San Diego Governments Brace for Impacts of Economic Tumult on Pension Costs
Health and safety concerns are the priority for local governments responding to the coronavirus, but they soon will have to grapple with what could be massive payment increases they will have to make to deal with huge investment losses.
It is a scary time for people who watch government balance sheets for a living.
“The odds of a recession have increased substantially within a short period of time,” the state’s legislative analyst Gabriel Petek wrote Wednesday. “The abrupt and nearly across-the-board curtailment of spending that is now underway sets it apart from previous downturns.”
As society grinds to a halt in a community effort to halt – or at least slow – the spread of the novel coronavirus, it’s not just businesses and laborers that will feel the financial strain.
Health and safety concerns are the priority for local governments responding to the virus, but they soon will have to grapple with what could be massive increases in payments they will have to make to deal with huge investment losses.
Pensions are guaranteed income for people who retire. They are made possible by payments from the employee, payments from the employer (taxpayers) and investment earnings. If investment earnings tank, the others have to pay significantly more – which can cripple other services.
“Transient occupancy tax and sales tax are being hit especially hard, it will have a significant impact on this year’s budget and next year,” city spokeswoman Racquel Vasquez said in an email. “We are monitoring this closely and will have to make difficult decisions in the weeks and months ahead.”
A San Diego County spokesman said Wednesday it is too early to quantify the financial impact locally, but county officials are also monitoring the situation.
Where government finances stood pre-virus, including the size of their reserve funds, will determine how many choices leaders have to respond to revenue losses in the short-term, but municipal finance experts say long-term increases to pension contributions are coming, and bond market disruptions may also derail planned capital projects.
City and county officials have some stashed cash at their disposal to respond to the financial impact caused by the pandemic, but the longer the virus disrupts life, the worse the economic pain will get for everyone.
“Right now, there is nothing for consumers to spend money on. Everything is closed. Everything is collapsing,” said Peter Kiernan, an attorney with Schiff Harden who specializes in public finance and previously worked as special counsel for the city and state of New York. “We could be a long way from the peak, so it’s a tremendous amount of unknowns, and there is not a lot of good news.”
“The last recession came on pretty quickly, but not this quick,” said William Glasgall, director of the Volcker Alliance, a New York-based nonprofit that studies and advises local governments.
To recap, the stock market plummeted Monday in one of the most dramatic single-day drops in decades, and continued to yoyo without significant rebounds this week. The S&P 500 Index losses repeatedly halted trading and lost 31 percent in the last month, while the Dow Jones Industrial Average has lost 34 percent in March alone.
“The market is disrupted,” said Lisa Washburn, managing director for the Massachusetts firm Municipal Market Analytics, who formerly worked at Moody’s Investors Service. “Financial markets are gyrating because of the uncertainty of the virus.”
And yet local governments have a lot invested in these markets succeeding. They have ways of smoothing out the volatility but over time, a significant enough downturn can mean major problems and impacts on everyday services governments provide: police and fire department operations, parks, libraries and roads.
Several municipal finance experts told Voice of San Diego we can expect to see pension funds report significant drops in assets at the close of the fiscal year on June 30. That will then decrease their funding levels and increase the amount governments are required to contribute.
But they have long set up systems to lessen the blow of major downturns. When things are good, they don’t give taxpayers a proportional break, and when things are bad, they don’t send huge bills.
Officials with San Diego County’s pension fund, known as SDCERA, said it’s too early to say what impact the turbulence will have, but solvency is not a concern. Any jumps in contributions due to major losses, they said, will be smoothed over five years.
“There should be no concern whatsoever about the Trust Fund’s solvency,” SDCERA’s chief of staff Rebecca Wilson said in an email. “SDCERA’s Trust Fund has $11 billion in assets. Using just 10 percent of these assets, combined with regular contributions by the plan sponsors and employees, SDCERA can pay retired Members and beneficiaries for well over a decade.”
Wilson said government pension contributions rates will be decided at the end of 2020, and changes won’t take effect until July 2021.
Officials with San Diego’s city pension fund, known as SDCERS, said they also smooth out market losses over several years and will assess the impact to contributions later this year. Previously, the fund had been on track for 100 percent funding by 2036.
“The city of San Diego’s retirement plan is well funded and is projected to be fully funded within 20 years,” wrote SDCERS’ spokeswoman Jessica Maloney in an email. “The retirement system will continue to provide accurate and timely benefits to its participants and ensure the trust fund’s safety, integrity, and growth.”
Finance documents show some governments are better positioned to handle the pension cost increases that are coming.
“Unless tomorrow we wake up and suddenly everything is better, I think required (pension) contributions are going to increase. I think how sharp is that increase and how many years we see that increase tied to the coronavirus is still up in the air,” said Amanda Kass, associate director for the Government Finance Research Center based at University of Illinois at Chicago.
Glasgall, with the Volcker Alliance said, “Pensions get hit on two fronts.”
Pensions systems invest contributions from employees and employers in the stock market and count on long-term earnings to help pay retirees the benefits promised. Some volatility is tolerable, but dramatic downward swings – like the losses seen in the Great Recession – can hurt or sometimes devastate pension funds. Once the money is lost, the pool of funds that eventually see future gains is smaller, so a couple good years can’t make up for it.
When pension investments lose substantial amounts of money, more money needs to be contributed over the long haul to make up for it and deliver the pension checks promised to current and former employees.
The city of San Diego’s pension benefits average $50,000 per person, per year, according to the latest pension fund valuation. The county of San Diego’s pension benefits average $39,000 per person, per the latest county fund report.
Following this month’s market losses, pension funds may also lower future long-term earnings expectations, and doing so will cause unfunded pension liabilities to rise and also have the effect of increasing the contributions needed.
Pension costs are already eating up larger shares of government budgets than past years thanks to past investment losses, missed earnings targets and rising employee compensation. Pension benefits are calculated based on salaries, so when salaries rise, pensions do too.
California’s Public Employees’ Retirement System and State Teachers’ Retirement System have escalated local government contributions in recent years following the Great Recession, but the funds overall remain 70 percent and 65.7 percent funded, respectively, in the latest market value counts before the virus hit.
CalSTRS’s funding level had dropped 30 percent in a single year after the market crashed in 2008-2009, and “it would take only one or two years of lower than expected returns in the near term to push the funded status below 60 percent or even below 50 percent,” according to a 2019 CalSTRS funding risk report.
Though still billions of dollars short of the money needed to ultimately pay for all accrued pension costs, San Diego’s two pension funds could be worse off.
“Compared to Illinois and Chicago, that’s a higher level of funding … so it’s going into the recession with a better level of funding than places where there are frequently headlines about there being crises,” said Kass, with the Government Finance Research Center. Still, Kass said, “Governments need to be ready to increase contributions right when there is less revenue coming in and especially with COVID-19, there is going to be a demand for services in various ways.”
County officials aren’t interested in spreading alarm about budgets at the moment.
“While impacts are inherently expected, it is too early to quantify potential impacts on the budget or pension system,” San Diego County spokesman Michael Workman wrote in an email Wednesday. “Employees and the public should be assured that the county will move through any resultant short- or long-term challenges in a thoughtful and practical manner while ensuring that residents continue to receive the critical services and support from the county.”
Rising pension costs had already created a real strain for some agencies, including cities, counties, schools and special districts providing services like fire and water up and down the state.
For the county of San Diego, contributions to the pension fund topped $556 million last fiscal year, or 14 percent of the county’s total general fund budget not including $80 million owed for decade-old pension obligation bond debt. Meanwhile, pension contributions cost the city of San Diego at least $325 million, or 23 percent of the city’s general fund budget, financial records show.
The county may have more capacity to absorb a large cost increase, at least initially, thanks to a massive reserve leaders built up over the years. After spending $3.9 billion last fiscal year, the county still had $2.4 billion left in its general fund, with $300 million set aside in a separate pension stabilization account, financial records show.
In contrast, the city of San Diego has just $4.6 million in its special pension reserve, and had a total of $257 million left in its general fund account after spending $1.4 billion last fiscal year, city financial records show. Almost $200 million in city reserve funds are already restricted for use in emergencies or to cover unexpected shortfalls, which may come in handy in the coming months.
There are 18 other cities in the county, though, and many of them have their retirement systems vested with the state CalPERS. Further pension cost increases will not be welcome news – and may necessitate budget cuts elsewhere, especially for agencies with already strapped budgets.
Amy Morgan, spokeswoman for CalPERS’ $353 billion fund, said in an email Wednesday officials there “are paying close attention to the major stock market declines. But one of our greatest strengths is our ability to endure short-term market turbulence and focus on the long term.”
Morgan noted that final investment returns for the year will not be known until after June 30 and said, “We can’t estimate what the fiscal year returns will be during an exceptionally volatile market such as we are experiencing now.” She also said CalPERS officials have contemplated the effect an economic downturn could have and in recent years have “taken several important actions to help lessen its impact” like shifting some more funds to more long-term stable investments, among other things.
CalSTRS spokeswoman Vanessa Garcia said, “The recent market decline could impact required contributions to CalSTRS by school district, subject to the limits set in statute,” and any losses would be analyzed for impact in the fall.
For now, CalSTRS’ funding plan has scheduled local government contribution rates through 2021, and then increases may be added totaling no more than 1 percent per year, “not to exceed 20.25 of creditable compensation,” Garcia wrote in an email.
Longer term, Washburn with Municipal Market Analytics said pension funds may also need to sell off more assets than usual to pay existing pension check recipients, which will worsen the financial health of the fund and have a compounding effect, by missing out on earnings those assets would have seen.
“For most pension funds, this is not an immediate issue but an increasing fiscal pressure,” she said.