Palo Alto's financial climate remains sunny, with rising revenues fueling expanding city services, but one giant cloud continues to hover on the horizon: a $296-million bill for pension expenses.
The City Council last week held a special meeting to discuss the city's unfunded pension liabilities and made plans to consider its options for reducing the balance. The council's Finance Committee plans to delve deeper into the issue in the coming months, before it returns to the council for possible reforms.
Last week, the council heard a presentation about the scope of the problem, as well as potential solutions, from actuary John Bartel, president of Bartel Associates. In his report, Bartel recalled the recent trends and events that have sent the city's pension obligations through the roof.
Chief among them is the financial downturn of 2008, which sent investment returns plummeting for the California Public Employees' Retirement System (CalPERS), the mammoth fund that administers the pensions of Palo Alto and many other cities around the state. The majority of the unfunded liability, Bartel said, was due to low investment returns.
Demographic changes have also contributed, though to a less extent, Bartel said. People are living longer, which means more people are collecting benefits than before. Almost 60 percent of the city's contributions to employee pensions for non-public safety workers is now for retirees. In 1997, the percentage was 35 percent, Bartel said.
The city has already taken some steps since the financial crisis to change the pension formula for all of the city's labor groups so that employees now contribute more toward their pensions. Statewide, reform came in 2013, when the California Public Employees' Pension Reform Act instituted new tiers for public employees, providing lower benefits for newer workers. CalPERS is also now pursuing its own reforms, Bartel said, to account for a lower return rate and the changing demographics, an effort that he lauded.
"They are saying that the CalPERS' population — not just active employees but retirees — is becoming much, much more mature," Bartel said. "What this means is that investment volatility can have a very significant adverse impact on the unfunded liability and where contributions are going to go. CalPERs is in the process of trying to decide how they're going to accommodate that."
But while assuming a more modest return rate should reduce volatility, the changes are expected to increase the city's contributions to the pension funds. Even despite the recent reforms, the city has already experienced what a new report from the Administrative Services Department calls "significant pension rate increases in the last five years."
In 2011, the contribution rate for "miscellaneous workers" (those not in public safety) was 17.6 percent of salaries and the safety contribution was 24.7 percent. In the current year, the rates are 27.7 percent and 41.9 percent, respectively. The report notes that the changes in CalPERS assumptions and investment policy, along with demographic changes, "have created a growing unfunded liability for the City." Today, the $296-million bill includes $190 million for public-safety workers and $106 for the remaining workforce.
"The main point we wanted to show you here is the significant increase in the number of retirees and how the number has grown," the city's Chief Financial Officer Lalo Perez told the council. "That's the bulk of our unfunded liability and the fiasco of 2008 just made it worse."
To address the problem and lower the gap, the city has several options – each with its own trade-offs. The city can pay more ahead of the required schedule thus saving on future interest costs. This can be done by exceeding the required contribution amount either every year or during surplus years. It can also contribute money into what's known as a Section 115 Trust, an irrevocable trust that is offered by two different agencies.
The trust, according to staff, would be a less risky option than contributing directly to CalPERS. At the same time, CalPERS would "likely invest the funds more aggressively and potentially attain a higher investment return than would the 115 fund managers," according to a staff report.
Another option is allocating an extra $1 million per year to close the gap sooner. If the city were to start doing that, miscellaneous contribution rates will have decreased by 1.2 percent and the unfunded liability by 2.9 percent over 10 years.
In its brief discussion, the council didn't make any commitments but agreed that the subject requires further discussion. Vice Mayor Greg Schmid cited the recent "dramatic changes" in the economy and in the demographics, and argued that the city should support more conservative assumptions about rates of return.
Councilman Pat Burt advocated for a "hybrid approach" in which the city raises its pension contributions during years in which it has surpluses.
"I'd be interested in having a minimal amount of General Fund revenue or percentage of all labor-related compensation or some amount that we'd pay every year and a supplemental amount that we'd pay on a discretionary basis when we do have surpluses," Burt said.
Staff is recommending exploring what the staff report calls a "dual approach" that uses both annual contributions to the Section 115 Trust and annual contributions to CalPERS to reduce the city's amortized payments. The council will consider these actions in the months ahead.
City Manager James Keene acknowledged that it won't be "a fast conversation unless we're going to write a $300 million check all at once."
"It's something that will unfold over the years that will have to be routinely revised," Keene said.
Comments
Duveneck/St. Francis
on Sep 17, 2015 at 10:34 am
on Sep 17, 2015 at 10:34 am
Dear Mr. Keene and Palo Alto City Council members. Having this "unfold over years" will merely compound the problem. Obviously, writing a $300M check isn't what I'm suggesting. But ALL other actions that can be can start being implemented immediately are of utmost importance. Please don't put off ANY actions you can imagine taking, as this will just make the problem bigger and worse. Be assured that any delay in action is the wrong thing to do. Even though it's a big problem and politically difficult, ACT NOW in as many ways as you can possibly come up with! Thanks.
Fairmeadow
on Sep 17, 2015 at 10:37 am
on Sep 17, 2015 at 10:37 am
While the current problem facing the City is how to pay down this unfunded liability of about $300M, it’s not clear that the City is actually looking forward to the future liabilities it is accruing due to its paying ever higher salaries. Digging through the City’s published salary data for 2104, we find that 20 employees make over $200,000 and 96 made over $150,000 and 323 made over $100,000. All of these people will be due 80% to more than 100% of their salaries in pension payouts, should they put in thirty years, or more. Since there are no caps on City salaries—these folks will continue to see their salaries increase before they retire—thereby increasing their pensions accordingly.
The City never seems to publish the total-cost-to-employ numbers, or even provide estimates of the lifetime cost-to-employ people. The following matrix of payouts provides a good estimate of what public sector pensions are worth (in this case public safety employees):
Using a COLA of only 2%, public sector retirees will receive the following minimum payouts in the following exit salary ranges:
--------------------------Minimum Pension Payouts-------------------------
Initial
Pension
Payout
$100K--10-Years: $1.1M | 20-Years: $2.5M | 30-Years: $4.1M
$150K--10-Years: $1.7M | 20-Years: $3.4M | 30-Years: $6.2M
$200K--10-Years: $2.2M | 20-Years: $5.0M | 30-Years: $8.3M
$250K--10-Years: $2.8M | 20-Years: $6.1M | 30-Years: $9.3M
$300K--10-Years: $3.3M | 20-Years: $7.4M | 30-Years: $12.4M
$350K--10-Years: $3.9M | 20-Years: $8.6M | 30-Years: $14.4M
$400K--10-Years: $4.5M | 20-Years: $9.9M | 30-Years: $16.5M
$450K—10Years: $5.0M | 20-Years: $11.2M | 30-Years: $18.6M
$500K--10-Years: $5.5M | 20-Years: $12.3M | 30-Years: $20.6M
(The table says that if an employee retires with an exit salary of $200K, that employee will receive an additional $8.3M during his first 30 years of drawing pensions from CalPERS.)
Police and Fire Department employees are routinely drawing salaries in the larger cities in the $125K-$175K range (and soon over $200K) with pensions as much as 90% of their high salary (or more). Within a decade, it’s hard not to expect some public safety employees to routinely be paid more than $300K/year. Other municipal employees’ pensions can be as much as 82% (or more) of their exit salaries. It’s not hard to show that during their retirement years most public sector employees will be paid more than twice what they were paid during their active working years.
CalPERS claims that the average pension payout is about $36K a year. While that may be true at the moment, as the people working for large California Cities retire, they will be paid far more than workers in previous generations--effectively twice (2X) in their retirement years what they made in their working years. The older cohorts of retirees are not generally aware of the high salaries that the current generation of workers is making. So, there is a lot of resistance in this group towards any kind of pension reform.
The City needs to also be looking forward twenty-thirty years forward to determine the cost of its labor—both direct costs and deferred salary (pension) costs.
Palo Verde
on Sep 17, 2015 at 10:55 am
on Sep 17, 2015 at 10:55 am
@Wayne, remind me whether these public pensions are fixed amounts or get cost-of-living increases. If the former, then inflation may bring us back to solvency.
Fairmeadow
on Sep 17, 2015 at 11:03 am
on Sep 17, 2015 at 11:03 am
The CalPERS and CalSTRS systems upgrade retirees pensions yearly with a complicated COLA that is linked to CPI. CalPERS, uses a minimum 2%, even if the CPI were to dip beneath 2%.
Adobe-Meadow
on Sep 17, 2015 at 11:28 am
on Sep 17, 2015 at 11:28 am
This topic is huge. Not just a PA problem. Should be a warning to us to keep our own financial houses looking forward. Be willing to talk to your friends and family about their financial planning. Too many of us are just not thinking ahead realistically.
Charleston Gardens
on Sep 17, 2015 at 11:34 am
on Sep 17, 2015 at 11:34 am
Please convert all new hires to 401k style (defined contribution) retirement accounts. That's the only way we'll ever know what our liabilities are. Given the rapid pace of medical advances defined benefit programs are fiscally unsustainable.
Registered user
Palo Alto High School
on Sep 17, 2015 at 11:50 am
Registered user
on Sep 17, 2015 at 11:50 am
Can future raises be "excluded" from retirement benefits? Meaning your salary upon retirement is ex-increase? (Yes, I know it is a negotiation - my question is whether the accounting rules for Calpers allow a raise without an increase in pension)
That allows cities to move salaries closer to market rates, which they claim they have to do, while capping the infinite future pension costs...
Registered user
Midtown
on Sep 17, 2015 at 12:24 pm
Registered user
on Sep 17, 2015 at 12:24 pm
Please remember that when interest rates are no longer held artificially at 0, investment returns should increase and some of this unfunded liability will disappear. This can lead to the problem of being overfunded. Why should this be a problem? Because then the city council will think they can avoid raises by enriching the pensions, as they did decades ago, which led to the problem we have today.
The real solution is to have a pension program that is reasonable and affordable. One fix would be to base the pension on the average of the last five year's salary. This was common in industry, which minimizes the impact of pension spiking, that is inflating the last year's salary which often results in a pension payout higher than one's base salary.
University South
on Sep 17, 2015 at 12:40 pm
on Sep 17, 2015 at 12:40 pm
Yes, Roger, PUT ALL NEW EMLPLOYEES ON A 401K path. Current situation is madness.
Woodside
on Sep 17, 2015 at 1:22 pm
on Sep 17, 2015 at 1:22 pm
Defined benefit pensions for public sector workers are simply far too expensive, running at an annuity equivalent of multiple millions of dollars of value per employee.
Only defined contribution (i.e., 401k-style) plans should be supported going forward.
Downtown North
on Sep 17, 2015 at 1:29 pm
on Sep 17, 2015 at 1:29 pm
It is past time for government workers to join the real world and real world workers. Tax paying residents of Palo Alto are being royally abused by these employees. They are currently paid what private sector workers receive but with their inflated benefits package and retirement plans they end up with multi-million dollar pensions. We need to put all employees on a 401K system and they can get medicare at 65 like the rest of us. It is also ridiculous in this 24/7 economy that we have firefighters who sleep, eat and play on the job. These positions need to become a working job like everyone else's. They should work a paid shift and be assigned duties while they are on the job. No more sleeping, shopping, TV viewing and lolling around the station. And no more working for 30 years and then getting paid for 30 years. They end up making about 400,000/year when you add it all up. Again the tax payers in Palo Alto are being abused by our employees. We need to leave the CalPers system and start fresh with a real world system that pays employees a fair wage but doesn't pay them for decades for doing nothing.
Adobe-Meadow
on Sep 17, 2015 at 1:55 pm
on Sep 17, 2015 at 1:55 pm
1- Start using pay for performance on all City workers
2- get rid of all pension and shift them to 401K system. Everyone else is doing the 401K route
3- immediately freeze hiring of non critical function personnel
4- use contractors for such services like Animal Control, librarian staffs, parking enforcers, public works. There is no rationale for the City to keep a full pension liability of FTEs on such services
5- consider contracting out Fire Department with the County or at least close down on "low use" fire houses around town. Again, the tax payers should not be on the hook for pension liability when the average usefulness of a fireman is around 12 years. Data have shown that person in this type of occupation will most likely opt for an early medical retirement leaving the City having to pay for his expenses in the next 70 years.
6. Seriously consider using County Emergency Services such as SWAT, Emergency Response Team from the county and perhaps considered Sheriff Services. This will save us a ton of pension $$$$
another community
on Sep 17, 2015 at 2:26 pm
on Sep 17, 2015 at 2:26 pm
cm - what makes you think that city retirees are not on Medicare? Got a revelation for you: they are! For years residents of PA have been suggesting that just about everything should be contracted out, that is, until they need a service right now. Funny how that works. I wonder if you, Me, would volunteer to live in the "low-use" area that has no fire station......right.
another community
on Sep 17, 2015 at 3:05 pm
on Sep 17, 2015 at 3:05 pm
Prop 13 passed in 1978.
Palo Alto and most other California cities have been kicking the can down the road for 37 years rather than face the the new lower service realities imposed by by the change. Compensation negotiations are hard work. It was easy to avoid the problem and let future generations clean up the mess.
Of course, when the going get tough, PA can always go the Vallejo bankruptcy route and have some obligations renegotiated. Public workers are hopelessly naive if they think the public will honor all their obligation.
Another Palo Alto neighborhood
on Sep 17, 2015 at 3:06 pm
on Sep 17, 2015 at 3:06 pm
Of course public employees should go on 401k’s like everybody else. The problem is it’s legally nearly impossible. Once a city is in CalPERS, it’s almost impossible to get out, and CalPERS will never allow such a compensation structure, even for new brand new employees. There are multiple reasons, but basically the public employee unions like things the way they are, surprise, and they have nearly absolute power in Sacramento.
Reformers like Chuck Reed have tried to use the initiative process to get constitutional change in California to get out from under the legal spiderweb here, but they get stymied right and left (mostly left) by elected representatives in hock to the status quo, by any number of mechanisms.
The only reason the whole pyramid even works at all is that public workers are still a minority of total workers, and with enough regular workers paying tax, you can support a small number of multimillionaires (see Wayne Martin’s chart above) living off that. Kind of like the Feudal Ages. But the numbers are becoming so big that even that is in jeopardy.
Green Acres
on Sep 17, 2015 at 3:57 pm
on Sep 17, 2015 at 3:57 pm
Its' Feast or Famine in this City.
Where does all the money go ?
$2.5 million windfall from property taxes last year spent on new PAUSD staff
$14.7 million in revenue from measure A for new stuff.
$14.5 Million for Buena Vista
$434K/yer to Keene plus $1M interest free loan. Keene receives some $52,000.00 in City paid deferred compensation in addition to his retirement. That is twice as much as any other City Manager. Web Link
$1.5M interest free home loan to McGee, $15k relocation and $750/mo car allowance, etc. Web Link
on and on...
spend spend spend.
Midtown
on Sep 17, 2015 at 7:28 pm
on Sep 17, 2015 at 7:28 pm
The Federal Govt abandoned pensions nearly identical to what Palo Alto, and indeed, most state and local employees enjoy, decades ago. The overly generous defined benefit pension plan the Feds had used for decades was deemed unsustainable in the 70's and starting in the mid 80's new hires were set up with another retirement plan that is much less generous and expects employees to contribute to their 401k and rely on Social Security like so many other employers.
Why do state and local governments still cling to this obviously unsustainable pension formula?
Because those making the rules are the ones receiving the very generous benefits at the tax payers expense.
It's time for real pension reform.
Another Palo Alto neighborhood
on Sep 17, 2015 at 8:14 pm
on Sep 17, 2015 at 8:14 pm
City Manager James Keene gets a pension. Enough said.
Duveneck/St. Francis
on Sep 17, 2015 at 9:57 pm
on Sep 17, 2015 at 9:57 pm
This is a tremendously complex topic with high emotional content. Prior to the 2008 market crash most public pension plans were funded at the 85 to 95 percent level. The decrease in the marke value has not been made up by CalPERS. Remember a 50 percent decrease in market value requires a 100 percent rate of return to get back to where you started!
20 years ago public employees were compensated at a level significantly lower than the private sector. Defined benefit plans were used to attract talent to the public sector and many, who saw the benefit to this defined future pension payment, took these public sector jobs because of this promise by officials elected by the citizens. Suddenly with the recession of 2008 public employees now appear to be sitting pretty. But the employees didn't make the promises: the voters did through their elected officials.
So the officials elected by the citizens have now capped the pension benefits for new employees. In 20 years pension liabilities will be significantly smaller because of these changes. The downside is that you will not have as much talent to serve the citizens. There are no free lunches.
That said, Palo Alto has always had an extremely rich package of benefits. Medical coverage for life after only 5 years on the job, high percent of salary paid at a younger age for employees, etc. Remember please that CalPERS only administers the plan that the City Council approves. CalPERS does not dictate what the benefits are. With the change in the state law, however, benefits for NEW employees are much more restrictive.
One other very important point not mentioned in the article or City Counsel meeting, is the additional unfunded liability for future City paid medical costs for the life of its retirees. It should be in the Financial Statements and I plan to look to see what that amount is. It may be, (but most likely isn't) as large as the unfunded pension liability, but not even addressing it during these discussions is burying heads in the sand. My guess is it's a very large amount not being discussed or addressed, but I am guessing until I look at the City's financials.
Remember folks, you voted these officials in and they raised the benefits. If you now are angry about what they did over the past 20 years, think carefully about who you vote for. Ask the tough questions before you vote. Get involved. There are so many items that our current elected seats are doing now that will have long term consequences, but I hear few voices asking the tough questions (e.g, our water service fees were just raised because we were doing too well in conserving water?? What that basically says is we, the city elected seats and officials, aren't going to think of ways to provide services more efficiently and effectively, we are just going to raise fees to our citizens). Are these"leaders" serving you well? Do they deserve to be re-elected? This, just as prior benefits, is in your hands...
Bob Adler, San Mateo County Controller, Retired