California Cities Facing Huge Pension Increases from CalPERS

In their most recent actuarial reports CalPERS for the first time provided pension cost estimates for the next 8 years, from 2015 to 2023.

How high are these costs going for California’s cities who retroactively increased their pensions at CalPERS urging over the past 15 years? To answer that question I looked at the largest city in my county, Santa Rosa and this is what I found.

Data Sources for this Report

The data used to develop the spreadsheet analysis done as part of this report are NOT numbers that I calculated. The past numbers for 2002 to 2015 are taken directly from the City of Santa Rosa’s Comprehensive Annual Financial Reports found on the City’s website (This page has the links to Santa Rosa’s CAFRs from 2001 through 2015. In each of these CAFRs, the pension information is found in the section entitled “Notes to Basic Financial Statements” under the heading “Employees Retirement Plan.”). The projected growth of certain costs – such as retiree healthcare benefits (also known as “other post employment benefits,” or OPEB), the payroll and sales and property tax revenues – use inflation rates or growth rates similar to what CalPERS uses.

The future pension costs were obtained directly from the 2013 and 2015 Actuarial Reports prepared by CalPERS and found on the CalPERS website. Since the future costs are based upon CalPERS achieving a 7.5% net rate of investment return, I believe their costs are understated, but I used them anyway. But since the pension plan has $804 million worth of assets if the pension fund returns 6.5%, in a single year it will add $8 million to the City’s pension debt and a 5% return would add $20 million.

Looking at the data going back 16 years what I found is that in 2000, Santa Rosa’s pension contribution was $1.8 million and the plan was 122% funded, meaning there were $1.22 worth of invested assets in the fund for every $1.00 worth of benefits earned.

With CalPERS wholehearted support and assistance, on August 6, 2002, the Santa Rosa City Council passed a board resolution to enact a new contract with CalPERS that changed formulas from 2% per year of service at 55 years of age for non-safety Miscellaneous employees to a 3% at 60 formula.  The new formula was provided prospectively, meaning it only applied to future years of service, not past years.

For Police and Fire employees, the new contract was adopted retroactively so it applied to past and future years of service. Their formula went from 2% per year of service at 55 years of age to 3% at 50. This represents a more than 50% increase in the benefit, since along with the “multiplier” increasing from 2% to 3%, the age of eligibility dropped from 55 to 50. But it was the retroactive granting of this benefit that caused even more significant financial liability. This is because the multiplier was increased by 50% even for years already worked and raised pensions from 60% of salary to 90% of salary for 30 years of service.

These changes ended up having a serious impact on the pension costs and the unfunded liability because CalPERS used an overly optimistic rate of investment return of 8.25% compounded per year in their cost analysis. Over the past 15 years since the increase, CalPERS has only achieved a 5% compound rate of return. Many experts believe in this current low interest rate environment returns will remain at the 5% return level for the foreseeable future.

In July of 2003 the City took on $53 million worth of new debt by selling Pension Obligation Bonds (POB) and giving the proceeds to CalPERS to pay down the unfunded liability that was created by the new formulas. With interest these bonds will divert over $100 million from government services to debt service.

CalPERS Flawed Cost Analysis and Lack of Proper Disclosure

CalPERS cost analysis provided to the City in 2002 stated the cost for the new 3% at 50 formula for Safety members would be 13.27% of salary and the cost for the 3% at 60 formula for Miscellaneous members would be 9.87% of salary. However, as previously stated, these estimates were calculated assuming that pension assets would grow at 8.25% per year into the future. Since CalPERS investments have only averaged 5% over the past 15 years the increases have created $287 million in unfunded pension liabilities for the City as of 2015.

In addition, the analysis did not provide the City with any warning or disclosure regarding what would happen if the 8.25% investment return was not achieved. CalPERS simply wrote “For many plans at CalPERS the financial soundness of the plan will not be jeopardized regardless of the new formula choice made by the employer.”

The Growth of Pension Costs Since the Increase

In 2001, the City’s pension contribution was $1.5 million and in the first 4 years following the increase it grew to $11.5 million. In addition, the funding ratio dropped from 122% in 2001 to 70% in 2005 meaning the fund, instead of $63 million in excess assets now had $128 million in unfunded liabilities.

In 2006, the annual cost grew by another $5 million hitting $16.6 million and by 2015 had grown to $21 million. However, this was a very modest growth considering CalPERS lost 29% of its assets during the Great Recession in 2008 and 2009. CalPERS lowered contributions in order to help cities and counties who saw their tax revenues during the recession drop. So CalPERS extended the amortization period on the unfunded liabilities from 9 to 20 years and smoothed their investment gains and losses from 4 to 15 years into the future. Basically, these were accounting gimmicks that resulted in severe underfunding of the pension plan and these changes exist today. The chart below shows the growth of Santa Rosa public employee retirement costs (click here to see the underlying calculations).

Santa Rosa Retirement Cost Growth

However, now CalPERS is worried that the plans are not being properly funded and pension contributions need to be doubled over the next 9 years.

Projected Future Costs

In their 2015 actuarial reports, CalPERS provided the City with their normal employer contribution as a percentage of payroll and the unfunded actuarial liability (UAL) as a total cost each year from 2015 to 2023. Using a 3% payroll growth assumption and their UAL numbers, I calculated the annual costs going forward. In addition, I added the pension obligation bond debt service each year going forward along with the cost of retiree healthcare benefits using a 5% annual cost increase assumption as CalPERS does.

My analysis indicates that during the next 8 years, the cost for retiree benefits will increase from $31.0 million or 33.7% of payroll in 2015 to $59.1 million or 48% of payroll in 2023.

The nearly doubling of pension and retiree healthcare costs means the City will need to cut salaries, benefits, services and/or increase taxes each and every year going forward by $3.2 million per year to meet their retiree benefit costs.

Pension and Healthcare Costs as a Percentage of Tax Revenues

More important than pension costs as a percentage of payroll are pension costs as a percentage of tax revenues because tax revenues are what enables the City to pay for its benefits. Once retiree benefit costs exceed the City’s ability to pay them, they will no longer be able to be fully paid and at that point either they will need to be reduced in bankruptcy or through significant pension reductions. The chart below shows the growth of pension costs relative to that of general fund property tax and sales tax revenues.

churchill-2016-10-31-chart

The results of my analysis are staggering. Over the past 15 years’ sales and property tax revenues have climbed an average of 3% per year, while employee retirement costs have increased an average of 19% per year. This has led to a growth of retiree benefit costs from 3.5% of major tax revenues in 2001 to 47% in 2015 and an estimated growth to 70% of major tax revenues by 2023 (Editor’s note:  the city receives other revenues which may also be available to finance pension costs).

Growth of the Unfunded Liability

The unfunded liability of the pension plan is calculated by taking the assets in the plan minus the present value of the benefits already earned by current employees and retirees, considered the plan’s liability. The funding ratio is determined by dividing the market value of assets in the plan by the liability.

CalPERS discounts the long term liability by assuming before the money is paid to retirees, it will earn investment income. CalPERS currently uses an assumed 7.5% rate of investment return to calculate the liability and payments to the plan. So if the assumed investment return is lowered, the unfunded liability of the plan increases along with the cost of paying off the liability. Unfunded liability costs are borne by taxpayers and are not a shared expense with the employees.

Currently, using a 7.5% assumed rate of return, the pension fund has $287 million worth of unfunded liabilities and pension bond debt and is 74% funded. However, many experts believe in this low interest rate environment a lower investment return assumption should be used. Many experts think that a 5.5% to 6.5% rate should be used. Other experts believe a 3.5% rate should be used since this is about the rate private pension plans are required to use and what CalPERS uses if a City wanted to buy their way out of the CalPERS system. I won’t guess what the future investment returns will be, but here is what happens to the unfunded liability at various rates of investment return assumptions:

  • At 6.5% the unfunded liability would increase to $426 million and $19.6 million per year to would be added to the City’s pension costs.
  • At 5.5% the unfunded liability would increase to $585 million and $31.6 million per year would be added to the City’s pension costs.
  • At 4.5% the unfunded liability would increase to $755 million and $43 million per year would be added to the City’s pension costs.
  • At 3.5% the unfunded liability would increase to $967 million and $53.5 million

Santa Rosa Analysis of Unfunded Liability at Various Rates of Investment Return

20161028-cpc-churchill1

City Pension Plan Status Using ERISA Standards

Under the Federal ERISA rules for private pensions, a high quality bond rate of return is used to determine the assumed rate of investment return. Today that is around 3.5%. ERISA also defines the health of a pension plan as follows:

  • Less than 80% funded is considered “seriously endangered”
  • Less than 70% funded is considered “at risk”
  • Less than 65% funded is considered “critical status”

So under ERISA standards, the City of Santa Rosa’s pension plan at 45% funded when assuming a 3.5% return is 20 percentage points below what ERISA would consider “critical status”. So one could more accurately describe the pension system as being on “life support”.  Also, under ERISA rules the pension benefits each year would stop being accrued until the plan becomes 60% funded to keep the hole from going deeper.

ERISA also requires the plan sponsor pay off their unfunded liabilities over 7 years. CalPERS currently allows public agencies to pay off their liability over up to 30 years. If the City was required to pay off its unfunded liability over the next 7 years, their annual contribution to the pension fund would grow from $28 million to $146 million in 2015 alone. So under ERISA rules pension costs would increase by $120 million per year and take them to 145% of payroll.

Conclusion

The City of Santa Rosa and all cities in California who retroactively increased pensions need to restructure their pension systems. Otherwise it is increasingly unlikely they will be able to afford the benefits that have already been earned and provide taxpayers with the services they deserve for their tax dollars.

City officials can no longer pretend a crisis does not exist. They would be well advised to form a Pension Advisory Committee and bring all the stakeholders to the table to look at all the options, have an actuary determine the savings for each option and make informed decisions to save the pension plan and benefits people are counting on to fund their retirement.

 *   *   *

About the author:  Ken Churchill is the author of numerous studies on the pension crisis in California and is also the Director of New Sonoma, an organization of financial experts and citizens concerned about Sonoma County’s finances and governance.

REFERENCES AND RELATED ARTICLES

California Court Ruling Allows Pension Changes, August 26, 2016

How CalPERS has Created a Ticking Time Bomb, November 30, 2015

The Devastating Impact of Retroactive Pension Increases in California, April 27, 2015

Evaluating Total Unfunded Public Employee Retirement Liabilities in 20 California Counties, May 6, 2014

Sonoma County’s Pension Crisis – Analysis and Recommendations, January 12, 2014

The Sonoma County Retroactive Pension Increase: Gross Incompetence or Billion Dollar Scam?, April 15, 2012

How Retroactive Benefit Increases and Lower Returns Blew Up Sonoma County’s Pensions, April 5, 2012

 

16 replies
  1. Pierre
    Pierre says:

    There is nothing new in this article.
    The word DEFINED embellishes the work ethics and the stupidity of the City fathers(mothers) together with those we elect to govern us at the county level.
    Back in 2004 I predicted all the above (not witchcraft) and our Board of Supervisors called me stupid. The County Administrator (at that time) pushed our ignorant elected officials, that Administrator currently is receiving Pension payments in excess of $300,000. And he probably has a lifespan of another 25/30 years.
    Item that is overlooked is those pensioners checks increase annually by at least 3%. The administer mentioned above will receive payments of $650,000 per annum on his 25 anniversary away from work.

    AND WE THINK WE ARE SMART ELECTING THOSE WHOSE NAMES WE RECOGNISE WHEN VOTING.

    Reply
    • john
      john says:

      There is something “new” in this Article, namely that from 2001 to 2005, the plan went from 122% funded to only 70% funded. That proved that plans were underwater before the 2008-9 financial crisis(which continues). I read article after article stating that the problem with Ca. public employee plans was only the 2008 crisis.

      Ken has described most of the factors leading to the 2005 unfunded liability. What is missing is the other elephant in the room, corrupt salary enhancements, via peer group raises, plus step raises and now the recently acquired union dagger described as arbitration of impasses via “partial neutral arbitrators(my term)”.

      Reply
      • S Moderation Douglas
        S Moderation Douglas says:

        “There is something “new” in this Article, namely that from 2001 to 2005, the plan went from 122% funded to only 70% funded.”

        There is something missing from this article, namely that from 2005 to 2007-08, the plan went from 70% to about 90% (depending on which plan(s) you are watching.)

        CalPERS funded ratio went from 137% in 1999 to 79% in 2003. Back up to 101% in 2007… Just before the you-know-what hit the you-know-what. I’m not implying that the market will magically save the bacon for either Santa Rosa or for CalPERS. But the system has weathered economic cycles fairly well so far.

        No, 2008 wasn’t the only problem. But it was a biggie.

        No, PEPRA isn’t the only answer. But it is a biggie also.

        Ed Ring on DB pensions…

        “And because risk in a defined benefit fund is shared across generations of workers, during eras when investment returns are low, existing workers guarantee extra cash coming into the plan to keep it solvent, and during eras when investment returns are high, surpluses are fed into the pension fund that can also be used to make up the shortfall during lean years.”

        Not to be taken out of context, in the same article, Mr. Ring stated, among other reforms, that pensions for existing workers AND retirees should be reduced, but there are obvious legal problems there, as well as differing opinions on whether those reductions are necessary or desirable.

        See…
        “Saving Defined Benefits Requires Lower Pensions for Existing Workers and Retirees”

        ED RING on Dec. 6, 2012 

        Reply
  2. Nancy Hair
    Nancy Hair says:

    Nothing new but there are still many people who believe that the bandaids applied last year will make a significant difference. Until taxpayers start seeing real reductions in service….or a bankruptcy…..they will be hoping for the best. The real problem is that everything is wrong in the city, county, state, country, world and people feel overwhelmed and helpless about choosing their battle. Thanks, Ken, for never giving up trying to get elected officials and unions to face the music.

    Reply
  3. Rich
    Rich says:

    History shows that political policies don’t change, reforms are not made, until massive pressure is applied to politicians and the status quo. Logic and presentation of factual data doesn’t work. As to pressure, citizens won’t take up pitchforks so to speak until they get mad enough. So the question is what would make that happen short of bankruptcy. They need to know something they don’t know now that convinces them they are being harmed in some way or are being treated unfairly. That message has not been composed nor been promulgated.

    Reply
    • john
      john says:

      Be careful about assuming that bankruptcy will solve anything. The three cities that filed all went in the tank by not eliminating the DB system, as a result they are the worst off of Ca. cities. Their Chapter nines in bankruptcy were “financial suicide” bankruptcies. But judge Klein, in the Stockton bankruptcy, set forth clearly that cities and counties could modify pensions in a bona fide chapter 9. A “bona fide chapter 9” is one that is not a “suicide chapter nine.”

      Reply
      • SkippingDog
        SkippingDog says:

        Judge Klein’s musings were nothing more than dicta, since they were never applied to the case before him. Such a decision by a bankruptcy judge would quickly make its way to the District, Circuit, and perhaps even the Supreme Courts.

        “DICTA

        The part of a judicial opinion which is merely a judge’s editorializing and does not directly address the specifics of the case at bar; extraneous material which is merely informative or explanatory.

        Dicta are judicial opinions expressed by the judges on points that do not necessarily arise in the case.

        Dicta are regarded as of little authority, on account of the manner in which they are delivered; it frequently happening that they are given without much reflection, at the bar, without previous examination.

        As one judge said, ‘If general dicta in cases turning on special circumstances are to be considered as establishing the law, nothing is yet settled, or can be long settled. What I have said or written, out of the case trying, or shall say or write, under such circumstances, maybe taken as my opinion at the time, without argument or full consideration; but I will never consider myself bound by it when the point is fairly trying and fully argued and considered. And I protest against any person considering such obiter dicta as my deliberate opinion.’ And another said it is ‘great misfortune that dicta are taken down from judges, perhaps incorrectly, and then cited as absolute propositions.’ “

        Reply
    • john moore
      john moore says:

      There are many “solutions.” But they all require a BOS or City Council majority to adopt pension reform and provide public employees with reasonable retirement sums. The key is for each city and county to provide a bi-partisan list of candidates that agree on reform and then elect them. Any discussion of reform without that realization is redundant. It is time for the real work. Why do I believe this? Because in Pacific Grove, we had the most staunch pension reformers in the state but lacked a council majority by only one. Reformers passed a pension reform initiative, the unions sued and the city atty threw the defense of the case. In Sonoma and Marin counties, the grand jury found that hundreds of millions in pension increases had been granted corruptly and illegally. The BOS of each obtained untruthful legal opinions that dismantled the facts(as documented by the grand jury)and found “substantial” compliance with the law where the facts showed “NO” compliance with the law. In each county, the BOS received evidence that its legal opinions were crooked, but not only accepted them but praised them. So I rest my case: no BOS or Council majority of reformers, no reform no matter what!

      Reply
      • SkippingDog
        SkippingDog says:

        Runaway Grand Juries, taken over by zealots with narrow goals, are quite common throughout our history. They are best disregarded.

        Reply
  4. Tough Love
    Tough Love says:

    Ken, Nice article. I’ve been an outspoken supporter of pension reform for at least a decade. What most do not realize is that even BEFORE those 50% (mostly retroactive) pension increases following SB400 that PUBLIC Sector pensions were ALREADY VERY VERY generous, at or above even the best Private Sector pensions of the 1980’s.

    As interest rates began to decline in the mid-1980’s, Private Sector Corporate Plan sponsors quickly recognized the dire future to Corporate survival if it allowed additional accruals on the formulas in place at that time and did something about it, by materially reducing the pension accrual rate for the future service of all CURRENT workers, FREEZING the existing “Final Average Salary” DB Plan and switching (for future service) to FAR lower costly “Cash Balance” Plans, or simply moving to low-cost/low-risk 401k-style DC plans. The PUBLIC Sector went the OPPOSITE way, materially increasing the promised pensions to levels that were clearly unnecessary to attract and retain a qualified workforce, were unfair to taxpayers called upon to pay for 80% to 90% of Total Plan Costs, and (although well-hidden at the time) were clearly unaffordable….. particularly the RETROACTIVELY granted pension increases.

    There are so many articles written on the State and Local Public Sector Pension mess. Unfortunately, few (certainly less than 10%) address the true ROOT CAUSE of the problem …. grossly excessive pension “generosity” …… and instead cite the lack of full funding as the CAUSE of the problem. Conveniently they choose to ignore (or simply do not make the connection) that the calculated annual amount that constitutes full funding moves in lock-step with the generosity of the Plan. A very “generous” Plan will be very “costly”, and hence very difficult to fully fund.

    The lack of full funding is not the CAUSE of the problem, is a CONSEQUENCE of the true ROOT CAUSE …… grossly excessive pension “generosity”.
    ————————————————————
    Another problem is the position that the Public Sector workers take …. we didn’t cause the problem ……………. blame the politicians and make them pay. Really ? Do the Politicians personally have $ Billions to make these pensions whole ?

    It‘s true that the “blame” lies primarily with our Elected Officials who (in exchange for Public Sector Union campaign contributions and election support) granted FAR MARE in pensions & benefits than was necessary, fair (to taxpayers) or affordable, BUT …… clearly the WORKERS are the beneficiaries of that Union/Politician collusion, so THAT is where the Taxpayers must look to right this wrong, by materially reducing these grossly excessive pensions (AND benefit) promises.

    FWIW, I believe little substantive change will take place until a medium to large City’s pension system fails with material reductions in the pensions promised both the actives and those already retired (a Detroit on steroids), and the Unions/Workers finally realize that the Federal Gov’t is NOT going to make them whole. At that point they MAY come to their senses and realize that a reasonable but secure pension is a better choice than a larger but very insecure pension.

    What would hasten moving the Unions’/Workers’ thought process in that direction, is making it clear that those ALREADY RETIRED will receive pension reductions no less in magnitude than those of the actives. Right now, there is a perverse Public Sector Worker mindset to STALL any & all substantive pensions changes, under the belief that if they can make it to the finish line (their retirement date), that THEY will be protected from any pension reductions. Making it clear that such thinking is WRONG, will go a long way to making “progress” on the pension changes that are certainly needed and undeniably justifiable.

    Reply
  5. SeeSaw
    SeeSaw says:

    I doubt the accuracy of the example you gave for Santa Rosa miscellaneous formulas. I don’t think that CalPERS would allow one group in the entity to receive a retroactive increase and other groups to receive only a prospective increase. In my entity the increase from 2% at 55 to 3% at 60 was retroactive. It was not a 50% increase for employees who worked a full career to the maximum age of 63–the previous 2% at 55 and 2% at 60 formulas maxed out at 2.418% at the age of 63. The formula for state miscellaneous employees maxed at 2.5% and the 3% formula was never adopted.

    Reply
    • Ken Churchill
      Ken Churchill says:

      As I stated in the article, I went to the City and had them pull the records regarding the increase.

      CalPERS offered the City 3 options to adopt retroactively for Misc. employees, 2.5% at 55, 2.7% at 55 and 3% at 60. CalPERS stated in their analysis that if employees did not receive a cost of living adjustment to their salary for 3 years (a 9% reduction for what they would have received in additional salary) it would pay for the increase so they were given the option of the salary reduction in return for the more generous formula.

      Then the City went to the Misc. employees for a vote on the increase and the employees decided they were better off making the increase prospective and keeping their COLA. They also understood that a retroactive increase would not be fair to future employees because they would be paying for a windfall that their predecessors received if it was retroactive and they lost that 9% of salary for the rest of their careers.

      Reply
  6. SeeSaw
    SeeSaw says:

    Well I stand corrected. I never heard of such a thing before. In my own former entity, the miscellaneous rank and file received the upgraded 3% at 60 formula in 2001 because management wanted it for themselves and CalPERS would not allow it to be given to just management without including non-management. There is no reason for those who hate unions to be so disdainful of such–not all rank and file are in unions–they are not now in my former entity–the employees are still organized and negotiate in-house. Nothing can be achieved without organization–why can’t that be understood without characterizing rank and file as greedy? If you think all that public employees think about are their pensions you are wrong! There was no SS and no pension when I first went to work in a local agency. The younger ones who came after me when the pension was in place could have cared less. The bottom line until one has been working for at least 20 years is the take-home pay.

    Reply
    • Ken Churchill
      Ken Churchill says:

      I agree with you. It was actually the engineers who did the calculations for the city employees and said the 9% of salary put into a 401k would end up providing a more secure retirement and they saw the unfairness of making it retroactive for new hires. Good for them.

      In Sonoma County which I have written extensively about it was the County’s retirement board who retroactively increased pensions and as you point out they had to give it to everyone in order to get it for themselves. And the head of the retirement board Robert Nissen retired the day after the increase went into effect.

      I do not at all blame the rank and file for this and agree that a good approach would be to raise salaries in exchange for reducing the formula going forward.

      Reply
      • Tough Love
        Tough Love says:

        Quoting Ken Churchill ….. “I do not at all blame the rank and file for this and agree that a good approach would be to raise salaries in exchange for reducing the formula going forward.”

        As a Taxpayer I support EQUAL Public/Private Sector “Total Compensation” in jobs with comparable risks and reasonably comparable requirement as to experience, education, knowledge and skills. There is ZERO justification for greater Public (than Private) Sector “Total Compensation, and I believe that for MANY Public Sector workers, we would NOT need to increase wages while at the same time VERY materially reducing Public Sector pensions & benefits in order to achieve that equality.

        Reply

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