The $253.2 million gorilla

Whom can Alamedans count on now to do battle with the gorilla in the basement of City Hall?

That’s what those of us who fear the predations of the gorilla – more formally known as the City’s accrued liability for pensions and other post-employment benefits, mostly for retired firefighters and cops – if left untamed want to know.

City management and financial staff – primarily former City Manager Jill Keimach, former Assistant (and then Acting) City Manager Liz Warmerdam, and Finance Director Elena Adair – did their part to restrain the beast by getting the prior Council to adopt policies for using “surplus” money in the General Fund to target the City’s pension and OPEB liabilities.

Thanks to them, during the last two fiscal years the City paid $16.8 million to CalPERS to reduce the amount of its UAL (i.e., “unfunded actuarial liability”) for pensions.  As a result, annual pension expense dropped by $1.06 million in fiscal year 2018-19, with an additional $500,000 in savings projected for FY 2019-20.  In addition, the City created a separate, City-controlled pension/OPEB trust and funded it with $9.1 million.  These sums (plus any investment earnings) will be available, as necessary, to pay the ongoing annual costs of retirement benefits.

But the two senior managers aren’t around any more.  After Ms. Keimach refused the demand by Alameda firefighters’ union president Jeff DelBono to give the job of fire chief to his predecessor as union boss, she was forced out as City Manager in May 2018.  Then, after Ms. Warmerdam was passed over for appointment as Interim City Manager, she accepted an offer to become Assistant City Manager in San Leandro in January 2019.  Of the three architects of the strategy for reducing pension and OPEB liabilities, only Ms. Adair remains to guard the cage.

Not only has top City management turned over, so has the composition of City Council.  Three current Council members – Mayor Marilyn Ezzy Ashcraft and Council members Jim Oddie and Malia Vella – voted in November 2017 to make the payment to CalPERS and deposit to the trust recommended by staff.  But only Ms. Ashcraft supported the companion recommendation to commit $2 million every year to paying down the UAL.

Moreover, neither of the two Council members elected last November has expressed much enthusiasm for the program devised by Mses. Keimach, Warmerdam, and Adair.  In a rare admission of lack of omniscience, Vice Mayor John Knox White told Council on May 16 that “I have learned in this process that my understanding of [the policy] and what the City has been doing have been different.”  At the same meeting, Councilman Tony Daysog called for Council to “revisit” the “formula” used to determine how much to spend on reducing pension and OPEB liabilities.

In any event, the City will not be able to continue the plan instituted under the Keimach administration at the same level simply because it won’t have the funds to do so.  During FY 2018-19, the General Fund provided $7.9 million to be used for paying down the UAL and funding the pension/OPEB trust.  But the budget to be presented to Council this Tuesday anticipates that only $3.7 million will be available for those purposes in FY 2019-20.  And the budget projects that the available funds will dwindle to less than $500,000 in the two years thereafter.

(And, oh, BTW, the major news in the budget presentation is that, with only two weeks left in the fiscal year, the City is expected to incur an operating loss – i.e., expenses will exceed revenues – in FY 2018-19.  The anticipated loss is small – $982,462 – but this will be the first year in at least a decade that the City actually has lost money.)

This Tuesday, Council will be asked to approve the budget for FYs 2019-20 and 2020-21 as a whole, and the pension/OPEB liability reduction strategy is not specifically up for review.  But when the time comes, there a couple of points we hope the current Council members will bear in mind.

First, the management team led by Ms. Keimach didn’t invent the idea of wrestling with the gorilla – i.e., attacking the City’s accrued pension and OPEB liabilities – by paying down the UAL and creating and funding a pension/OPEB trust.  Our elected officials who are inclined to defer to the “experts” will be reassured to learn that the received wisdom in the municipal finance community is that cities should do exactly what Alameda has done.

For example, the League of California Cities published a report in January 2018 in which it recommended six ways for a city “to address the fiscal challenges attributed to growing pension liabilities.”  The top three were:

  1. Develop and implement a plan to pay down the city’s Unfunded Actuarial Liability (UAL):  Possible methods include shorter amortization periods and pre-payment of cities UAL. . . .
  2. Consider local ballot measures to enhance revenues. . . .
  3. Create a Pension Rate Stabilization Program (PRSP): Establishing and funding a local Section 115 Trust Fund can help offset unanticipated spikes in employer contributions. . . .

The strategy devised by Mses. Keimach, Warmerdam, and Adair for reducing pension and OPEB liabilities included the first and third items in the League’s recommended list.  Moreover, the same team proposed – and voters approved – a ballot measure to increase the City’s sales tax by a half-cent.  The measure didn’t call out pension/OPEB liability reduction as the purpose for raising additional revenue – if it had, a two-thirds majority would have been required to adopt it – but this was plainly one of the intended uses of funds.

Second, although it is true that paying down the UAL puts only a dent in the City’s total unfunded pension liability – as of June 30, 2017, that amount was $253,191,143, of which $175,917,927 was attributable to the public-safety plan – the immediate impact on operating results is significant.  By paying down the UAL, the required annual payment to CalPERS goes down and therefore so does General Fund expense.

A couple of charts prepared by staff and presented to Council made the case graphically clear.

This one, presented in November 2017, shows the impact of paying down $6 million in FY 2017-18 and $2 million every year for 15 years thereafter:

2017 Recommended PERS pay down

This one, presented in March 2018, shows the impact of continuing to make annual
$2 million payments after paying down $10.7 million (the increased amount recommended by staff and approved by Council) in FY 2017-18:

2018 Recommended PERS pay down

The accompanying text stated that the total savings from the strategy recommended by Ms. Keimach, Ms. Warmerdam, and Ms. Adair would amount to $25 million over 15 years.

Since the Council majority rejected the proposal to keep paying down the UAL by
$2 million every year, the actual savings will differ from those shown in these charts.  By the same token, the charts do not reflect the effect of the pay down made in the current fiscal year, which staff estimated will save $500,000 in FY 2019-20.

We expect that it will be difficult for any current Council member to come up with factual arguments against either of these points supporting the pension/OPEB liability reduction strategy crafted by the Keimach administration.  And none of them may try to do so.  Rather, the debate is likely to center on how much the City should spend every year to reduce its accrued pension and OPEB liabilities and how to determine that amount.

The “funding policy” proposed by staff, and adopted by Council in June 2016, provided that, “One-half of each fiscal year’s General Fund surplus over the 25% available fund balance shall be put into a Trust Fund or directly into paying off the CalPERS unfunded liability for either pensions or post-employment benefits.”  Then, in November 2016, staff recommended, and Council approved, a refinement:  75% of the “surplus” computed according to the policy would go to CalPERS to pay down the UAL and 25% would go into the pension/OPEB trust.

Applying these rules made it possible for the City to make the multi-million-dollar pay downs and deposits discussed above:  The “surplus” for FY 2016-17 provided $10.3 million to be used for reducing pension and OPEB liabilities.  Together with $6.043 million previously committed for that purpose (and transfers of funds from “closed” pension plans), this enabled the City to pay down the UAL by $10.7 million and to deposit
$6.6 million into the pension/OPEB trust ($3,565,017 for pensions and $3 million for OPEB, according to Ms. Adair).  Likewise, the “surplus” for FY 2017-18 provided
$7.9 million to be used for pension/OPEB liability reduction.  This (together with transfers from the closed pension plans) enabled the City to pay down the UAL by $6.1 million and to deposit $2.5 million into the trust ($2,047,172 for pensions and $500,000 for OPEB, according to Ms. Adair).

Should the City stick to the same methodology going forward?  That is the issue the current Council will have to decide.

Based on his comments at recent Council meetings, it appears that Mr. Daysog doesn’t like the current policy, but it’s not exactly clear why – or what he would propose instead.

At the March 19 meeting, Mr. Daysog suggested that using a “surplus” in the General Fund to reduce accrued pension and OPEB liabilities encouraged public-safety managers not to fill vacant positions, since the vacancies kept operating expenses down and thereby produced a greater “surplus.”  This was, frankly, a pretty silly comment, and Mr. Daysog backed off when other Council members called him on it.

Then, at the May 16 meeting, Mr. Daysog brought up the issue again.  This time, he argued that the “formula” used for pension/OPEB liability reduction might “constrain” the City’s ability to address needs such as park maintenance, street paving, and the “urban forest.”  “Maybe there’s something about that formula that some money that could be used for other items [is] just not there,” he said.

No other Council member echoed Mr. Daysog’s criticisms (such as they were).  In fact, at the March 19 meeting, Mayor Ashcraft staunchly defended the policies for which she had voted (and claimed credit for suggesting the ideas behind them).  “I think we just keep socking away that percentage as much as we can,” she said, “and then are better prepared for that rainy day.”  (Mr. Oddie’s principal contribution to the discussion was to express his view that “it’s super-critical to involve the bargaining units” [i.e., the unions] in any decision.)

Here’s the rub:  The current Council may feel bound by its predecessor’s decision to maintain a “reserve” in the General Fund equal to 25% of operating expenses.  Any balance remaining above that amount represents funds available to be spent.  But why spend half of the “surplus” to reduce pension and OPEB liabilities when there are so many other uses that fit the Council members’ political agendas more closely?

Suppose the prior Council had ignored the recommendation by Mses. Keimach, Warmerdam, and Adair altogether.  There would have been another $18.2 million of “surplus” money left in the General Fund.  That sum would pay for a lot of state-of-the-art fire equipment and deputy fire chiefs; maybe even a brand-new fire station at Alameda Point.  Right, Mr. Oddie and Ms. Vella?  Or it might pay for converting both Central Avenue and Clement Avenue into “complete streets”; maybe even a bike-pedestrian bridge over the estuary.  Right, Mr. Knox White?

We’re not sure even Ms. Adair and Ms. Ashcraft would be able to stand in the way of such schemes.  If not, the gorilla will be free to roam the streets of Alameda.

But there is a new zookeeper on the scene:  City Manager Eric Levitt.  According to Ms. Ashcraft, Mr. Levitt “does have some ideas to share with us regarding funding our PERS [i.e., pension] and OPEB obligations.”  We’ll keep our ears open – but we won’t take our eyes off the gorilla.

Sources:

League of California Cities report: LCC, Retirement System Sustainability Study

Pension/OPEB trust: 2017-03-21 staff report re pension trust; 2017-06-06 Ex. 5 to staff report – Pension and OPEB Funding Policy – Revised

Pension/OPEB payments: 2017-06-06 staff report re FY 2017-18 & 2018-19 budget; 2017-11-07 staff report re use of reserves; 2018-03-20 staff report re amending 17-18 budget; 2019-03-19 staff report re FY 2018-19 budget

 

About Robert Sullwold

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

9 Responses to The $253.2 million gorilla

  1. tony daysog says:

    I am going to write quickly since I am in the middle of work: the point I was trying to get across was\is the “excess-reserve-to-pay-down-unfunded-liability-formula” is out of whack. No one doubts that the amount we typically\normally pay into either CalPERS or OPEB is not enough when it comes to dealing with the huge unfunded liabilities — so we have to a mechanism where (when possible) we pay more into lowering the unfunded liabilities. To me, the issue is that, with the current formula in place, in the last three fiscal years alone (including this one), we will have socked-away slightly more than $20 million of the excess reserves. Yet, at the same budget workshop meetings, we’re talking about not adequately funding parks or streets especially **at levels** we ought to be funding. So, maybe that amount should have been, say, $10 million over three years instead of the formula-driven $20 million over three years, with the balance devoted to putting more into parks and streets?

    Now, you also need to stop and slowly repeat the following: we . . spent . . . slightly over . . . $20 million . . . over the last three years (including this). Last time I checked, this order of magnitude spending usually involved greater participation of residents. Think about it this way, ok? Measure “O” in year 2000 for the library entailed a vote of the people to allow the city to seek G.O. bonds at roughly $10.6 million: so, we need to go to the people for $10.6 million in G.O. bonds to pay partly for a new library (the debt repayment of which would be spread out over many years [ 20?]) — but we don’t need to go to the people to spend $20 million over three years for a part of the City Hall budget driven largely by public safety? Something doesn’t compute here. Am I saying we, the Council, must always go to the people when spending this order of magnitude sum (i.e. $20 million)? It certainly should . . . . but at a minimum there should be a very lengthy discussion involving the public so the people see, know, and understand Council decisions of this order of magnitude “with eyes wide open.”

    Again, the issue is not that we do not need to pay more to lower out incredibly large unfunded liabilities. Of course we do. But we need to do so in a strategic manner that takes into account not just the needs of unfunded liability situation driven largely by police and fire post employment regimes, but also the needs of our other outstanding and very real needs. The “excess-reserve-to-pay-down-unfunded-liability-formula” is out of whack, I submit. Honestly, if you have the time, go check out those budget workshop tapes: I mean I find myself basically scraping for morsels for our parks against the backdrop of what I call an “excess-reserve-into-pay-down-unfunded-liability-formula” that — on an auto-pilot basis — adds a sum leading to that thre-year cumulative total of $20 million+ I’m deeply concerned about.

    In sum, there are two issues: (1) “excess-reserve-to-pay-down-unfunded-liability-formula” is out of whack and working on auto-pilot; and, (2) this order of magnitude spending has to involve residents in a more heightened manner.

    Back to work . . .

    /s/ Tony

  2. tony daysog says:

    ps: fortunately the city manager is aware of this situation and will, I am sure, provide new options.

  3. Alan says:

    I begin by acknowledging I am ignorant of many of the details, mechanisms and history of this issue. That being said, I don’t understand “unfunded liabilities”. What does that mean? I assume that public sector employees don’t pay social security. We don’t know how long retirees will live. But SS and CALPERS fund retirement until death? So how are liabilities calculated? Actuarials? So probably SS and CALPERS have “theoritical” unfunded liabilities? So correct me if I’m wrong but haven’t most corporations and other business organizations moved away from this “forever’ benefit? And why can’t all new hires in the Fire Department start paying SS and begin the process of getting out from under this burden in the future? And why do we keep hiring more fire department employees to add to this problem? Of course the elephant in the room is the apparently regular approval of public service contracts in the full knowledge that these “unfunded liabilities” are going to steadily eat any plausible city budget. Like the Alien, eaten from within. OK, I’m done with my rant. Thanks for listening.

  4. Alan,
    Your comment raises a host of issues, but let me quickly address your initial question. The non-partisan State Legislative Analyst’s Office has provided as good a definition as any for “unfunded liability”: “A pension system has an unfunded liability when its assets (investments and other holdings) are insufficient to cover its liabilities (the future cost of pension benefits that employees have earned to date).” And estimating the total amount of the liabilities does indeed require making actuarial assumptions about, among other things, life expectancy.
    RTS

  5. Mike McMahon says:

    I am confused. As a participant in a statewide pension called CALPERS why would any city be individually responsible for any unfunded pension liability. It would be like saying a private corporation that pays in Social Security would have to show unfunded Social Security liabilities incurred by its employees. CALPERS is responsible for insuring pension benefits get paid out not any individual city. What I am missing?

  6. Steve Gerstle says:

    The City of Alameda is going to be getting one-time windfall real estate transfer tax on this. Let’s see how they spend it.
    https://www.mercurynews.com/2019/06/18/big-alameda-office-park-bought-east-coast-investors-tech/

    • dave says:

      I’ve been a lender to and a follower of Brookfield for many years. They are a very sharp and clever lot. They’re selling into a frothy market to 90% financed buyer.

      That indicates we’re in the top of the 8th inning of this cycle.

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