I was interested to read this week about the city of Denver.

It’s booming. The city government is trying to divvy up surpluses. Even cannabis has started turning a civic profit – more than covering what it costs to regulate.

The city of San Diego isn’t there.

Next year the city will face tough decisions.

Haunting the city still is its employee pension fund. We are living through what alarmists worried about more than decade ago. Despite all the reforms – and in part because of them – the bill has come due. In 2016, the city sent the pension system $261 million.

That’s not much less than the entire amount of money the city collected in sales taxes – $275 million.

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This year, the city sent the pension system $325 million.

Next year, the treasurers project it could reach $329 million. Of all the bluster about pensions, that these kinds of bills might come was the heart of the concern.

The pension fund has only three sources of money. It gets money from the employees, who contribute with every paycheck. It gets money from the city, via those checks we send over, funded by taxes.

The pension fund combines that, and makes money on its vast portfolio investments across the world.

For years, the pension system assumed its investments would earn an average of 7 percent every year for 30 years.

But last week, trustees of the once chaotic and beleaguered system made a change. They decided to assume that the system would only earn 6.75 percent on its investments next year. The year after that, they decided to drop it again to 6.5 percent – the most conservative assumptions in the state.

The moment trustees tell actuaries to assume they’ll make less in investment returns, the bill gets larger for everyone else.

Indeed, next July police officers and firefighters in the system will see their take-home pay drop 0.9 percent of their salaries as the pension fund claws for higher contributions.

The year after that, police officers will have to contribute another 0.9 percent. That means that, as the city grapples with a recruitment and retention crisis in the police department, it will have to give them a nearly 2 percent raise just to keep them where they are.

The expected rate of return of pension investments is called the “discount rate.”

“I understand what they’re doing and I’m not opposed to reducing the discount rate, especially if the actuary believes returns will be below that,” said Brian Marvel, president of the Police Officers Association. “It would have been nicer if they’d done smaller amounts of lowering over a longer period of time.”

Marvel didn’t seem too concerned, though. His union is currently in negotiations with Mayor Kevin Faulconer and it expects to get raises.

The other side, though – the city and taxpayers – got a kind of break in the deal. Next year’s $329 million bill will actually be less. More like $312 million.

The employees have to pony up. How did the city get out of it?

“They took an additional step to ensure a more consistent cash flow into the system,” said Mark Hovey, CEO of the San Diego City Employees’ Retirement System.

It was a complex move but essentially they pushed off some of the pain. It surprised me because after 13 years of covering San Diego politics, one basic law I knew was that if they lowered the assumption of what they earned in the market, it would cause significant pain.

Over the long term, the bill will come but Hovey and his team argued that in the future years, the city will get an enormous break. Its pension bills will drop by more than $200 million in 2029.

Basically, when the city closed the pension to new hires in 2012 (except for police) it forced itself to pay off the debt of everyone else in just 15 years. When that’s over, taxpayers will experience enormous relief, but Hovey said the income from the city dropping that much could cause the pension system to have to sell assets or otherwise come up with cash to send out its regular monthly pension checks.

The thing is, the pension system is paying out more than it’s taking in every year. So trustees want to make sure the city has to pay more in 2029 than it would have under the old plan.

That’s the charitable view. The more cynical one is that, like past decades, the pension trustees are worried about the city and wanted to give Faulconer and his colleagues a break, especially so that they can have some funds to pay police officers more.

Val Hoy, chairman of the pension board, is a lawyer and was appointed by Faulconer.

He made comments at a board meeting in July that seemed to indicate he was very concerned about the city’s ability to give the police raises.

Hoy ended up not supporting the move that gave the city a break. He lost that vote. But still, pension board members are not supposed to really talk like that. Their only concern is supposed to be about the health of the pension fund.

So I asked him what he meant. He said he was concerned about police officer pay.

“But the point of my comments is that we have to keep the interest of the pension system as a whole in the forefront. Even though we can’t control whether or not police and fire receive pay increases, we still need to do what is best for the pension system,” he wrote in a statement.

For her part, longtime pension reformer April Boling, who is also the chairwoman of the Airport Authority, said it is obvious trustees went out of their way to give the city a break.

“There’s no other reason to do it but that,” she said.

No matter the motivation, as the city’s budget tightens next year, it will now be easier to give the police officers across-the-board raises or otherwise make the job more attractive because of the decision the pension board made.

For some, it was worth it just to see the system acknowledge that it would not get the kind of investment returns it has assumed for so long. Thirteen years ago, the idea that the city or county’s pension fund would assume returns of only 6.5 percent would have been shocking.

And yet that’s still ambitious – a lot of investors would love steady 6.5 percent returns.

Tough decisions are on the horizon. Boling said that to make room for police raises, cuts will have to come elsewhere in the city’s budget.

Overall, it’s an improvement.

“We needed to be able to see what the impact of the decisions, those things were being hidden. They were ugly but being hidden. This is ugly but not being hidden,” she said.

    This article relates to: Government, Pensions

    Written by Scott Lewis

    Scott Lewis oversees Voice of San Diego’s operations, website and daily functions as Editor in Chief. He also writes about local politics, where he frequently breaks news and goes back and forth with local political figures. Contact Scott at scott.lewis@voiceofsandiego.org or 619.325.0527, and follow him on Twitter at @vosdscott.

    Don Wood
    Don Wood subscriber

    Voting to reduce the projected future earnings estimate, which increases the city's projected contributions, while at the same time putting off the time when the city has to make those contributions, sounds a lot like the actions the city and the retirement board took earlier, which ended up with the city being labeled "Enron by the Sea". Those who refuse to learn from history are likely to repeat it. Whether or not the city is flush enough to give pay raises to some of its employees isn't the kind of metric the pension board should be basing its decisions on. 

    Nathan Wollmann
    Nathan Wollmann

    As you noted, there are three sources of funding for public pensions: Employees, Government, and the market.

    The Public Employees Pension Reform Act (PEPRA) made it so that this year, public employees must now contribute half of the initial funding, with government providing the other half. This is in effect serving to make pension adjustments unaffordable for employees where costs before were more easily absorbed by governments with larger budgets than individual employees.

    However, the fact that governments have larger budgets alone is not to say that it is necessarily fair that Governments should absorb market changes. It's important to protect public funds from market problems.

    So what's changed from the days when pensions were the norm and had fewer problems? The market has changed. Today's market is more disconnected from actual physical industry and development, and relies more on risky derivatives and business models that change more quickly than they used to.

    Even so, the market is still returning around 7% for these plans, with notable exceptions. A few years ago, the County hired a pension manager and paid him $10 million a year. He created an unprecedented risky portfolio. The years he was responsible for (before he was promptly fired within a couple years) lost more than was typical. The returns were around 3%. As such, the last actuarial review for the County looked pretty dire. As usual, the public focus was on unfunded liability. This is a snapshot and doesn't necessarily show a current trajectory for a fund.

    There was a whistleblower lawsuit filed due to the $10 million man's hiring and tenure. The County has joined on. So I think the moral of this story is that the major threats to government (or any) pensions is a changing market and corruption just remember that unions are not the only groups capable of corruption. Government and business requires just as much vigilance. In fact, they have an actual interest in the failure of pensions, whereas unions have an interest in keeping them healthy.

    Jeffrey Davis
    Jeffrey Davis subscribermember

    Any discussion of the pension fund's assumed discount rate is incomplete without including two other assumed rates: inflation and pay. A 7% discount rate with 4% inflation -- real returns of 3% -- had been the assumption for far too long. (Inflation hasn't seen 4% annually since 1991.) Pay too is assumed to generally track with inflation. SDCERS had used a 3.75% pay inflation rate until it was lowered to 3.25% a few years ago. The former is the rate Prop B hawkers used in coming up with their $1B savings estimate. (That is to say, they assumed that absent Prop B, city pay would have increased at 3.75%/yr from 2011-2016. Inflation for that time turned out to be about 1.7%/yr. More than zero, but closer to zero than to 3.75%.) Anyway, lowering the discount rate is a recognition that inflation is low and will stay low, which is also to say that pay increases are low and will stay low -- and that it's appropriate, then, that that assumption be likewise updated in pension payment calculations. So far, it hasn't. Doing so would lower City and employee payments substantially.

    Al Allen
    Al Allen

    Back in 1999, CalPERs and Union Bureaucrats made up Fake News to say there was so much money in the fund,it was growing so well, state could increase pensions at "No Cost To Taxpayers." Fact is it was all a lie. Gov Davis actually believed this line of shibai, and signed SB 400 into law. His financial incompetence has gone on to cost state taxpayers billions and billions of wasted money.

    Under the bill, "More than 200,000 civil servants became eligible to retire at 55 — and in many cases collect more than half their highest salary for life. California Highway Patrol officers could retire at 50 and receive as much as 90% of their peak pay for as long as they lived."

    Taxpayers need to understand this is what unions do. Publish Fake News every time they can. Never, ever, ever, ever, trust anything from unions or union lapdogs until vetted by outside, impartial financial experts. 

    Thanks to Gov Davis the state's pension money pit will continue to be a growing leech on taxpayers. San Diego needs to continue moving new hires to the 401k Retirement Plan. Can't be spiked, can't be raided. A Win - Win for government workers. Feds use the TSP/401k plan for the majority of their pension requirements. A huge savings to taxpayers. Sad to say our state and city haven't got a clue. 


    Chris Brewster
    Chris Brewster subscribermember

    Mr. Allen: Governor Pete Wilson was the first California governor to propose raiding CALPERS. He wasn't motivated by unions. He was motivated by the false assumption that a fully funded pension system meant that the state could reduce its annual payments and let the market take up the slack. That opened the door to later deals aimed at reducing pension contributions and expanding benefits (at the same time). It proved to be unwise, but it is inaccurate to place the blame on unions. There were many contributors to this decision, which is why it is best to keep pensions below 100% funding. http://www.sandiegouniontribune.com/opinion/commentary/sd-utbg-public-pensions-funding-20170914-story.html

    Mark Giffin
    Mark Giffin subscribermember

    Public employee pensions, not just in this city, are a huge financial drain and opportunity cost. But it is not just us. This state and other states with defined benefit systems they are in trouble. The reason is over promising and underfunding. Calpers is also adjusting their discount rate.

    Just look at Illinois to see where California is headed. The systems are unsustainable

    .  The retirement in the private sector comes no where near the over generous public sector retirement. It is a huge imbalance. Prop "B" was a move in the right direction to correct that imbalance and also shift some risk from taxpayers. 

    San Diegans were right to pass prop "B" as it creates a turn around point in which the payments will drop. A couple years back that was supposed to be 2025. Appears now its going to be 2029.

    Remember, The retirement scheme brought on the reforms in San Diego

    Chris Brewster
    Chris Brewster subscribermember

    VOSD promoted Proposition B which, as noted in this piece, closed the system to most employees and increased the cost of the city’s contributions to the system for many, many years to cover the cost of the closure. It was an expensive gambit which may well turn out to be a bad one financially. It may be overturned in the courts, which could be hugely expensive. It will certainly make recruiting and retention of employees harder.

    Mr. Lewis may dislike public pensions, as he alludes here, but he and San Diego need to face the fact that they are the norm for public employees statewide. Thus, in competing for employees among other governments, San Diego is at a distinct disadvantage that it must make up with higher wages. In a competitive market, whether in the public or private sector, your pay and benefits must be comparable or better to attract and retain good employees.

    As for the statement that a lot of investors would love steady 6.5 percent returns, it’s a cheap throw-away line. Pension funds invest for the long run, not the short run. The compound annual growth rate of the S&P 500 from January 1, 1992 to December 31, 2016 (25 years) was 9.15%. From 1996 to 2016 it was 8.35%. Over the past five years it was 14.64%. The compound annual growth rate of AAA corporate bonds over the same periods was 5.82%, 5.42%, and 4.674% respectively. Assuming one placed 35% in AAA bonds and 65% in the S&P 500, the total returns in these periods would be 7.99%, 7.33% and 11.15% in these same periods. The move to 6.5% assumes poorer returns in the future than in the past. There is no basis for that assumption of which I am aware.

    Nationwide surveys have shown equal anxiety, across party lines, about retirement security. This is partly due to the lack of employer funded retirement programs that were the norm in the past. Rather than complain about public retirement systems, we should perhaps encourage them to be responsible and properly funded, while also promoting similar systems in the private sector, like Secure Choice. http://www.treasurer.ca.gov/scib/