$200 million — and counting

Buried in the footnotes to the recently released annual financial report is the news that the City of Alameda passed another financial milestone last year: the City’s “unfunded liabilities” for retiree benefits now exceed $200 million.

That’s right: As of June 30, 2013, the City owes $200 million more than it has set aside to pay for pensions and retiree health benefits for public employees.  The total breaks down this way:

  • $85,728,554 (as of June 30, 2012) for pensions for public safety employees;
  • $25,206,659 (as of June 30, 2012) for pensions for “miscellaneous” employees (i.e., City workers who aren’t firefighters or cops); and
  •  $91,172,000 (as of January 1, 2013) for “other post-employment benefits” (“OPEB”) – i.e., retiree health benefits – for both groups.

In the three years since the administration headed by City Manager John Russo and Mayor Marie Gilmore took over, unfunded liabilities have jumped by more than $21 million.  Yet, for some reason, the P.R. machine at City Hall failed to crank out a press release bragging about breaking the $200 million barrier.

To be fair: one can’t lay all of the blame for the rise in unfunded liabilities on the Russo/Gilmore administration.  The increase isn’t attributable, solely or even primarily, to their stewardship of the City’s financial affairs – any more than the growth in reserves or the upgrade in the City’s bond rating is due, solely or even primarily, to their management of the City’s business.

By the same token, it is fair to point out that, since Ms. Gilmore was elected and Mr. Russo was hired, City Council has made only token efforts to rein in current costs and future liabilities for retiree benefits.  Mr. Russo began well enough: as one of his first acts as City Manager, he appointed a task force to study the City’s pension and OPEB obligations.  The task force duly met and came up with a list of recommendations.  Council’s response was to . . . ignore them.

Start with OPEB.  The task force reached consensus on four action items:

  •  Make further changes to the vesting and eligibility rules for new hires;
  • Establish a plan such as a 401(a)(h) in which employees make contributions now to fund their future health care;
  • “Buy out” the accrued benefits by establishing a program like the one in Beverly Hills in which employees are given an option of receiving money (either cash or tax advantaged account) in exchange for their defined benefit; and
  • “Work with employee bargaining groups to negotiate down the liability.”

So which of these four recommendations did Council implement after receiving the task force report?  None of them.

But the OPEB problem wasn’t going to go away – it was getting worse – so staff made another presentation in July 2013 focused specifically on OPEB.  The staff report laid out nine possible courses of action:

  •  Create an “OPEB trust” that would accumulate funds to be used to pay future liabilities;
  • Create a tiered-benefit program in which the longer an employee worked, the more benefits she would earn ;
  • “Cap” the City’s contribution rate;
  • Move to a defined contribution plan in which the City contributes a flat amount regardless of benefit costs;
  • Buy out the benefits (the “Beverly Hills solution”);
  • Increase the City’s annual OPEB contribution and use the excess over cost to pay down future liabilities;
  • Negotiate an agreement with the unions in which employees would start contributing toward the cost of retiree health benefits;
  • Limit spousal benefits;
  • Change the benefit to the PEMHCA minimum.

The easiest step to take was the first one, since setting up an OPEB trust is simple; the real issue is how much to put into it and where the money’s coming from.  So which recommendation did Council decide to execute?  The first one, of course.  The remaining eight – including getting employees to start contributing — were, as they say, laid on the table.

And funding the OPEB trust?  It hasn’t happened.  Last month, Council got around to approving hiring a consultant to manage the trust. Once everything gets set up, staff reported, the City will make its first contribution: $250,000!

And then there’s pensions.

The pension/OPEB task force appointed by Mr. Russo suggested a number of actions the City could take to reduce pension costs and liabilities.  The majority didn’t go along with the concept — favored by the public safety union representatives – of selling Alameda Point or other City assets and applying the proceeds to the accrued indebtedness.  (The City couldn’t have taken money from selling Alameda Point for this purpose anyway).

The majority of the task force supported creating a less generous pension plan for newly hired employees.  Unfortunately, the financial impact of this move wouldn’t be felt for many years.  But a majority also endorsed negotiating an agreement with the unions for employees to pay more of the City’s share of pension costs.  This would produce an immediate and dramatic impact on the City’s financial condition.

To get an idea of the potential impact, look at the numbers for the most recent fiscal year, which ended on June 30, 2013.  The City’s required employer contribution for the safety pension plan was 38.683% of payroll – a total of about $8 million.  For “miscellaneous” employees, the required employer contribution was 14.561% of payroll – a total of about $3.3 million.  Any cost-sharing by employees would reduce, dollar for dollar, the money sent to CalPERS from the General Fund.

As it happened, just as the pension/OPEB task force completed its work, the Public Employees Pension Reform Act of 2013 (“PEPRA”) was winding its way through the Legislature and City staff was sitting down with the public safety unions to discuss new four-year contracts.  PEPRA required or permitted employers like the City to offer less generous pension terms to new hires, as the task force had recommended.  And that’s what the new public safety contracts did.

More importantly, PEPRA expanded the scope of permissible cost-sharing by employees.  Public safety employees pay 9% of their salary as the employee contribution toward their pensions.  Under prior law, cities and unions could agree for employees to share a portion of the required employer contribution as well.  But the cost-sharing was limited to the cost of the “optional benefits” provided by the plan.

PEPRA abolished this limitation and allowed employees to pick up as much of the required employer contribution as their union would agree to — theoretically, up to all of it.  So the opportunity was there during the fall of 2012 for staff to negotiate, and Council to approve, new public safety contracts that would increase cost-sharing and thereby decrease the City’s pension costs.

What did staff, Council, and the unions come up with?

If you listened to the Mayor’s State of the City address, you might think it was quite a lot:

We’ve also taken steps to confront our long-term liabilities.  I have the utmost respect for public safety.  They have agreed to take on more, and by that I mean pay more, of their own benefit costs.  And this really important because they’re paying more than we could have imposed on them by California law and they’re paying more than all of the surrounding cities.  I think that’s really important.

But beneficence is in the eye of the beholder (or maybe, in this case, it’s more accurate to say the eye of the beholden).

Under the “optional benefit” cost-sharing permitted under prior law, Alameda’s public safety unions had agreed – for the first time ever – that their members would pay a portion of the required employer contribution beginning in January 2012.  Although state law would have permitted the employees to pick up 5.057% of the City’s pension costs, the unions agreed to only 2%.  The new four-year contracts continued the 2% for FY 2012-13 and upped the cost-sharing formula by 1% per year in each of the four fiscal years beginning with FY 2013-14.

This sounds good – until one looks at what’s going to happen with the required employer contribution rate for the safety plan during that period.  Here are the numbers:

Table -- rates(The employer contribution rates, we hasten to add, don’t take into account the recently announced changes to mortality assumptions).

Viewed in the context of the projected increases in the required employer contribution rate, a 1% annual increase in cost-sharing by employees doesn’t seem like so much. Moreover, since the required employer contribution will rise at a rate greater than 1% per year over the next four years, the City’s pension costs still will increase significantly despite the new contracts.  The increased cost-sharing assuages, but hardly eliminates, the pain.

Estimating dollar amounts is tricky, since the other relevant factor is the size of the payroll.  Based upon payroll projections provided to the Merry-Go-Round by City Finance Director Fred Marsh during last year’s budget workshops, here are the figures for the safety plan:

Table -- cost sharing

The bottom line is that, while it’s true that cost-sharing by Alameda’s public safety employees will go up in the next four years, the firefighters and cops will be picking up nowhere near as much of the City’s pension costs as PEPRA permits them to do.

According to many commentators, PEPRA was designed to promote equal sharing between employers and employees of pension costs, both the so-called “normal cost” – i.e., the cost of the benefits earned in the current year – and the amount paid to amortize the unfunded liabilities.  In fact, the law requires equal sharing between employers and newly hired employees of “normal cost” and makes such sharing the “standard” for current workers as well.

Just for kicks, let’s suppose the City and the public safety unions had agreed to write the “equal sharing” principle into the new contracts.  According to CalPERS, the “normal cost” plus amortization for Alameda’s safety plans totals $11,408,142 for FY 2013-14.  If you split it down middle — $5.7 million to the City, $5.7 million to the employees — the result would be to reduce the City’s pension costs by about $2.9 million.

Of course, the equal sharing principle would raise the costs to the firefighters and cops by the same amount.  One can’t imagine the unions ever agreeing to hand their members a $2.9 million bill.  Nor can the City force them to.  In fact, PEPRA doesn’t allow a city to impose any cost-sharing, even of “normal costs,” until January 1, 2018.

Since draconian measures won’t be available for another four years, it was disingenuous for the Mayor to say in her State of the City address that public safety employees now are “paying more than we could have imposed on them by California law.”  But it wasn’t surprising.  When it comes to dealing with spiraling costs and liabilities for pensions and OPEB, the marching orders at City Hall are:  Don’t do what the law won’t let you do — and take credit for it.  Do less than what the law will allow you to do — and take credit for that, too.  And hope nobody notices – or cares.

Unfortunately, that may be a winning strategy. It’s worked so far.

Sources:

2013 CAFR: 2013 CAFR

2012 CalPERS annual valuation (miscellaneous): 2012 CalPERS annual valuation report (misc)

2012 CalPERS annual valuation (safety): 2012 CalPERS annual valuation report (safety)

2013 Bartel OPEB report: Bartel OPEB Final Report (2014-01-27)

Staff reports: 2014-02-04 staff report re OPEB Trust; 2013-07-23 staff report re OPEB; 2012-10-30 staff memo re pension task force report; 2011-12-06 staff report re cost sharing

State pension law: CA Public Employees Retirement Law (2014)

R. Blum, “Opportunities to Save Pension Costs Through Collective Bargaining After Pension Reform”: Bob Blum article on reducing pension costs

About Robert Sullwold

Partner, Sullwold & Hughes Specializes in investment litigation
This entry was posted in Budget, City Council, Firefighters, Pensions and tagged , , , , , , . Bookmark the permalink.

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