The Fall of Pacific Grove – CalPERS Begins Calling Deficits "Side Funds," Raises Annual Contributions
Part 3 of 7:
By 2005 Pension Costs Were Crippling the City
In 1999, CalPERS represented to the state legislature that a 50% increase in pension benefits for safety unions would not result in increased costs. It based its opinion on its investment prowess.
But by 2002, the tech bubble broke, and CalPERS began suffering significant investment losses. Its response was to persuade the legislature to authorize the largest rate increase in CalPERS history. The method used was to have each employer (city, county, et al.) set up a “side fund” in the amount of its pension deficit and to pay it off at 7.75% interest and principal over 26 years. Payment was back loaded but still substantial. Prior to “side funds,” employers paid nothing to reduce the deficits.
CalPERS announced its intention to create “side funds” in late 2001, prior to the Pacific Grove adoption of the 50% pension increase for safety on June 5, 2002, but did not include any reference to it in the mandatory actuary report (the report that the Pacific Grove city manager concealed from the council). It was an additional cost per year of over a million dollars, commencing in 2004.
In summary, when the 2002 Pacific Grove city council adopted the 50% pension increase for safety: (1) it was told that the cost per year was $51,500, when the hidden actuary report indicated that it was over $800,000 per year; (2) it was not told that the benefit extended to time previously served by Pacific Grove safety officers (one chief received 24 years of free credit); and, (3) it was not told that in just two years there would be an additional cost exceeding a million dollars per year.
By 2005, Pacific Grove was and is totally under water financially It now has a new unfunded deficit of about $45 million dollars, and pays about $1.6 million a year for pension bonds. Over 20% of its budget is used to pay for pensions — 8% to 10% is the norm. CalPERS has announced a 50% rate increase in the next few years. The $45 million pension deficit grows at the investment rate of 7.50% per year, or $3.75 million per year compounded. Pacific Grove operates by firing employees, slashing services, ignoring road maintenance, and failing to provide sinking funds for equipment (replacement of a new fire truck, for example). Its beautiful golf course is in a state of shocking unplayability. Evidently Pacific Grove cannot afford to water it.
The response of the union-led city manager and management staff is to promote plans to increase revenue in an attempt to squeeze a few more years out of Pacific Grove. Staff needs to raise revenues by $3.75 million per year to hold the pension deficit to $65 million dollars, including pension bonds. It may even have the gall to propose new taxes.
Union Controlled City Gives Raises and Issues Pension Bonds Exceeding Pension Debt
By 2006, Pacific Grove replaced its city manager and city attorney. The safety unions and the new management team set out to enhance their compensation packages, despite the fact that Pacific Grove was broke. The police unions wanted a large raise (30%), and the fire department wanted to merge with the Monterey fire department — a city notorious for generous employee/management compensation. The issue for new Pacific Grove management was how to convince a council majority that Pacific Grove could pay for the expensive union expectations—especially now that Pacific Grove had an additional million-dollar-a-year pension charge (as described in the last chapter). The answer was to have Pacific Grove issue pension bonds (POB), but defer payment on the bonds for three years.
In 2006, management convinced the council to issue $19 million in POB. The proceeds paid off the side fund, thereby eliminating the million-dollar-per-year payment on the side fund. By deferring interest for three years, it freed up about a million dollars per year for the safety unions’ goals of a raise, and a fire merger with Monterey. Of course after three years, there would be bond payments of about $1.6 million per year. And the three-year deferred interest increased the POB from $19 million to just over $22 million. But the new city manager intended to move on in three years, just as the $1.6 million POB payment commenced. And he did.
In January of 2007, the city manager prepared a mailer to every address in Pacific Grove, indicating that Pacific Grove was hopelessly broke and making it clear that substantial new taxes, together with a severe cutback of non-safety services, was in order. Yet, just three months later, he pushed through a 30% raise for the police unions (over a three-year period). He pointed out that Pacific Grove had (mysteriously?) acquired a million dollar reserve, so it could afford the raise. Five of the council agreed. All of this was accomplished in a closed session. The great financial risk from issuing POB is not just that it kicks the deficit problem down the road without curing the underlying problem, but that CalPERS would then lose a large part of the proceeds in the market. And, of course, in 2008-9, CalPERS lost 28% of its assets and failed to earn 7.75% on a sum equal to its benefit liability, for a total loss of 35.5%.
It is important to understand that the losses sustained by CalPERS were across the board for all different levels of pension plans. About 40% of CalPERS deficits arise from non-safety plans, while safety plans account for the remaining 60%. Politicians claim that setting up new tiers with lower pensions for new hires is pension reform, but it is like getting stabbed twice instead of three times. Over time the city will die, but a bit more slowly.
Read the entire series:
The Fall of Pacific Grove – How it Began, and How City Officials Fought Reform
– Part 1, January 7, 2014
The Fall of Pacific Grove – How City Thwarted Reform, and CalPERS Squandered Surpluses
– Part 2, January 14, 2014
The Fall of Pacific Grove – CalPERS Begins Calling Deficits “Side Funds,” Raises Annual Contributions
– Part 3, January 21, 2014
The Fall of Pacific Grove – Outsourcing of Safety Services Causes Increased Pension Deficits
– Part 4, January 28, 2014
The Fall of Pacific Grove – Anti-Pension Reform Mayor Claims to Favor Reed Pension Reform
– Part 5, February 3, 2014
The Fall of Pacific Grove – Privately Owned Real Property are the Only Assets to Pay for Pensions
– Part 6, February 11, 2014
The Fall of Pacific Grove – The Cover-Up by the City After the Hidden Actuarial Report Surfaced in 2009
– Part 7, February 18, 2014
The Fall of Pacific Grove – Conclusion: The “California Rule” Cannot Stand
– Conclusion, February 24, 2014
About the Author: John M. Moore is a resident of Pacific Grove, Ca. He is a licensed member of the California State Bar (#34734) and a member of the “Public Law” section of the State Bar. He is retired and no longer practices law, but has Lexis/Nexis for research. John graduated from San Jose State College with majors in Political Science and Economics (summa cum laude). He then received a JD from The Stanford School of Law and practiced business and trial law for 40 years before retiring. In 1987, he was the founding partner of a Sacramento law firm that he formed in 1987 to take advantage of the increased bankruptcies brought about by the Tax Act of 1986. Although he did not file and manage bankruptcy cases, he represented clients in numerous litigation matters before the bankruptcy court, including several cases before judge Klein, the current judge of the Stockton bankruptcy case. He is an admirer of Judge Klein, for his ability and accuracy on the law. As managing partner, he understood the goals of bankruptcy filings and its benefits and limitations.