A billion in debt and big payments define 'success'

Daniel Weintraub, Scacramento Bee Columnist, March 24, 2005

With Gov. Arnold Schwarzenegger pushing hard to overhaul government employee pensions in California, it's no surprise that the people who cherish those benefits are pushing back. But as the debate unfolds, it would help if everyone were arguing about the same thing.

Last week, the San Diego County retirement board voted to oppose Schwarzenegger's proposal. Top county officials blasted his plan and defended the status quo.

"There's no reason to fix something that's not broken," said County Treasurer-Tax Collector Dan McAllister, according to the San Diego Union-Tribune. Added County Supervisor Dianne Jacob: "Instead of punishing all public pension systems in California, what the state should do is focus on the problem funds and fix those funds, and allow the funds that are financially sound and healthy ... the flexibility to manage within the current defined-benefit system."

The pair cited their own retirement plan as evidence that the current system is working just fine.

But if San Diego County is a model of success, I would hate to see what failure looks like.

The county's pension fund is facing a $1.2 billion unfunded liability. The shortfall is the result of generous benefit increases awarded when the stock market hit its peak earlier this decade, followed later by investment losses. The deficit has grown even though the county has borrowed money three times since 1994 - in increments of $430 million, $737 million and, most recently, $454 million - to help keep the pension fund afloat.

San Diego taxpayers, meanwhile, are paying about 23 cents on top of every dollar of county workers' salaries to provide these benefits. And those taxpayer contributions don't even reflect the money it takes to service the county's debt, which is accounted for separately.

It's relatively easy to keep a pension fund solvent if you are willing to borrow unlimited amounts - obligating future taxpayers - and pay one-fourth of the cost of salary in premiums to the plan. But that's not evidence of success. It's just the opposite.

The plan Schwarzenegger favors isn't only about keeping pension funds solvent, though it would do that. It's about stabilizing the public's costs and, over time, shifting more resources from retirement benefits to providing current services. It would do so by creating individual accounts for each worker, funded by contributions from the employee matched by the employer. The worker would own the account, could take it with him or her when leaving government service and pass it on to heirs.

One of the virtues of such a plan is its transparency. Everyone - worker, employer and taxpayer - would know what it cost and exactly how it worked.

San Diego County is a perfect example of how that is not the case with the current, defined benefit system.

The county's problems date to 2002, when, flush with revenue from the rising stock market, pension fund managers and county officials boosted benefits by 25 percent to 35 percent for employees about to retire and gave cost-of-living increases to those who had already left the county work force. Employees were allowed to retire earlier with full benefits, and their pensions were based on their highest year of salary, rather than the average of three years, as had been the case. All of this cost upward of $1 billion.

Unfortunately, just as the benefits were approved, the stock market crashed, and the county's investment fund cratered. That left taxpayers paying more for the bigger benefits and paying still more to make up for the losses in the investment fund.

The county's response was to borrow three-quarters of a billion dollars and pour more than $500 million of that directly into the fund. The rationale: The county could get a better interest rate borrowing on the open market than it was obligated to pay the pension fund for the unpaid portion of the future obligation.

But even with that infusion of borrowed money, the unfunded liability soared, and the contribution rates for the taxpayers skyrocketed. The county's answer: Borrow again.

In June 2004, the county borrowed $450 million and put the money into the pension fund. Later, county officials sent out a press release crowing about the fact that the fund had gone from 75 percent of solvency to 81 percent. What they didn't say is that all of the improvement resulted from borrowed money. This is like congratulating yourself for paying off a portion of your growing credit card balance with funds from a second mortgage on your house. The San Diego County pension fund is like a leaky bucket that can stay full only as long as you've got a hose running into it.

When the county approved the benefit hikes back in 2002, the retirement association's newsletter featured a number of workers who shared their stories of glee. One happy camper said she was going to retire early - and still get a pension 10 percent bigger than she had counted on.

"I've already booked my first cruise to the Mediterranean," the woman said.

Let's hope she had a good time. But it was the county's taxpayers who were really taken for a ride.

Addendum to Article

Since San Diego County increased pension benefits by 25 percent to 35 percent three years ago, the average salary of county employees has climbed by 23 percent.

Doesn't this call into question the argument that sweet pensions are necessary to make up for the lack of competitive salaries in the public sector? If pensions and wages were a trade-off, you wouldn't expect to see them both soaring at the same time.

Schwarzenegger drops pension reform, but the crisis continues

Dan Walters , Saccramento Bee Columnist, May 16, 2005

Gov. Arnold Schwarzenegger may have abandoned his pension reform measure due to inartful drafting and a very artful opposition campaign by public employee unions, but that doesn't mean the problem has vanished. California has the nation's most generous public pension benefits - due to local and state politicians' Pavlovian responses to union demands - and soaring costs are siphoning money away from more urgent public needs and pushing some local governments to the brink of insolvency.

The high-tech stock market bubble of the late 1990s temporarily fattened pension investment funds, and union-controlled pension boards, led by the immense California Public Employees' Retirement System, provided superficial assurances that benefits could be expanded dramatically without cost to taxpayers. Politicians of both parties, from then-Gov. Gray Davis down, were eager to please the unions - particularly those representing police and firefighters - and fattened the benefits.

When the dot-com bubble burst, those blithe assurances vaporized, and governments at all levels were left scrambling. It was the same underlying dynamic and the same political mentality - using short-term windfalls for tax cuts and permanent spending - that led to the state's budget crisis. And the rising pension costs exacerbated the budget squeeze at all levels.

The state's pension costs soared to $2.6 billion a year - a sizable chunk of its "structural deficit" - while many local governments were hit with staggering bills from CalPERS as it adjusted to stock market declines, and larger cities and counties that maintained their own pension funds had similarly jolting experiences.

The poster child for irresponsible pension management is the state's second-largest city, San Diego, which once was widely admired for its prudent fiscal policies. San Diego's union-dominated pension board and its City Council joined in the giveaway orgy and then, by all accounts, the city deliberately and secretly avoided appropriating enough money to cover its new obligations. To compound their misconduct, city officials apparently hid the underfunding from Wall Street. There are myriad official investigations into the San Diego mess, with criminal charges a possibility for those involved. The political fallout forced Mayor Dick Murphy, a former judge, to resign.

As legal and political aspects of the San Diego scandal are played out, the pension system's financial mess remains unresolved. Unlike most forms of government spending, pension obligations cannot be reduced once they're granted; benefits have the same legal standing as bonds or other forms of debt. San Diego's city manager wants the city to slash 355 city jobs, reduce library hours, cut back on child care and close all community service centers, largely so that it can stash away more money to cover a $1.4 billion deficit in its pension fund - recommendations he made last year only to be ignored.

The expanded pension benefits that politicians dispensed during the brief windfall of paper profits may be legally untouchable, but we could - and should - learn from the experience. Politicians cannot be trusted to exercise fiduciary prudence, because they are driven by immediate political pressures and disinterested in the long-term consequences of their actions, as both the pension imbroglio and the state's immense budget crisis attest. And open-ended pension commitments are inherently dangerous, as the financial meltdown of United Airlines proves.

Schwarzenegger was on the right track with his pension reform, limiting new public employees to defined-contribution plans, rather than cost-be-damned defined-benefit plans, to produce some stability in taxpayers' burden. It was widely condemned as "privatization" to tie it to President Bush's controversial Social Security overhaul, but in fact the administration said that the new plans could be administered by CalPERS and other pension systems, not private firms.

Were benefits more dependent on what CalPERS and the other funds earned on investments, rather that open-ended hits on taxpayers, perhaps workers and unions would be more vigilant about those investments and less tolerant of pension fund trustees' side-agenda high jinks.

3 officials connected to pension crisis quit

High-level departures continue to rock City Hall

By Philip J. LaVelle, San Diego Union, May 17, 2005

In a dramatic shake-up at City Hall, three veteran San Diego city officials deeply involved in the pension crisis resigned yesterday, three days after another official was placed on administrative leave for allegedly failing to cooperate with federal investigators.

The departure of former Deputy City Manager Patricia Frazier, former Treasurer Mary Vattimo and Human Resources Director Cathy Lexin was seen as a signal to federal investigators by senior city officials that City Hall is taking urgent steps to enact financial reforms.

City Manager Lamont Ewell announced the resignations in a memo that said the trio "have each chosen to resign from their positions and pursue other professional interests."

Frazier oversaw the city's financial management for many years, and Vattimo and Lexin  a key player in the city's labor negotiations  served on the board of trustees for the $3.6 billion San Diego City Employees Retirement System. Frazier and Vattimo had already been moved out of positions of influence.

Their resignations follow by three days the placing of former acting Auditor Terri Webster on administrative leave for her alleged failure to hand over evidence sought by a federal grand jury. Webster also is a former pension board trustee.

It was the latest in a string of high-level departures at City Hall, a place known for years for relative stability in its executive ranks, and comes as federal investigations into city finances enter their 15th month.

Exit San Diego

Top city officials who in the past 16 months have left or have announced they are leaving:

January 2004  City Auditor Ed Ryan (resigned)

March 2004  City Manager Michael Uberuaga (resigned)

April 2005  Mayor Dick Murphy (resigned effective July 15)

Friday  Former acting Auditor Terri Webster (administrative leave)

Yesterday  Deputy City Manager Patricia Frazier, Human Resources Director Cathy Lexin and former Treasurer Mary Vattimo (all resigned)

"This is huge," said City Attorney Michael Aguirre, who has called for city officials involved in the pension crisis to resign.

The Securities and Exchange Commission is investigating whether current and former city officials violated securities laws by failing to disclose to bond investors the deteriorating condition of the pension system, which today has a deficit of at least $1.4 billion. Officials also failed to disclose unfunded retiree health-care costs of more than $500 million.

CalPERS uses creative accounting to blunt losses

By Daniel Weintraub, Sacramento Bee, May 24, 2005

After years of bad news about public pensions, California taxpayers caught a break last week when the public employees' retirement fund announced that the state's obligation to the pension system would decline by nearly $200 million in the coming year.

But don't start celebrating yet.

Unfortunately, that reduction didn't come from gains in the pension fund's investments, or from more efficient management of the program. Instead, the discount was the result of accounting changes that might eventually come back to haunt us all.

The changes were part of a package meant to reduce the volatility that has plagued the fund since it rode the stock market boom to the top in 2000 and then back down again. That wild ride first reduced public employer payments into the pension fund to almost nothing, then, coupled with the cost of benefit increases adopted in 1999, forced those payments up by $3 billion in just a few years.

Taking some of the peaks and valleys off that rollercoaster ride is probably wise. But the changes CalPERS implemented last week might also be a case of too much of a good thing.

The least risky of the changes is a new policy meant to require a minimum payment by the taxpayers even in good years. The old policy allowed public employers to skip or drastically reduce payments when the fund was riding high. This deprived the pension system of assets needed for the long term and made the annual payments seem that much bigger when they resumed. The new policy will tend to make the payments relatively larger in good times and smaller in bad times, compared to the way it has been done until now.

That seems sensible. But the other changes implemented last week were more problematic. They will reduce volatility in the pension fund essentially by ignoring it. In other words, when the fund's investments are riding high or dropping low, the new rules will allow CalPERS to wait longer before reacting to the change in its bottom line.

Under the old rules, gains and losses in the investment fund were absorbed over a rolling three-year period. So if the investment fund grew from $100 billion to $109 billion in one year, only one-third of that gain - or $3 billion - would be counted in the first year. If the gain were sustained over time, eventually all of it would be realized. The same applied to losses.

The new rules stretch out that period to 15 years. In theory, this will allow bull markets and bear markets in the stock market to balance each other out before they are fully felt by the pension fund. On the upside of the market, this is, again, probably a good thing. It will reduce the chances of a phantom "surplus" and with it the temptation to spend that money.

But if the fund suffers a string of bad years, or if the stock market begins to consistently underperform compared to expectations, the new policy will shield the pension fund managers - and the taxpayers - from that reality. Rather than recognizing those losses relatively quickly and increasing the payments required from public employers to counteract them, the 15-year look will keep everybody blissfully ignorant about the consequences of the steady erosion in the value of the fund.

At the same time, CalPERS also decided to widen the accounting buffer it uses as another tool to slow the recognition of gains and losses. Historically, instead of trying to keep its investment fund at exactly 100 percent of what is needed to pay its long-term obligations, CalPERS shot for a corridor of between 90 percent and 110 percent of that target. Again, that meant not reacting to every little blip in the stock market.

The new policy will give the fund even more room for error. The corridor will be twice as wide, from 80 percent to 120 percent of the target. Now if losses occur, the reaction time will be even slower.

The timing of the new accounting policy certainly raises eyebrows. The reason that the changes resulted in a $200 million break for taxpayers is that taken together, they are reducing the pension fund's acknowledgement of what's left from the recent losses in the stock market. The pension fund hasn't grown any richer. Its books have just has been altered to make it look that way.

This is exactly the opposite of what was done in 1999, when the CalPERS board was lobbying the Legislature to approve benefit increases for state employees and retirees. Back then, with big gains in the stock market too enticing to resist, the board accelerated its recognition of those gains so that the money could be spent for benefit increases. Unfortunately, almost as soon as those benefits were approved, the stock market crashed and the paper profits disappeared. The result is still being felt by the taxpayers.

If a private company changed its accounting procedures to make its profits look bigger in good years and hide its losses in bad years, we would call that fraud. It's not fraud when a public pension fund does it. But it is cause for concern.

County faces steeper bills for pensions

By Phillip Reese, Sacramento Bee, December 28, 2005

More than two years after improving retirement benefits for public workers, Sacramento County leaders are seeing the long-term effects of their decision. The bill is coming due, with tens of millions in new payments owed next fiscal year, more than doubling the county's pension debt service costs. Retirees are making more money, including some with six-figure pensions. More than 1,400 county workers have retired under the new benefits - marking an increase that some officials say is contributing to a high job vacancy rate.

"It's having some real widespread repercussions," said county Supervisor Roger Dickinson, when asked to evaluate the effects of the enhanced pension benefits. "I'm not sure we know where this actually takes us."

County leaders realized they were headed into murky water when the new pension benefits started in mid-2003. But their options were limited. The state recently had bolstered its own pension benefits, and counties and cities across the region were following suit to stay abreast.

"It quickly became apparent that we were going to become noncompetitive if we didn't do this," Geoff Davey, the county's chief financial officer, said.

The burden of paying for the new benefits also has become immediately apparent. To lessen the sting, the county issued bonds to cover its obligations, then delayed payments on the new bonds for a couple of years.

This fiscal year the county pays about $21 million toward all its pension bonds. But next year, that bill will rise to $51 million. It's the first in a string of jumps that will see annual payments pass $100 million by 2014.

The county has squirreled away funds in anticipation of the increase, saving much of a $50 million surplus this year that largely resulted from higher-than-expected property tax revenue.

"We've taken care of it for next year," said supervisor Roberta MacGlashan. "It worries me beyond that."

Even with money in the bank, county budget officials still predict a roughly $10 million budget deficit in 2006, largely due to the increased pension debt payments. That's only a small part of a massive $2 billion budget - but it could still sting. Deficits often mean cuts, though it's too soon to say what, if anything, might get trimmed.

"Obviously, to the people that depend on and enjoy the programs that are affected, it will be significant," Davey said.

And after next year, the county likely won't have a large reserve to fall back on. That could lead to some tough decisions. A big deficit is harder to absorb, so the cuts could be deep.

"Until we see how this plays out, it concerns me," MacGlashan said.

Adding to the county's financial strains is that retirements have increased dramatically under the new pension benefits, faster than some leaders expected.

County workers, faced with the option of retiring at a younger age with the same, or even higher, pensions, than before, decided to retire early.

In the fiscal year that began in 2003, the first full year the enhanced benefits were in place, 683 county workers retired, up from 194 the previous year.

County officials are quick to point out that many workers delayed retirement until the enhancements were in place. Even so, 505 people retired in the fiscal year that began in 2004. Another 225 have retired or announced plans to retire so far this fiscal year, with the busiest season for retirements - the period when cost-of-living salary increases kick in - still to come, county officials said.

Eventually, those numbers are expected to taper off to about 400 retirees a year, said Richard Stensrud, chief executive officer for the Sacramento County Employees' Retirement System. That's still about 75 to 100 more retirements a year than was typical before the benefit enhancements kicked in.

The early retirements have left holes - nearly 1,800 of the county's 14,000 authorized, permanent positions are unfilled. While many of the openings are the result of a previous hiring freeze, the county has been able to hire during 2004. Some of it could relate to the high number of recent retirements, said supervisor Dickinson.

"Our vacancy rates are relatively high - even after the hiring freeze," he said.

The reason for the sharp increase in retirements is simple: more money. The enhanced pension benefits have created a new class of retirees - those making more than $100,000 in annual pension, county data show.

Under the old system, most county employees could retire at age 60 with an annual pension that was 2 percent of their salary for every year they worked. For law enforcement officials, the payout was 2 percent per year starting at age 50.

Now, most employees get 2 percent per year starting at age 55 1/2. And law enforcement officials get 3 percent per year at age 50 - a 50 percent bump.

That's translated into big bucks for some. During fiscal 2004 alone, more than 30 county employees, most of them deputies in the Sheriff's Department, retired with annual pensions above $100,000, according to county data.

At the same time, many retired law enforcement officers earning those pensions have returned to work in the Sheriff's Department part time and earn a salary on top of their pension, according to county data requested by The Bee, but obtained only after a Sacramento Superior Court ordered it released.

These "reserve deputies" - there were about 80 rehired during 2004 - typically work as bailiffs or behind a desk, Undersheriff John McGinness said in an interview. They're cheaper to employ than full-time officers, he said, because the county doesn't have to pay for certain benefits as part of their compensation.

Sheriff's Department employees - because of special early retirement policies for law enforcement - received the most lucrative pensions. Across the county work force, the median pension benefit paid to 2004 retirees was $36,300.

Almost all of the 44 county retirees currently earning more than $100,000 in annual pension benefits retired after the new enhancements began, Stensrud said.

Regardless of the fiscal consequences, however, Davey said the county had little choice but to approve the benefits. Everyone else was improving benefits for their workers, and the county needed to remain competitive.

With just three or four exceptions, Davey said, "Almost every local government ... chose to match the state's new levels."