Pension costs: Pushing cities to fiscal disaster

By San Jose Mayor Chuck Reed & Santa Ana Mayor Miguel Pulido, The San Diego Union-Tribune 

The skyrocketing cost of public employee retirement benefits is one of the greatest challenges facing cities and other government agencies across California today. Annual taxpayer contributions to CalPERS, the state’s main retirement system, have jumped from about $2 billion to nearly $8 billion over the past decade. Many non-CalPERS agencies have seen similar retirement cost increases as well.

Despite these rising contributions, the state’s retirement systems are significantly underfunded, with their collective unfunded liabilities for pension and retiree health care benefits totaling hundreds of billions of dollars.

That’s why, four years ago, then-CalPERS Chief Actuary Ron Seeling declared that the cost of public employee retirement benefits was “unsustainable.” And without reform, these unsustainable benefits threaten to push more cities, counties and other public agencies into insolvency.

This is a problem that all Californians should care about. It is draining money away from core public services. It is increasing pressure for new taxes and steeper borrowing. It is preventing much-needed investments in infrastructure. And it threatens to leave our children and grandchildren with an enormous debt that they won’t be able to afford.

For example, when state spending on retirement benefits increases, it squeezes out funding for important services like education. The state’s retirement system for teachers, CalSTRS, recently stated it needs another $4.5 billion annually to reach full funding in 30 years. That will leave fewer dollars available for K-12 education, which has already seen funding decline by 12 percent over the last five years.

The impacts are even more apparent at the local level where personnel costs make up a large portion of the budget:

• In San Jose, our annual retirement contribution more than tripled over the past decade and now consumes more than 20 percent of the city’s entire general fund. These increased costs have forced us to lay off police officers and firefighters, close libraries and community centers, and watch our streets deteriorate year after year. We eliminated about 2,000 positions from our city workforce.

• In Santa Ana, the annual retirement contribution more than doubled over the past decade and CalPERS is currently projecting that the city’s pension rates will double again within the next six to seven years. These higher pension costs have been a contributing factor in Santa Ana having to reduce its full-time workforce by 41 percent over the past six years. While the city has been able to mitigate some of the increase through a cooperative effort with its unions — employees currently contribute beyond the standard 8 percent employee share — meaningful reforms to reduce current benefit levels and obligations in the near term are needed to protect Santa Ana’s ability to maintain services.

• A few cities have already been pushed into insolvency. In just the past year, San Bernardino and Stockton filed for bankruptcy, with unfunded retirement liabilities among their largest debt obligations.

Some cities have been able to absorb increased retirement costs without much impact to services, while others have benefitted from accounting gimmicks that push costs far out into the future.

But every city will be facing painful decisions as retirement costs continue to rise. In fact, local governments were just put on notice by CalPERS that their pension contributions will go up by another 50 percent over the next seven years. And that assumes that CalPERS hits its 7.5 percent investment-return assumption every single year, which would equate to the stock market doubling over the next decade. If not, costs will go up even higher.

It’s important to remember that these problems are not the fault of our government employees who have dedicated their lives to serve the public and are continually asked to do more with less.

However, we simply cannot afford to continue providing retirement benefits that are far better, and far more expensive, than the average Californian receives. Today, many government employees can retire as early as age 50 and collect a guaranteed pension — which can equal up to 90 percent of their highest annual salary — for the rest of their lives. Some agencies allow their employees to collect much more by counting overtime and vacation payouts in their “salary,” and some employees will end up earning more in retirement than they did in their careers.

The unsustainability of these benefits should be a serious concern for government employees as well. Many have already faced layoffs and pay cuts due to rising retirement costs. In addition, huge unfunded liabilities could threaten the government’s ability to pay out the benefits that public employees will be counting on in retirement.

Some government retirees have already seen their accrued retirement benefits cut in bankruptcy. The City of Stockton has been forced to eliminate health care coverage for all of its retired employees. In Central Falls, RI, retirees had their pensions slashed by up to 50 percent. And Pritchard, Ala., let its problems grow so big that its pension fund ran out of money in 2010 and stopped sending checks to retired employees.

Momentum for Reform

As mayors, we have a responsibility to ensure that we can: 1) provide services to the public; and 2) pay our employees and retirees the retirement benefits that they have earned and accrued.

That’s why we are staunch advocates for meaningful pension reforms that will help us achieve both of these objectives over the long-term. We agree with Gov. Jerry Brown, who said:

“Pension reform can be hard to talk about, but in the long run, reform now means fewer demands for layoffs and less draconian measures in the future. It’s in the best interest of all Californians to fix this system now.”

Unfortunately, California’s enormous pension problems were not fixed by the reforms enacted by the state last year. While they were a step in the right direction, most of the savings are far in the future and, by CalPERS’ own calculations, only cover about 5 percent to 10 percent of the state’s unfunded pension liabilities.

More significant efforts are taking place at the local level, including recent reforms adopted in two of the state’s largest cities.

• In San Diego, 66 percent of the voters overwhelmingly approved a citizen initiative in June 2012 that will reduce retirement costs by freezing existing employees’ “pensionable pay” (the amount of an employee’s pay that is used to calculate his/her pension benefit) until 2018, and placing most new employees in a 401(k)-style retirement plan.

• In San Jose, nearly 70 percent of the voters approved a set of pension reforms that were placed on the ballot after 8 months of negotiations with employee unions. New employees will now have a more affordable pension plan and, going forward, existing employees will have the choice to either contribute more for their current plan or move to a new, lower-cost plan for future years of service.

Despite this progress, there are still significant legal, procedural and practical obstacles to achieving meaningful pension reform in California, particularly for local government. Even the voter-approved reforms described above are being stalled by a bevy of lawsuits and implementation challenges.

Overcoming these obstacles will require action at the state level, which ironically enough, is where this problem was created 15 years ago. That’s when state leaders created the generous pension benefits in place today, backed by CalPERS’ claim that it could be done “without it costing a dime of additional taxpayer money.” Of course, CalPERS’ prediction turned out to be dead wrong and we have been paying the price ever since.

It’s time for our state leaders to help fix the mess that their predecessors created by providing cities, counties and other government agencies with the tools necessary to reform their pension benefits and avoid insolvency.

Making Changes

We believe that California’s constitution should be amended to grant state and local governments clear authority to modify pension formulas for an existing employee’s future years of service.

Such an amendment would not take away benefits that employees have earned for prior years of service. However, it would allow government agencies to prospectively adjust benefit formulas, employee contributions, retirement ages and cost-of-living increases — either through the collective bargaining process or by voter approval.

This would settle the ongoing dispute over the “vested rights” doctrine, which has been used to block any effort to prospectively change the rate at which existing employees accrue benefits in the future. Private-sector pension plans have the flexibility to change benefits going forward, and we believe government leaders should have that option as well.

Resolving this issue is critical to the success of pension reform for three reasons:

1) Government leaders need to be able to generate immediate savings to offset the huge cost increases coming in the next few years. Absent clear authority to prospectively reform current employees’ benefits, many governments have opted to only address benefits for new employees. But that doesn’t provide any significant savings for years and many cities cannot afford to wait.

2) It will help cities and government agencies avoid costly and time-consuming litigation. Public employee unions have used the “vested rights” argument to challenge all sorts of different pension reforms. Contra Costa County employees have even sued the state, claiming they have a “vested right” to use vacation and sick leave payouts to spike their pensions.

3) It will provide additional options for bringing down retirement costs. The current debate over “vested rights” has left many government agencies in the fallback position of making their employees pay more into their pensions. But the truth is that neither taxpayers nor employees can afford to pay the true cost of these generous retirement benefits. When given a choice, many employees would likely prefer a more modest retirement plan rather than see their take-home pay reduced.

Some argue that all of our pension problems will be solved once the stock market recovers. But it would take double-digit investment returns for many years in a row to eliminate the unfunded liabilities in California’s retirement systems and cover rapidly rising contributions in the year ahead. As Warren Buffett put it, it’s that kind of overly optimistic “Alice in Wonderland” thinking that got us in trouble in the first place.

Others have proposed issuing pension obligation bonds or modifying actuarial assumptions to delay cost increases. But those kinds of gimmicks cost us more in the long run, place an even greater burden on our children and grandchildren, and increase the risk of our retirement systems becoming insolvent.

Without fundamental reform, skyrocketing retirement costs and massive unfunded liabilities will push more cities, counties, school districts and, ultimately, the state, toward fiscal disaster. But by providing all levels of government with clear authority to modify current employees’ future pension benefit accruals, we can preserve public services and ensure the long-term health of the retirement plans that our public servants rely on.

Reed is the mayor of San Jose. Pulido is the mayor of Santa Ana.