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Pension burden in 5 California counties now over 10%

Years after the Great Recession slammed their Wall Street investments, at least five California counties have broken through the 10 percent ceiling, spending at least one of out of every $10 to fund their government-employee retirement programs.

The resulting strain on local budgets, called the pension burden, is revealed in California Policy Center’s latest analysis of county reports.

Five California counties reported that their pension contributions now exceed 10 percent of total revenues: Santa Barbara County (13.1 percent), Kern County (11 percent), Fresno County (10.7 percent), San Diego County (10.4 percent) and San Mateo County (10 percent). We will consider each below.

A sixth county, Merced, is also expected to report that its required contributions topped 10 percent of 2015 revenue when it files its audit. We estimate Merced’s payments at slightly over 11 percent of revenue.

CPC’s review of audited financial statements filed by 30 California counties shows pension contributions accounting for between 3 percent and 13 percent of total county revenue.

“For years, public employee union leaders denied the pension burden was even close to 10 percent,” my colleague Ed Ring notes. “This study shows the burden is now approaching 15 percent of revenues.”

The surveyed counties, which account for more than 95 percent of California’s population, made over $5.4 billion in pension contributions during the fiscal year. These counties also made $660 million of debt service payments on pension obligation bonds, raising total pension costs to over $6 billion last year.

That figure accounts for about one-sixth of all California state and local pension contributions (not including payments on pension obligation bonds), estimated at $30.1 billion in 2014.

As investment markets remain relatively flat, it seems likely that many California counties will bow to pressure to cut government services or to raise cash through debt instruments or taxes.

METHODOLOGY

In 25 of 30 counties, we used 2015 audits. Five other counties had yet to file their 2015 reports; in these instances, we estimated revenues and pension contributions from 2014 audits, 2015 budgets and actuarial valuation reports.

Most large counties operate their own pension systems, rather than relying on CalPERS. These county systems often also serve special districts and even cities in the county. Our survey was limited to pension contributions made by the county governments themselves, and excluded separately reporting units – that is, entities that participate in county systems but produce their own financial statements.

In 2015, state and local governments implemented new accounting standards promulgated by the Government Accounting Standards Board (GASB). Aside from reporting net pension obligations as a liability on the government’s balance sheet, GASB Statement Number 67 requires filers to report “Actuarially Determined Contributions” and actual contributions made to their defined benefit plans. The Actuarially Determined Contribution (ADC), previously known as the Actuarially Required Contribution, is calculated by an independent actuary. The ADC is supposed to be the amount sufficient to finance pensions for current and future retirees while gradually closing any gaps in pension funding.

For the 25 larger counties that had released 2015 audits by late February, we recorded ADCs and total revenue, and calculated the quotient of these two values in order to get a rough idea of the relative burden that public employee contributions place on county finances. Because pension systems usually require their actuaries to assume high rates of return on their investments (typically 7.25 percent or more), it’s arguable that reported ADCs understate actual pension burdens.

That said, the reported ADCs provide a reasonable basis for comparison across counties. Further, California public agencies generally make pension contributions roughly equivalent to their ADCs, so the ADC is at least a good gauge of near-term pension burdens.

Total county revenues, ADCs and pension cost ratios appear in the following table:

California County Pension Burden
Total Annual Pension Payments As Percent of Total Annual Revenue
20160312-CPC-Joffe-County-Pensions2

  1. Santa Barbara County

Despite its strong economic performance, Santa Barbara County had the highest pension cost burden among the 25 counties we reviewed – by a considerable margin. Employer contribution rates ranged from 20.8 percent to 59.5 percent, and have risen substantially since 2007. Employer contribution rates represent the percentage of public employee salaries a public agency contributes to its pension plan; they are generally higher for public safety employees, who receive more generous retirement benefits.

In the fiscal year ended June 30, 2015, the Santa Barbara County Employees’ Retirement System (SBCERS) suffered a decline in its funded ratio, from 81.1 percent to 78.4 percent. The drop was largely due to a disappointing 0.83 percent return on plan assets, compared to an assumed 7.5 percent annual asset return.

Despite the decline, SBCERS is still on somewhat stronger footing than the state’s CalPERS – which was about 73.3 percent funded on June 30, 2015. SBCERS is also amortizing its unfunded liabilities faster than CalPERS, using a 17-year timeframe versus 30 years for CalPERS.

SBCERS ended the fiscal year with an unfunded liability of $698 million, about 93 percent of which was the responsibility of county government (the rest belongs to courts and special districts). The system was last fully funded in 2000.

According to a 2007 report commissioned by the county auditor, the system’s position deteriorated for a variety of reasons including poor investment performance and benefit improvements granted by elected officials. The report does not detail these benefit improvements, but they included a change to the final average salary calculation used to determine benefit levels. Liberalizing final average salary calculations can enable pension spiking – a practice under which employees work extra overtime or get last-minute promotions at the end of their careers to maximize pension benefits.

  1. Kern County

Although Kern County’s ADC/revenue ratio is two points lower than that of Santa Barbara County, its situation is worse in a variety of ways. According to the most recent Kern County Employees’ Retirement Association (KCERA) actuarial valuation report, the system was only 64.08 percent funded as of June 30, 2015 – down from 65.11 percent the previous year.

Also, as of June 30, 2015, the county had $284 million in outstanding pension obligation bonds. If the $51 million in scheduled debt service on these bonds is added to the $201 million in Actuarially Determined Contributions the county was required to make, its pension cost burden would exceed that of Santa Barbara County – which has not issued pension obligation bonds.

KCERA’s funded ratio reflects an assumption of 7.5 percent annual returns on its portfolio. This contrasts with an actual fiscal year 2015 return of only 2.3 percent. On the other hand, KCERA is trying to amortize its unfunded liabilities more rapidly than CalPERS – employing an 18-year amortization period versus 30 years for CalPERS. KCERA’s severe underfunding and rapid amortization help drive relatively high pension contribution rates, which range from 37.8 percent for Kern’s court employees to 63 percent for public safety employees.

Kern County shows other signs of fiscal distress. In January 2015, county supervisors declared a financial emergency, prompted by the precipitous decline in oil prices. When the emergency was declared, oil companies paid about 30 percent of the county’s property taxes. That said, it is worth noting that property taxes accounted for just 15 percent of the county’s total 2015 revenue. Counties receive a substantial portion of their revenue from state and federal grants, so declines in a major source of county tax revenue are often less damaging than they are for cities.

After the emergency declaration, Standard and Poor’s affirmed the county’s A+ rating (four notches below the agency’s top AAA rating) and changed its outlook to negative. No downgrade has followed.

Kern County’s liabilities exceed its assets, leaving it with a negative Net Position – another sign of fiscal stress. Since most of a government’s assets are already committed to specific requirements (like paying debt service) or tied up in capital assets that are difficult to sell, analysts often focus on its Unrestricted Net Position – a measure of reserves that could be freely allocated by elected officials. Kern County has a negative Unrestricted Net Position of almost $2.3 billion – suggesting a serious fiscal problem.

On the other hand, the county has a strong general fund balance – equal to more than six months of general fund expenditures. As we have reported elsewhere, low or negative general fund balances have been the best predictor of municipal bankruptcy in recent years.

More recently, the county made further budget cuts which could result in closures of fire stations, jails and other facilities. If the county was not paying over $1 in every $8 for pension contributions and pension obligation bond debt service, these reductions might not have been necessary.

  1. Fresno County

Like Kern County, Fresno County has used pension obligation bonds (POBs) to address pension underfunding. As of June 30, 2015, the county had $454 million in POBs outstanding. This balance actually exceeds the $402 million principal amount of the POBs when they were issued in 2004, because much of the 2004 offering consisted of capital appreciation bonds (CABs). Interest on CABs is added to principal over the life of the bond and then paid at maturity.

In fiscal year 2015, Fresno was scheduled to pay over $37 million in debt service on its POBs. If this is added to the $153.5 million in Actuarially Determined Contributions the county was obliged to make, its pension-cost-to-revenue ratio would (like Kern County’s) exceed that of Santa Barbara County’s, which did not issue POBs.

Fresno County has the highest employer contribution rates as a percentage of payroll of the counties discussed here. In fiscal year 2015, contribution rates range from 37.4 percent to 74.6 percent for certain public safety employees. The county’s retirement program provisions are relatively generous. According to the system’s actuarial report, most plans allow members to retire at age 50. If they remain on the payroll after 55, many classes of employees accrue additional benefits at accelerated rates.

On the plus side, the Fresno County Employees’ Retirement Association is amortizing its unfunded liabilities over a 15-year period and has a relatively strong funded ratio – 79.4 percent (down from 83 percent at the end of 2014).

Illustrating that optimistic investment forecasts plague local government financials, Fresno County assumes annual asset returns of 7.25 percent. Its actual return in fiscal 2015 was a dismal -0.10 percent.

  1. San Mateo County

Like Santa Barbara County, San Mateo County has a strong economy, so it’s surprising to see it near the top of our list. One driver of the county’s pension burden appears to be high employee salaries. Since pension benefits are based on final average salaries, high employee compensation translates into high pension benefits.

A San Jose Mercury News story revealed that San Mateo County had 78 employees paid over $200,000 in the 2013 fiscal year. More recent data available on Transparent California shows that number grew to 90 employees in 2014.

Employee contribution rates ranged from 28.3 percent to 65.5 percent. For a single employee earning $200,000, the county’s annual pension contribution could be as a high as $130,940.

A 2012 San Mateo Civil Grand Jury report noted that county pension contributions had grown from $78 million in fiscal 2006 to $150 million in fiscal 2012, but the plan continued to generate substantial unfunded liabilities. The jury made a number of recommendations including “significantly decreasing the number of county employees through outsourcing and/or reducing services, and by attrition.”

The county’s board of supervisors agreed with most of the Grand Jury’s findings but did not specifically respond to the call for headcount reductions.

In late 2013, the board of supervisors decided to make extra contributions to SamCERA (the San Mateo County Employees Retirement Association) in order to more rapidly cut its unfunded liability. The supervisors authorized a one-time payment of $50 million in fiscal 2014 followed by annual $10 million payments in each of the next nine fiscal years. These payments, totaling $140 million over 10 years, are above the county’s Actuarially Determined Contribution.

The extra contributions have improved SamCERA’s funded ratio despite lackluster stock market performance in the most recent fiscal year. The system’s funded ratio rose from 73.3 percent in 2013, to 78.8 percent in 2014 and to 82.6 percent in 2015. The system achieved portfolio returns of 3.5 percent in fiscal 2015 as opposed to a 7.5 percent projected return rate.

Since 2013, the system’s unfunded liability has fallen from $954 million to $702 million. SamCERA amortizes unfunded liabilities over a 15-year period. Given the improvement in SamCERA’s funded ratio, it seems likely that San Mateo County will fall off the list of highly burdened counties in future years.

CONCLUSION

Generous benefits, aggressive return assumptions and (in some cases) high employee pay have left a number of California counties heavily burdened with pension costs. This year’s poor stock market performance will likely mean additional stress.

Over the longer term, the state’s 2013 pension reform should provide some relief, as newly hired employees receive less generous benefits. But if the stock market continues to be weak or if county systems make poor investment choices, asset returns will remain below the 7.25 percent-7.50 percent typically anticipated in actuarial valuations. Under those circumstances, employer contributions and overall pension burdens may continue to rise. The result will likely be ballooning public debt, pressure to raise taxes and cuts in government services.

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About the author:  Marc Joffe is the founder of Public Sector Credit Solutions and a policy analyst with the California Policy Center. Joffe founded Public Sector Credit Solutions in 2011 to educate policymakers, investors and citizens about government credit risk. PSCS research has been published by the California State Treasurer’s Office, the Mercatus Center and the Macdonald-Laurier Institute among others. Prior to starting PSCS, Marc was a Senior Director at Moody’s Analytics. He has an MBA from New York University and an MPA from San Francisco State University.