San Diego putting off pain from new pension debt

San Diego increased its pension debt on Friday by adopting the most conservative investment return projections in the state, but pushed much of the financial impact several years down the road.

Lowering the pension system’s projected investment returns from 7 percent to 6.5 percent, which will require higher contributions by taxpayers and city workers, was widely praised as a prudent move in light of the volatile global economy.

But critics called the decision to spread the impact over several years irresponsible, comparing the move to previous underfunding schemes more than a decade ago that earned San Diego the nickname “Enron by the Sea.”

Supporters of delaying the impact, which the city’s pension board approved in a 7-5 vote, said it would stabilize the city budget and help fund long-awaited employee pay hikes when a voter-imposed salary freeze ends next year.

Police officers in particular are expected to be offered hefty pay increases this fall to boost recruiting and retention in the face of a severe and worsening officer shortage.

Without delaying the impact, which many call “pension smoothing” or creating a “glide path,” the city’s annual pension payment would have increased roughly $10 million a year over the next five or six years.

Those increases would have been on top of a huge long-term spike the pension board approved last year after a new actuarial study showed that city employees and retirees are living significantly longer than previously thought.

Those increases in employee longevity, which will force the city to pay out pension benefits several years longer to many workers, increased the city’s unfunded pension debt from $2 billion to nearly $2.6 billion.

Friday’s moves by the pension board will increase the city’s unfunded debt by a relatively smaller amount that won’t be determined until January, a pension board spokeswoman said.

The impact will be smaller because lowering projected investment returns requires employees to share the burden by increasing their contributions, and because strong stock market gains this year have boosted short-term pension system revenue.

The board last year decided against smoothing the impact of the employee longevity increases, which ballooned the city’s annual pension payment from $261 million in fiscal 2017 to $324 million in fiscal 2018.

In contrast, the board decided on Friday to smooth the impact of decreases in projected investment returns. That means instead of an increase beyond $324 million, the city is expected to see a small decrease in its annual pension payment next year.

The smoothing will also somewhat alleviate concerns about deep budget cuts next spring after the city made some modest cuts last spring. And it will mean more money for pay raises, which employees haven’t gotten since voters approved Proposition B in 2012.

The smoothing is possible because the city’s annual pension payment had been scheduled to sharply drop from $330 million in 2028 to $119 million in 2029 when a series of amortized debts will be paid off.

Under the plan adopted on Friday, the city will soften that sharp drop by decreasing payments between now and 2028 and increasing payments in 2029 and beyond.

City Councilman Scott Sherman, who took the unusual step of testifying before the pension board on Friday, urged the members not to opt for smoothing.

“Too many times when we’re getting into a little difficult budgetary season we like to try and change things so the bill we get for our retirement plan is a little less than anticipated, so we can have money to spend in other places,” Sherman told the board. “But we need to make the tough decisions when we need to make them, and we need to keep paying.”

Sherman said the pension payment “cliff” in 2029 was promised to voters when they approved Proposition B.

“It shows good fiscal responsibility to the voters that their city has got a plan for paying our bills and we’re paying off our debt,” Sherman said. “I don’t want to see us pushing the payment further and further down the road on to future generations. That’s kind of how we got to where we are.”

Former City Councilman Carl DeMaio, who helped write Proposition B, offered similar sentiments in a news release.

“History seems to be repeating itself as city politicians and labor union bosses scheme to once again intentionally underfund the pension system and divert those funds to give city workers salary increases,” DeMaio said. “Unfortunately taxpayers will be left holding the bag.”

The San Diego County Taxpayers Association said smoothing also confuses taxpayers about how pensions are funded and how pension debt is paid off.

Supporters of smoothing compare it to when the city sells bonds to pay for large infrastructure projects like roads or water pipes. The debt is paid off slowly and steadily, similar to how the pension board now plans to take care of the city’s pension debt.

They also contend that stabilizing the city’s annual pension payment helps with budgets and planning, because wild fluctuations force the city to make cuts during years with high pension payments and then restore programs during years with low payments.

Adopting a 6.5 percent projected return on investments makes San Diego the most conservative pension system in the state. San Mateo County, which has begun using 6.75 percent, was the first to go below 7 percent.

Since 2007, San Diego has been slowly lowering its projected rate of return from 8 percent, where it had stood for many years before the Great Recession.

It was lowered to 7.75 percent in 2008, 7.5 percent in 2011, 7.25 percent in 2013, 7.125 percent in 2015 and 7 percent last year.

The board on Friday considered a decrease to 6.75 percent, which would have been more in line with the incremental approach taken in recent years.

But board members and the board’s actuary, Gene Kalwarski, said 6.5 percent matched better with actual investment projections by the board’s consultant.

So the board eventually voted for a decrease to 6.75 percent this year and 6.5 percent next year for the pensions system, officially known as the San Diego City Employees Retirement System.

Those combined increases will cost public safety employees 1.8 percent in increased pension contributions, and other workers with pensions 1.2 percent in higher contributions. Employees are required to contribute to their pension a substantially equal amount to what the city must contribute with taxpayer funds.

The board also discussed, but did not change, an actuarial assumption that city employees will get average pay raises of 3.05 percent in coming years.

Many members of the board said that estimate was too low because relatively large raises are expected after the freeze.

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