now instead of pushing the debt into the future.

To do so, Schmid said the council has to take a real look at reducing the assumed rate of return from 7.5 percent to 7 percent, as Bartel mentioned and as was discussed two years ago.

The real economic picture may be starker.

“There have been some dramatic changes that have taken place… in the last 15 years,” Schmid said. “Between 1980 and 2000, the real economy grew 3.1 percent per year. Since then it’s grown 1.9 percent per year.”

In that time, work force rates, productivity rates and the median wage have all declined, Schmid said.

“There are a lot of real indicators in the economy that rates of return aren’t gonna return to where they were in the 70s and the 80s and the 90s,” Schmid said. “So these historic rates of returns seem to me to be unrealistic. And it’s important we confront that issue.”

David Crane, a Stanford Institute for Economic Policy Research lecturer, said the city needs to start assuming a lower rate of return when making contributions.

Optimistic projections of returns on investments caused the national pension crises — not the stock market — Crane said.

“Despite the quintupling of the stock market from 1993 to 2013, California’s unfunded pension liabilities grew 30 times over,” Crane said. “That was due in large part to inadequate set-asides.”

Crane said the city should assume an even more conservative rate of return, such as the 6.6 percent Warren Buffett uses in his investments.

“If they assume that rate of return, then their upfront contributions would be much greater but there would be a much less chance of unfunded liability in the future,” Crane said.

CalPERS’ rate of return assumption of 7.5 percent “requires the stock market to double every nine years for decades to come, and that’s not going to happen,” Crane said.