From Ed Mendel: Pension reform in San Diego

La Mesa has become one of the first cities to launch part of a pension reform pushed by a group of city managers in San Diego County — have workers make annual payments to help fund their pensions.

As is common among local government pension systems in California, workers have not been making annual contributions toward their pensions in nearly all of the small cities in San Diego County.

Firefighters in La Mesa agreed in July to contribute 9 percent of their pay to help fund their pensions, said Sandra Kerl, the La Mesa city manager. General employees agreed last week to contribute 8 percent.

As a sweetener, said Kerl, “They were given half of that back in a salary increase.” But employees will begin contributing to their pensions, she said, and the city expects to save about $1 million a year.

Employee contributions are part of a pension reform plan issued last June after a six-month study by city managers from 17 cities in San Diego County — all except the city of San Diego, which has its own troubled pension system.

The other cities in the county had a front-row seat for the pension scandal in San Diego. A mismanaged retirement system is taking a big bite out of the San Diego city budget and eight former pension officials still face charges filed some four years ago.

The city managers plan says their pensions are “not financially sustainable and are increasingly politically controversial.” The local government executives, who would prefer a statewide solution through legislation, are acting on their own because “we cannot wait due to the stalemate in Sacramento.”

If all of the cities in the county adopt the same retirement plan, the plan contends, unions will not be able to use competition among employers as leverage during negotiations. The San Diego group also is taking its ideas to city managers in other regions.

The innovative plan for contributions from employees is one of the few ways, apart from pay cuts and layoffs, that governments can immediately cut their pension costs.

In California, vested pension rights are generally regarded to have ironclad protection under contract law and court rulings allowing cuts only in exchange for something of equal value.

The city and county of San Diego have both recently adopted “two-tier” pension systems, giving new hires lower benefits. But it’s a long-term plan not expected to produce significant savings for several decades.

The city managers estimated that their two-tier plan would save 2 percent of payroll per year when a majority of the employees are receiving the lower benefits. After 30 years, the savings are expected to be 5 percent of payroll.

In their reform plan, the city managers make it clear that they are strong supporters of the “defined benefit” pension plan that provides a guaranteed monthly check for lifetime.

The city managers say that the “defined contribution” 401(k)-style individual investment plan has a number of shortcomings, among them high fees, lack of professional investment management, and no protection against stock market crashes.

All of the 17 cities in the city manager group are members of CalPERS, the giant California Public Employees Retirement System that covers state workers and 1,500 local government agencies.

After an historic stock market crash last fall wiped out a quarter of its investment fund, CalPERS adopted a “smoothing” plan in June in an attempt to avoid shocking local governments with a big contribution rate increase.

A rate increase will be phased in over three years, beginning in July 2011, to pay off the investment losses over 30 years. But the city managers think that an economic sea change is likely to result in a slow recovery of their tax revenue.

“The increased rates will catch cities just as they are beginning to crawl out of this tenacious global recession,” says the city manager plan.
“As such, pension costs will soon escalate beyond our ability to manage them while the benefits exceed what taxpayers themselves can receive and what is needed to attract qualified employees,” the city managers say. “The local government situation will become untenable.”

The city managers want to give new hires the same benefits provided by their cities before CalPERS-sponsored legislation, SB 400 in 1999, boosted benefits for state workers, prompting many local government retirement systems to do the same.

“It is now common for public safety officers to retire close to age 50 with almost a full salary under the 3 percent at 50 plan,” says the reform plan. “These increased benefits have proven to be unsustainable and need to be rolled back to more appropriate pre-1999 levels.”

Most police and firefighters currently receive pensions based on 3 percent of final pay per year of service at age 50. The proposal by the city managers for new hires is 2 percent at 50.

For general employees, the city managers are proposing 2 percent at age 60, down from 2.5 percent at 55 in many areas. One of eight proposals for legislation by the city managers would change the CalPERS board.

The 13-member CalPERS board, dominated by representatives and allies of labor, would be changed “to achieve better employee/employer balance and greater public agency representation.”

The trendsetting SB 400 legislation enacted a decade ago still rankles some local government officials.

“We don’t feel like we have had a voice at the table,” said Kerl, the La Mesa city manager. “When the new formulas were put out there, a lot of us said, ‘Are you kidding me?’ We had no say in that.”

“Yet the employers ultimately are responsible for making those payments, and CalPERS isn’t responsible,” she said. “I think we felt there was a need for equal representation on the board.”

An overhaul of the Oregon Public Employees Retirement System in 2003 went a different direction. A 12-member board was reduced to five members, three of whom are private sector financial experts who have no connection to the retirement system.
“You have to make sure that you have people with an independent view of the program,” Oregon Gov. Ted Kulongoski told Plansponsor magazine.

California Gov. Arnold Schwarzenegger has proposed a “two-tier” plan for state workers, returning new hires to pre-1999 benefits. Unlike most local government workers, state workers are already contributing to their pensions.

State general employees currently contribute 5 percent of their pay (the state another 17 percent). The Highway Patrol and state firefighters contribute 8 percent (the state, respectively, another 28 and 26 percent).

As the stock market boomed in the late 1990s, the state contribution to CalPERS dropped sharply while state worker contributions were unchanged. The result is a statistic that may be startling to some.

“Over the last 10 years, 75 percent of the income to CalPERS has been from investments, not employer or employee contributions,” a CalPERS research brief (page 3) said in 2005. “Over the last decade, members’ contributions have actually exceeded the amount of employer contributions by $1.1 million.”

Reporter Ed Mendel covered the Capitol in Sacramento for nearly three decades, most recently for the San Diego Union-Tribune. More stories are at his web site,  http://calpensions.com.