Lock it up

If we recall correctly, it was Al Gore who first introduced the concept of a “lock box” into the political lexicon.

The idea was to put certain governmental funds beyond the reach of Congress so that the money could be used only for a specific purpose, not for any project the legislators – for political or other reasons – might want to spend it on.  (In Mr. Gore’s proposal, Social Security and Medicare tax payments would go into a “lock box” where they could be used only to pay benefits.)

Now it’s happening in Alameda.

Having already established an irrevocable trust to secure partial payment of health benefits to public-safety workers who retired after January 2019, Council recently took the first step toward replacing this “lock box” with a new one that would fund payments for health benefits for all of the City’s retired firefighters and cops.  In addition, it approved staff’s recommendation to create a separate account in the new trust whose purpose would be to defray a portion of the City’s annual pension expense.  (It’s not clear whether this account would cover “miscellaneous” as well as public safety employees.)

None of these actions would eliminate the City’s unfunded liability for retirement benefits, which amounted to $113 million for retiree health benefits (aka OPEB) and $203 million for pensions at the most recent valuation dates.  But they would ensure that, whatever else Council might decide to shell out City funds for, at least some money would be available to pay future OPEB and pension bills.

We’re not absolutely sure that the Council members understood the extent to which they were surrendering control over discretionary spending when they approved the staff recommendation.  (After all, budget items probably don’t command this group’s attention to the same extent as resolutions demanding impeachment of the president or a halt to the Dakota Access pipeline.)  Nor are we convinced that staff picked the right purposes for which to sequester funds or that its proposal actually is likely to make a material difference in the City’s annual payments for retirement benefits.  But we suppose we shouldn’t complain about anything that makes it more difficult for the politicians to raid the municipal cookie jar.

Absent a “lock box,” they might very well choose to build another $14 million Emergency Operations Center/fire station.

Let’s start with the cookie jar.

Back in December 2014, staff reported that, thanks to a number of “one-time” events, revenues significantly exceeded expenditures in fiscal year 2013-14, resulting in an addition of $11.48 million to the “unassigned” balance in the General Fund.  (“Unassigned” essentially means “free to spend”; the politicians like to call it the “surplus.”)  Staff recommended that it would be “prudent” to “set aside” $3 million of this amount to “safeguard against future deficits and for other long-term liabilities.”  Shortly after 2 a.m. on December 3, Council approved the recommendation.

But the $3 million didn’t stay “set aside” in the General Fund for long.  Instead of using the money for the stated purpose, Council agreed four months later, as part of a deal with the public-safety unions, to transfer the cash into an irrevocable trust where it could be used only to pay a portion of the annual cost of providing retiree health benefits to firefighters and cops who retired after January 2019.  (The $3 million was part of a $5 million initial City contribution to the trust; the City also agreed to kick in an additional $250,000 per year for 10 years.)  The trust was projected to run out of money by 2035, but no matter:  until then, it would guarantee that at least part of the annual medical insurance bill for this group of retired fire and police union members would get paid.

There was more to come, for the cookie jar was about to get re-filled.

In September 2015, staff projected that $14.5 million would remain in the “unassigned” General Fund balance even after all of the spending authorized in December 2014 had taken place, and it presented Council with a list of potential uses for the “surplus.”  One suggestion that appealed to the Council members was to use some of the money to take care of the rest of the City’s retired public-safety employees.

Remember, the trust established by the new public-safety union contracts covered only firefighters and cops who retired after January 2019.  But what about the public-safety workers who had retired before then?  Back in 2014, Council had set up a trust to fund part of the City’s annual OPEB payments to existing retirees, but it had put in only $300,000.  Now, staff proposed that Council “allocate” $3 million of the “surplus” to pay a portion of the future costs of providing health benefits for the pre-January 2019 retirees.  (We’re assuming, although the staff report didn’t say, that none of this money would go toward the minimal – $128 per month – health benefit paid to retired “miscellaneous” employees.)  As a result, all public-safety retirees, not just those who left the job after January 2019, could rest easier.

At the same time, staff suggested that, while they were at it, the Council members could “allocate” $3.043 million of the “surplus” toward the future costs of making the City’s annual required pension contributions to CalPERS.  The staff report didn’t make clear whether this subsidy covered only contributions on behalf of public-safety employees, but if the disbursements from the trust were made in the same ratio as the contributions, the benefit would go primarily to retired firefighters and cops.  (In FY 2015-16, the City contributed $9.57 million to the safety plan and $4.536 million to the miscellaneous plan.)

This time, the clock had just struck midnight on September 16 when Council approved staff’s recommendation.

By passing the resolution to “allocate” a total of $6.043 million from the General Fund, Council simply moved these amounts from the “unassigned” category to the “committed” category on the City’s books.  By itself, this did not mean that the money could be spent only for the specified purposes.  To the contrary, by passing another resolution, Council could reverse the re-categorization – and then spend the cash on whatever it chose.  (As the CAFR puts it, the “constraints” imposed by a Council resolution on the use of “committed” funds “may be altered” by “the same formal action of the City Council.”)

Which is where the new “lock boxes” come in.

At the March 21 meeting, staff recommended that the City establish a new “combined OPEB/pension” trust with two “components.”  The assets from the previously established OPEB trusts, plus the $3 million “committed” in September 2015, would go into the “OPEB account.”  These funds could be used solely to pay future retiree health benefits, for both pre- and post-January 2019 retirees.  The “pension account” would get the $3.043 million “committed” for pensions in September 2015.  These funds could be used solely to make future annual required pension contributions to CalPERS.

In addition, the City would agree to keep pumping money into the new trust every year:  at least $250,000 annually to the pension account and at least $100,000 annually to the OPEB account.  It also would transfer any “leftover” funds from two pre-CalPERS pension plans into the trust.

At the Council meeting, staff sought only authorization to proceed with setting up the “combined” trust; the actual appropriation of funds would come later.  After barely three minutes of discussion, Council voted unanimously (and this time, well before midnight) to accept staff’s recommendation to move forward.

The idea of creating an irrevocable trust to “pre-fund” future retirement benefit expenses is not a new one.  Indeed, as far back as 2008, Council considered doing just that for OPEB.  Both the Fiscal Sustainability Committee appointed in August 2008 and five members of the OPEB-Pension Task Force set up in 2011 endorsed the concept.  And the few Council candidates who paid attention to budget issues – like former Councilman Tony Daysog – supported it as well.

From a policy standpoint, the idea makes a lot of sense.  As City Finance Director Elena Adair delicately pointed out to Council, transferring cash into an irrevocable trust ensures that the elected officials can’t spend those funds on some other project, however “great” it might be.  Moreover, as Ms. Adair also explained, since the trust may invest in higher-yielding securities than the General Fund can, the vehicle could enhance the rate of return earned on the “surplus” funds.  (Incidentally, we hear that Wells Fargo Bank does a bang-up job of managing money for municipal pension trusts.)

Likewise, a compelling case can be made for setting up an account dedicated to paying a portion of the City’s annual required pension contributions.  Unless the City drops out of the state-run public employee pension system – which will never happen – it will be legally obligated to send funds to CalPERS every year.  The amount of the annual required contribution has been increasing – and things are only going to get worse.   During her presentation, Ms. Adair showed Council the following slide that would have elicited gasps from a more financially astute and attentive audience:

If the estimates are right – and Ms. Adair cautioned they are based on preliminary information – the amount the City will have to pay to CalPERS will jump from $14.1 million in FY 2015-16 to $25.76 million in FY 2019-20 and $35.56 million in FY 2022-23.  Despite Councilman Frank Matarrese’s frequently expressed confidence that development projects will generate boatloads of money for the General Fund, it is highly unlikely that revenues will grow sufficiently during that period to cover the increased pension costs.  Indeed, the last five-year forecast prepared by staff in June 2016 predicted only a $1.7 million rise in revenue between FY 2015-16 and FY 2019-20, far less than the amount of the additional pension expense.  And even if the forecast is too conservative, unless something is done, every dime of new revenue will go to CalPERS to pay the higher pension bills.

Unfortunately, the new trust won’t solve the problem.  Even if the $3.043 million in seed money for the pension component was spent all at once, it would cover less than 20% of the City’s required contribution to CalPERS for the current fiscal year (and less than 10% of its required contribution for FY 2022-23).  To make the money last longer, staff is proposing to limit annual withdrawals to 10% of the annual required contribution for any given year.  But even under this limitation, if the trust were established this fiscal year, the City would spend $1.58 million in FY 2016-17 and $1.88 million in FY 2017-18, and all of the money likely would be gone by June 2018.

The limited impact of a pension lock box containing only $3.043 million (plus investment earnings) raises an issue of priorities:  If the City has another $3 million in “surplus” funds to spare, why not put that money into the new trust’s pension account instead of using it to “pre-fund” health benefits for public-safety workers who retired before January 2019?   The OPEB trust established under the public-safety union contracts can be justified as part of a bargain in which the current employees who will benefit from the trust agreed to make annual contributions themselves toward future OPEB costs.  But the OPEB account proposed for the new trust will benefit already-retired public safety workers who didn’t make any similar contributions during their careers.  Sure, it would be nice to take care of these retirees, too – if the City had the money to do so and still meet its contractual obligations to CalPERS and to current employees.  But it doesn’t.

There is also a more fundamental issue.  As the Fiscal Sustainability Committee reported back in 2009, the unfunded liabilities for pension and OPEB are only two of the swords hanging over the City’s head – and maybe not even the most worrisome ones.  According to the FSC report, it would cost $13.54 million annually to maintain City-owned assets such as streets, sidewalks, parks, and buildings adequately – the number is undoubtedly higher now – but the City was spending an average of only $4.06 million a year for this purpose.  Deferring maintenance was dangerous, the FSC warned, because “the cost of maintaining particular infrastructure, such as streets, increases exponentially over time. As road quality deteriorates over time, it becomes more costly to make needed repairs.”

To redress this danger, the FSC recommended that Council increase General Fund spending on maintenance to $9.5 million in FY 2009-10, with higher amounts in subsequent years.  That didn’t happen.

It’s not that staff is unaware of the issue.  Beginning in June 2015, the annual budget transmittal letters state that the Public Works Department was “working with a consultant” to develop a “more accurate estimate” of deferred maintenance costs and a plan for paying for them.  (If any consultant report has been prepared, we haven’t seen it.)  And, when staff offered its list of potential uses for the “surplus” in September 2015, it included $2 million for “high priority deferred building maintenance items” like weather sealing for City Hall, the police station, and the library.

Yet staff has not taken the further step of recommending, as it did for OPEB and pensions, an irrevocable trust into which part of the General Fund “surplus” would be deposited to pay for deferred maintenance.  It certainly can be argued that a deferred maintenance “lock box” would do as much good as as the “lock boxes” staff has proposed – if not more.  Fixing streets and sidewalks would benefit all Alamedans, not just those who happen to have been employed by the City in the fire and police departments.  Moreover, putting funds for deferred maintenance into a trust might forestall a looming disaster even if the elected officials would prefer to focus their efforts on gratifying their political and financial backers.

We’re not sure the current Council would go for this idea, especially if it takes money away from firefighters’ union members.  But who knows?  Maybe we can get Al Gore to sign on.  That’ll at least give the self-proclaimed “progressives” some cover.

Sources:

March 21, 2017 staff presentation: 2017-03-21 staff presentation re trust

Staff reports: 2014-12-02 staff report re amending 2014-15 budget; 2015-04-29 staff report re IAFF contracts; 2015-09-15 staff report re additional spending; 2017-03-21 staff report re budget amendments

Fiscal Sustainability Committee report: Fiscal Sustainability Report

FY 2015-16 mid-cycle update: 2016-06-07 Ex. 1 to staff report – FY 2016-17 Budget Transmittal Letter