The proposed public safety union contracts

We’re sure that, if anyone heeded the exhortation by Vice Mayor Frank Matarrese to begin studying the proposed new public safety union contracts as soon as they were posted Tuesday afternoon, it was readers of the Merry-Go-Round.  After all, who else would be willing to try to analyze all of the financial implications of those contracts in the mere 15 days Council gave the public to look them over before it votes on them?

What, you mean you didn’t?

Well, there’s still another 10 days left to get the job done and keep the vice mayor happy.  Today, we’ll try to give you a head start.  Then you’re on your own.

As we see it, the proposed new contracts will have the following financial consequences for the City over their six-year term:

• The MOUs guarantee that police and firefighters will continue to receive annual raises for five out of the next six years regardless of how well or poorly the City performs financially.

• The annual raises are calculated by a formula that allows one-time revenue – e.g., from the sale of property to or by a developer – to trigger the maximum possible annual raise (which then is built into every subsequent salary).

• Over the six years beginning on January 1, 2016, the contracts will increase public safety wages and benefits by not less than 17.17% and as much as 42.25%.  In dollar terms, we’d estimate that the raises (and associated CalPERS contributions) will cost the City between $3.6 million and $9.0 million.

• These costs will not be offset, to any significant extent, by any savings resulting from the establishment of the “OPEB trust.”

• The contracts do not require public safety employees to share any portion of the increases in the City’s pension contributions expected from 2017 through 2021.

• The contracts delete the language in the prior MOUs making it difficult for firefighters hired before January 1, 2013 to engage in pension “spiking.”

In the rest of this column, we’ll lay out the basis for each of our conclusions.  (Warning: you may be in for some rough going).  But first, let’s back up and put the issue into perspective:

Concerned ever since his appointment about the City’s “OPEB problem” – i.e., its unfunded liability for retiree health benefits – City Manager John Russo decided to recommend creating an “OPEB trust” as a “partial solution.”  Some of the money to fund the trust would come from the City:  $5 million in January 2016, and $250,000 per year for 10 years thereafter.  But Mr. Russo knew that even those sums wouldn’t be enough to reduce the $91.2 million unfunded liability to any significant extent.  Since the only other source of funding for the trust was City employees themselves, Mr. Russo needed to persuade the unions to agree that their members would pay into the trust as well.  And so he did before he walked out the door for his new job in Riverside.

The result of his efforts is the new public safety union contracts that will be submitted to Council for approval on April 29.  Essentially, Mr. Russo has presented Council with a classic trade-off:  If it approves the new MOUs, the City will get a “partial solution” to the OPEB problem.  (How much of a solution remains open to debate).  In exchange, the City will incur the financial consequences identified above.

And let’s be blunt about it:  Over the next six years, the new contracts will drag the General Fund even deeper into the red.  At the “budget study session” Tuesday, staff presented five-year projections showing that that the City will begin running an operating deficit – i.e., revenues will not cover expenses – beginning in Fiscal Year 2016-17 and that the deficit will hit $5.3 million by FY 2019-20.  But those projections do not take account of the proposed new contracts.  When the impact of the new MOUs on the City’s operating expenses is factored in, the picture inevitably will get worse.

So, in the end, the issue for Council to decide on April 29 is straightforward:  Is the “partial” solution to the OPEB problem proposed by Mr. Russo worth the price the City is being asked to pay for it?

Now into the weeds.  We’ll start with the provisions in the contracts regarding wages.

Under the current MOUs, police and firefighters got raises on January 1, 2014 and January 1, 2015, and another is scheduled for January 1, 2016.  The proposed new contracts, which cover the six-year period from November 2015 through December 2021, extend this pattern of annual raises through 2021 (except for 2019, when no raise is due).

Both the current and the proposed MOUs compute the amount of the raise using a formula based on 50% of the annual increase in five revenue categories.  When this formula was introduced in the MOUs approved in December 2012, the pitch was that public safety workers would get paid more only if the City took in more revenue.  Seems only fair – right?  Indeed, the pitch was so persuasive that even Interim City Manager Liz Warmerdam believed it – at least until last October.

In fact, police and firefighters are guaranteed a 2% annual raise for every year between 2015 and 2021 (except for 2019, where there will be no raise, and 2020, where the minimum raise goes up to 3%) regardless of how well or poorly the City performs financially.  If the total of the five revenue categories increases by more than 4%, the public safety workers get a raise equal to half of the increase (up to a maximum raise of 5%).  But if total revenue increases by less than 4% – or even stays flat – the employees still get a 2% raise.  And if total revenue actually goes down, well, the cops and firefighters get a 2% raise then, too.

This structure produces an anomalous result.  Suppose that in year one, the specified revenue categories increase 10% but in year two they decline by an equal amount.  At the end of year two, the City is in the same financial position as it was at the beginning of year one.  But the public safety workers will have gotten a 5% raise at the beginning of year two and they will get another 2% raise at the beginning of year three.  So they’re actually better off – even if the City isn’t.

And this isn’t the only perverse feature of the contracts’ wage-increase methodology.  Of the five revenue categories chosen for the formula, property taxes and sales taxes tend to reflect ongoing economic trends, and, arguably, it’s fair for the City to share any gains with its employees (as long as the workers also share in any declines).  But one of the other categories – taxes paid on the sale or other transfer of real property – doesn’t fit that mold.  As City Treasurer Kevin Kennedy told Council Tuesday night, “I don’t think it’s the City’s intention to give anyone raises based on one-time revenue.  And the property transfer tax is one-time revenue.”

Mr. Kennedy then explained that the issue he was raising was not just academic.  “We’ve got a lot of big projects in the hopper so there’s a good chance in the next five years that we could see big chunks of transfer tax come in,” he said. “If we have major development going on in this city and we end up paying higher salaries indefinitely for some money we garnered in one fiscal year, that’s a huge problem.”

In fact, the phenomenon Mr. Kennedy described already may have happened.

In response to our request, Ms. Warmerdam was kind enough to provide us with the figures used to calculate the last two years’ raises.  They show that the City handed out 4.1% raises on January 1, 2015 based on a $4.1 million revenue increase in FY 2013-14 over the prior year.  But if you go back and look at the staff report discussing the financial results, you’ll see that about half of the revenue increase was attributable to “one time sources of revenue”:  “unanticipated Redevelopment pass through payments” and – hang on, Mr. Kennedy – “transfer tax on the sale of two large apartment complexes.”

The current MOUs didn’t – and the new MOUs don’t – require staff to exclude revenue generated by one-time events like these from the computation.  Mr. Kennedy told Council he believes the formula should be revised to exclude transfer taxes, and perhaps other one-time events.  Unless Council takes his advice, the new residential and commercial developments of which he spoke are likely to generate transfer tax revenue that triggers the 50% formula – and corresponding raises of up to 5% – in one or more of the next six years.

So how bad might it get?  Let’s look at the numbers.  The following chart shows the annual and cumulative raises over the six-year term of the new MOUs using the minimum percentage:

But these figures don’t represent the full cost of the raises, since, as Mr. Kennedy pointed out Tuesday, every additional dollar paid in wages requires a corresponding contribution to be made by the City to CalPERS.  The following chart revises the schedule by taking account of the required CalPERS contribution:

The two preceding charts are based on the assumption that public safety workers get only the minimum annual raise guaranteed by the proposed new contracts.  But now let’s assume that the City does well financially and the maximum raise is due.   Here are those numbers:

Raises only

Raises plus PERS

How much, in dollars, will these raises cost the City during the term of the proposed new contracts?  This is where it gets tricky.

The staff report posted Tuesday states that, “Cumulative salary and related benefits increases over a five-year period is [sic] estimated at approximately $1.2 million for all safety groups.”  The report does not explain how staff arrived at that figure, and we have been unable to replicate it.  In fact, it strikes us as exceedingly low.

Here’s why we say that:  To translate the percentage raises into dollars, you need to make assumptions about the total public safety payroll in each year.  The staff report posted Tuesday doesn’t provide those figures, so, as a proxy, we decided to use the “projected 2013/14 Safety payroll” – $21,194,000 – in Bartel & Associates’ “alternative funding study” and assume that this figure would remain the same during the entire term of the new MOUs.  Under those assumptions, the dollar cost of the raises (and associated CalPERS contributions) over the six-year period is $3.6 million if the police and firefighters get only the minimum raise and $9.0 million if they get the maximum.

(We need to add one caveat:  The proposed new contracts overlap the current ones for the period from November 2015 through June 2017.  To calculate the cost for just the period by which the new MOUs “extend” the term of the current MOUs, we need to exclude the raises for the last half of FY 2015-16 and all of FY 2016-17 that are covered in both contracts.  Our back-of-the-envelope estimate is that this adjustment would reduce the total dollar cost by about $900,000 in the minimum-raise scenario and $2.3 million in the maximum-raise scenario).

But we can’t stop there.  To assess the net impact of the new MOUs on the bottom line, we need to offset the costs resulting from the wage raises with savings flowing from establishment of the OPEB trust – if there are any.  Unfortunately, again we are hampered by a lack of data.

As we understand it, public safety workers will begin making contributions to the OPEB trust in January 2016.  But those contributions themselves will have no impact on the City’s annual public safety expenses, since they go to the trust, not to the retirees.

The trust itself will not begin making payments to retirees until January 2019.  Instead, the City will pay the entire cost of retiree health benefits out of the General Fund for the first three years of the proposed new contracts – the last half of FY 2015-16, FY 2016-17, FY 2017-18, and the first half of FY 2018-19.  So the trust will provide no offset to the costs associated with the wage increases during that period.

Finally, beginning in January 2019, the trust will begin making payments to retirees.  According to the staff report posted Tuesday, “approximately $272,000 will be used toward the reduction of City’s OPEB cost in FY 2018-19 and FY 2019-20.”  Presumably, payments from the trust will continue for the remaining 18 months of the new MOUs.  But neither the staff report nor the Bartel “study” says how much those payments will be.  (The only clue we can find is that Bartel estimates that the payment from the trust in the year following expiration of the new MOUs will be $898,000 – out of $4.6 million in total OPEB costs).

We’d like to see a year-by-year estimate of payments made by the trust for retiree health insurance over the term of the proposed new contracts.  (And we think Council should insist on it).  Only then can the extent of the savings be known.  Based on the data available, we will be very skeptical of any claim that, over the next six years, the trust will offset all, or even a significant portion, of the costs resulting from the wage increases conferred by the new MOUs.

Now let’s turn to the provisions regarding pensions.

The annual contribution to CalPERS for pensions for City workers consists of both an employee contribution and an employer contribution.   The state pension law sets the employee contribution rate; for public safety employees, it’s 9% of “PERSable salary.”  CalPERS sets the employer contribution rate; for FY 2014-15, it’s 44.115% and it’s projected to go to 56.3% by FY 2020-21.

One of the major changes made by the pension reform law enacted in 2013 was to expand the scope of permissible cost-sharing by employees.  Under prior law, cities and unions could agree for employees to share a portion of the required employer contribution in addition to making their own employee contribution.  But the cost-sharing was limited to the cost of the “optional benefits” provided by the plan.  The pension reform law 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.

The prior City administration did not take full advantage of this opportunity.  Instead, the current MOUs approved in December 2012 provided for 2% employee cost-sharing in FY 2012-13, followed by annual 1% increases in each of the next four years.  This meant that, by the time the contracts were set to expire in June 2017, public safety workers would be paying 6% of their “PERSable salaries” toward the required employer contribution; the City would pay the rest.

As we pointed out a year ago, the financial impact of this employee cost-sharing was negligible compared to the cost borne by the City.  But guess what?  It turns out we’ve already gotten all the unions are willing to give.

The proposed new contracts provide that the contribution rates in the current MOU “will remain in effect until the expiration of this MOU with the understanding that after July 1, 2016 the level shall remain at 15% [i.e., the 9% mandated by statute plus the 6% employee cost-sharing].”  This means that, as the employer contribution rate rises during the term of the new MOUs to 56.3%, all of the additional cost will fall on the City without any help from the police and firefighters.

Here’s a chart that breaks down the numbers:

To translate these percentages into dollars, we’ll use the same assumptions we did before about public safety payroll.  Under those assumptions, the City will be paying $10.7 million in FY 2020-21, and the employees will be picking up the $1.3 million balance of the total required employer contribution.  Even when the statutorily mandated 9% employee contribution – $1.9 million using our assumptions – is factored in, the disparity between the amounts paid by the City and the amounts paid by the employees toward pensions for public safety workers remains dramatic.

It didn’t have to be this way.  City Manager Russo is fond of saying that a city can’t “impose” increased cost-sharing on its employees, but that’s only true (as he probably knows) as of January 1, 2018.  In any event, there’s no reason that the City’s negotiators could not have insisted that, in any new deal, police and firefighters continue picking up an additional 1% per year of the required employer contribution.  Using our assumptions, this would have reduced the City’s CalPERS bill in FY 2020-21 by $1.1 million.

The pension section of the proposed new contracts contains another section worth noting.

One of the other changes made by the pension reform law was to define the term “final compensation” – the salary upon which a pension is based – to mean the highest average annual pay earned during the last three years before retirement rather than the pay earned just in the last year.  The stated intention was to discourage the practice known as “spiking,” in which an employee seeks to boost her pay in the year before she retires in order to increase the amount of her pension.  Typical “spiking” techniques included working a lot of overtime hours or taking a higher-paying job on an “acting” basis.

The new definition applied only to employees hired after the pension reform law took effect on January 1, 2013.  For some reason, the IAFF Local 689 MOU approved in December 2012 adopted (effective January 1, 2017) the more restrictive language for all firefighters.  The proposed new contracts delete this language and re-establish the old one-year rule for firefighters hired before January 1, 2013.

What’s the reason for the revision?  If anyone other than John Russo had represented the City during the negotiations for both contracts, we would be tempted to say that it must be just fixing a drafting error.  A more cynical view is that the change is designed to restore the ability for firefighters hired before January 1, 2013, to engage in spiking.  (It may be just a coincidence, but the Alameda Sun recently published two articles reporting the amounts of overtime and acting pay had begun to increase significantly).  The staff report doesn’t say one way or the other.

Thus far our report on the financial impact of the proposed new public safety contracts.  We encourage our readers to use the scant time remaining before the vote to perform their own analysis.  We are confident that members of Council will do the same.  And if they do, we hope that at least some of them will see fit to consider whether the “partial solution” proposed by Mr. Russo to the OPEB problem truly is worth the financial consequences these contracts will create for the City during their six-year term.

Sources:

2013-17 IAFF MOU: 2013-17 MOU

Proposed 2015-21 IAFF MOU: 2015-04-29 Ex. 3 to staff report – MOU between the City of Alameda and the IAFF; 2015-04-29 Ex. 4 to staff report – Redlined version of MOU between the City of Alameda and the IAFF (redlined version)

Staff report re proposed 2015-21 IAFF MOU: 2015-04-29 staff report re IAFF contracts

Bartel & Associates “alternative funding study”: 2015-04-29 Ex. 5 to staff report – Bartel Associates OPEB Safety Alternative Actuarial Study Report

Staff report re FY 2013-14 financial results: 2014-12-02 staff report re amending 2014-15 budget

Staff report re proposed FY 2015-16 & FY 2017-18 budget: 2015-04-16 staff report

CalPERS 2013 annual valuation report: 2013 CalPERS annual valuation report (safety)