Grand jury urges county cities to prepare for crushing pension costs


Few budget-eating monsters weigh as heavily on the financial futures of California cities as a notably unsexy pest: pension costs. And, according to the findings of a new civil grand jury report, San Mateo County's cities are not doing enough to incapacitate that pest before it becomes capable of wreaking Godzilla-like levels of havoc on city finances.

Pension primer

According to the report, San Mateo County's cities offer their employees pension plans through CalPERS, the state's public employee retirement system. Pensions are funded with a set of sources: employer contributions, which make up about 26 percent of pension money and come from cities, and by extension, taxpayers; employee contributions, which make up about 13 percent of pension money, in some cases; and CalPERS.

The bulk of pension money, about 61 percent, comes from CalPERS' returns on its investments. The agency invests employer and employee contributions, and operates with a series of assumptions about how much it will earn back each year, plus considerations like expected inflation, salary growth, and pension recipient longevity.

When the agency's assumptions are wrong, though, the burden falls on cities to pay for the difference, which is considered an "unfunded pension liability."

In the past, CalPERS has assumed that its investments yield a 7.5 percent return on investment, a number some experts say is overly optimistic.

In the past three years, the agency's net return on investment has been only 4.6 percent. Over the past 20 years, that average annual return has been 6.6 percent.

To increase the accuracy of its projections, the CalPERS board in December 2016 voted to reduce its assumed rate of return from 7.5 percent to 7 percent in phases by the 2024-25 fiscal year. It may sound like a small change, but it's expected to double pension costs for many cities around the state.

And there's no guarantee that CalPERS won't reduce that assumed rate of return – called the "discount rate" – again. Consultants have told the CalPERS board it should expect a return on investment of only about 6.2 percent over the next decade, according to the report.

Unfunded pension liability is particularly hard on cities because they have to pay "amortization" costs on it, which is the principal of the amount plus interest accrued at high rates over long periods. Interest is generally set at the same percentage of CalPERS' assumed return on investment, and repayment has generally been set over a 30-year period.

In February, the CalPERS board shortened future amortization periods to 20 years, which is expected to eventually decrease overall costs but increase annual funding requirements.

According to the report, cities already spend the majority of their pension dollars – about 60 percent – on amortization costs, of which a major part is interest, in addition to regular annual pension costs (though this breakdown varies widely in the county).

In the 2017-18 fiscal year, East Palo Alto paid a low of 38 percent of its total contribution costs for amortization, while Half Moon Bay paid a high of 79 percent. Menlo Park fell somewhere on the lower side among cities in the county, spending about 51 percent on amortization costs.

Preparing for the hit

So what can cities in the county do to prepare for soaring pension costs?

The report presents a range of policy tools cities can use to mitigate their pension obligations with a key directive: Don't wait to make a plan.

"If cities do not address unfunded liabilities now, when will they ever be able to?" the report asks. "Now is the time for the Cities to engage their residents in the issue and, with the residents' support, take the difficult actions necessary to secure a bright future for their communities."

The reports cites options cities can pursue to reduce pension obligations: increase contributions to CalPERS beyond the minimum required payments, develop a pension reserve, negotiate to share pension costs with employees, shorten the "amortization" periods over which unfunded liability is paid back, make sure salary increases don't surpass what CalPERS has assumed they will be, reduce operating costs, or find new revenue sources.

Shortening the amortization period from 30 years to 20 years could result in savings for Redwood City of $55 million or, if shortened further to a 15-year amortization period, $134 million. But cities aren't allowed to reverse their decisions once they decide to shorten it.

Menlo Park

According to Nick Pegueros, the city's financial and administrative services director, Menlo Park has already taken a series of proactive steps to mitigate its future pension costs.

But costs are still expected to rise substantially, with projections indicating the city can expect to pay $11.2 million for pension costs by the 2024-25 fiscal year, up from $5.7 million in 2017-18. That's an increase in average cost of about 13.7 percent a year between now and then.

Pegueros explained that the city has negotiated a cost-sharing program with nonsafety city employees, or everyone except the police department, which requires the employees to pay half of the city's future pension cost increases. For nonsafety personnel, after employee cost sharing, the city's contribution is projected to be approximately 25 percent of employee payroll in the 2027-28 fiscal year, up from approximately 18 percent in the 2016-17 fiscal year.

For safety personnel, the expected contribution will be higher, and is currently projected to be 57.5 percent of safety payroll in 2027-28, up from 29.3 percent in 2016-17.

The city has also created a strategic pension reserve fund. Since the time the grand jury report was compiled earlier this year, the City Council has added $1 million to that fund, bringing its total to about $4.2 million, or a reserve of about nine months' worth of current pension costs.

Other cities have put pension reserve dollars into a restricted pension trust, called a "Section 115 trust," which could boost the city's rate of return on investment from its current 1 percent to 4 percent but would limit how the funds can be used. Redwood City, Burlingame and Brisbane have Section 115 trusts to address pension costs.

Changes ahead?

Some statewide pension reform has occurred in recent years, and more could be on the way.

A 2013 state law called the California Public Employees Pension Act, or PEPRA, curbed pension benefits for public employees hired after 2013, created salary caps used to calculate pensions, and disallowed certain loopholes that enabled public employees to boost their pension incomes, such as "spiking" their salaries by reporting overtime, bonuses, severance or unused vacation or sick leave. Whether some of those provisions can apply to people hired before PEPRA passed is pending review in a couple of cases brought to the California Supreme Court.

CalPERS has also promised to lower the amortization period to 20 years, from 30 years.

Other things that could be done to ease pension burdens on cities appear not to be options right now, the report says; they include renegotiating pension formulas for employees, creating a defined contribution pension plan

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6 people like this
Posted by Uh oh
a resident of Atherton: West Atherton
on Jul 31, 2018 at 5:23 pm

And instead of preparing for CRUSHING COSTS that are going to be coming our way, the troika of Elizabeth Lewis, Rick DeGolia and Cary Wiest want to put Atherton even further in the hole by taking out debt to finance an over-the-top city center that the town doesn't need and cannot afford. They don't even want to take a vote of the residents on this one.

Scale this down, way down.

Winter is coming.

4 people like this
Posted by Citizen
a resident of Menlo Park: other
on Jul 31, 2018 at 6:11 pm

I’m sure the fire district will give Atherton all the money it needs.... I don’t think so

Like this comment
Posted by what...
a resident of Atherton: other
on Jul 31, 2018 at 8:46 pm

Fire and police unions?

13 people like this
Posted by Brian Reilly
a resident of another community
on Aug 1, 2018 at 6:37 am

Sooner or later, there is going to be a (or many) default of the entire set of public debts. The incurred and obligated costs will not be covered by returns in the investment markets, and the taxes required are more than the citizens will pay. So default of some sort is unavoidable, and in the not-too-distant future.

What is the municipal financial manager to do? Extend and pretend is the only available course until the time when checks will no longer clear. The taxpayers will (by this time) already have seen rates rise to confiscatory levels and those with any resources will have left. There will be a rump of needy people, broke, who do not even really understand what is going on. THe pensioners will be well organized, and mad, and have the courts on their side. But one cannot get blood from a stone. The pensions will be cut massively, and may even stop entirely, depending on broader, national trends, issues and events.

Remember that a deliberate inflation is a form of default. Paying in nominal dollars that are a shadow of their past value may be the easiest means of effecting the inevitable purge of unpayable debt. No one will like it, but that is where it may well end up, and faster than you thought possible.

4 people like this
Posted by Peter Carpenter
a resident of Atherton: Lindenwood
on Aug 1, 2018 at 6:42 am

Peter Carpenter is a registered user.

The only viable strategy for those public agencies that have the discipline to accumulate sufficient pension reserves is to hope is that enough other jurisdictions go bankrupt first so that the legislature will do something.

When 10 or 20 large local governments go bankrupt the State will have to step in to make fundamental changes.

Like this comment
Posted by Dixiebrick
a resident of another community
on Aug 1, 2018 at 3:15 pm

LOL! I can solve this problemo. Just arm every city and school employee, declare yourselves part of the DOD and lo and behold the Federal Gubmint can fund you to the tune of Billions of dollars a year. What the heck they borrow money we dont have anyway. Or better yet declare yourselves Space Defense professionals and they will throw money they dont have at you.

7 people like this
Posted by Been There
a resident of Atherton: Lindenwood
on Aug 1, 2018 at 3:26 pm

Been There is a registered user.

The sad part is that Atherton's council is mostly unable to understand a budget, let alone clearly understand the explanation of this looming problem.
One simple way to reduce the exposure is to outsource as many of the town departments. Lets start with the Town Manager. The company handling the employees can offer a sane retirement that is more in line with the rest of the employed population. The Public Works Department saw an immediate cost reduction of 25% while eliminating any future PERS obligations.
Sadly, the council is unable to comprehend this concept nor are they strong enough to make tough decisions for the benefit of the taxpayers. It is all about the staff.

7 people like this
Posted by Richard B.
a resident of another community
on Aug 2, 2018 at 3:30 am

A root cause of this problem was created when JFK authorized collective bargaining for public employees in the early 1960's. Public employee unions should be outlawed, for a start.

2 people like this
Posted by Jimmy
a resident of Atherton: Lindenwood
on Aug 2, 2018 at 8:24 am

Collective Bargaining for public employees is simply meaningful democracy in the workplace. JFK understood that and every President since him touts Democracy across the globe ... except within the walls of the workplace!

2 people like this
Posted by history buff
a resident of Menlo Park: Park Forest
on Aug 2, 2018 at 9:10 am

"A root cause of this problem was created when JFK authorized collective bargaining for public employees in the early 1960's"

Funny. And who else "authorized collective bargaining for public employees in the 1960's"?

St. Ronnie Reagun, who's administration become the most criminal administration in history (over 100 members guilty or indicted.) Well, Donnie is going to surpass that, in one term, of course.

"In 1968, then-California Gov. Ronald Reagan signed the Meyers-Milias-Brown Act, establishing collective bargaining for California's municipal and county employees."

Criminal Conspiracy: "The presidency of Ronald Reagan in the United States was marked by multiple scandals, resulting in the investigation, indictment, or conviction of over 138 administration officials, the largest number for any U.S. president"

That isn't even looking at St Ronnie's tripling of the national debt, his 11 working class tax hikes, etc..

Now, what were you mumbling about JFK?

8 people like this
Posted by pensionner
a resident of Menlo Park: Menlo Oaks
on Aug 2, 2018 at 10:47 am

Menlo Park is another pension time bomb.

They should freeze salaries and create another tier.

Council should stop rewarding the city manager for screwing up -- oh wait -- the council works for the city manager.

Like this comment
Posted by What?
a resident of Menlo Park: Central Menlo Park
on Aug 2, 2018 at 2:39 pm


Menlo Park has funded their pensions. And tiers have already been established. How bout you back up what your alleging with facts.

1 person likes this
Posted by Peter Carpenter
a resident of Atherton: Lindenwood
on Aug 2, 2018 at 3:43 pm

Peter Carpenter is a registered user.

"Menlo Park has funded their pension"

Wrong - From Menlo Park's own Comprehensive Annual Financial report:

Net pension liability -$50,992,672

2 people like this
Posted by Uh oh
a resident of Atherton: West Atherton
on Aug 2, 2018 at 4:17 pm

And Peter, just to put things in perspective with what the troika is demanding with respect to the proposed new civic center, what is Atherton's unfunded pension liability?

Like this comment
Posted by Peter Carpenter
a resident of Atherton: Lindenwood
on Aug 2, 2018 at 4:25 pm

Peter Carpenter is a registered user.

You would have to ask the Town - I cannot find their CAFR on the Town web site or on their Financial Data Transparency Portal.

Like this comment
Posted by Data Points
a resident of Menlo Park: Downtown
on Aug 6, 2018 at 7:45 am

The Civil Grand Jury did not provide specific data in their report. The CalPERS actuarial reports from 2016 provide the latest published data. Here is a summary of the unfunded accrued liability and percent funded for the agencies in south San Mateo County:

Agency Class Projected Value of Benefits Unfunded Accrued Liability Funded Ratio
Redwood City Safety $422,086,086 $134,144,187 61.6%
Redwood City Misc $341,058,780 $104,630,224 65.1%
East Palo Alto Safety $25,910,502 $6,379,298 67.4%
Atherton Safety $43,567,323 $11,162,375 71.0%
Menlo Park Safety $99,207,936 $24,164,032 71.6%
Menlo Park Misc $139,025,235 $32,145,956 72.8%
East Palo Alto Misc $19,366,886 $3,973,447 73.2%
Atherton Misc $18,618,599 $4,364,480 73.6%
MPFPD Misc $11,529,692 $2,245,745 74.7%
MPFPD Safety $214,097,569 $44,960,194 76.2%
Atherton Safety PEPRA $1,509,564 $17,479 87.0%
Menlo Park Safety PEPRA $1,169,064 $15,695 88.5%
MPFPD Misc PEPRA $787,956 $7,804 88.8%
MPFPD Safety PEPRA $5,258,889 $40,182 89.0%
East Palo Alto Misc PEPRA $2,169,076 $44,184 89.9%
Atherton Misc PEPRA $513,158 $7,795 90.7%
East Palo Alto Safety PEPRA $4,377,939 $38,085 90.7%
Menlo Park Safety 2nd Tier $1,692,497 $21,531 93.4%

Like this comment
Posted by LC
a resident of another community
on Aug 8, 2018 at 8:08 am

>> Public employee unions should be outlawed, for a start.

They tried a version of that in Ruby Red Missouri last night, and the law got put to a vote of the good citizens of Missouri.

Results last night? A crushing defeat of the anti-worker/anti-family mob. Resounding support for American workers.

Unions notch win in deep-red Missouri with rejection of right-to-work law
Web Link

A two-to-one margin. Not even close. Missouri families destroyed an anti-union law - rejecting it: 67 to 32

Please put an initiative like that up for vote in California! Imagine the turnout!

Like this comment
Posted by So there!
a resident of Atherton: other
on Aug 8, 2018 at 10:19 am

Public safety employees are going to take all of your money and there's nothing you can do about it!


2 people like this
Posted by Roy Thiele-Sardiña
a resident of Menlo Park: Central Menlo Park
on Aug 9, 2018 at 2:41 pm

Roy Thiele-Sardiña is a registered user.

As the co-chairman of Citizens for Fair and Responsible Pension Reform (Measure L in 2010) I can attest to the fact that Menlo Park has a multi tiered pension system.

We forced a 2%/60 pension on them with an overwhelming vote of the citizens of Menlo Park. Heyward Robinson and Kelly Fergusson, both council members, fought the initiative. We were sued by the Unions. We fought them all off, and won with 72% of the vote on our side.

The work of several members of the current City Council helped us win the approval of our citizens.

Menlo Park still has a LONG way to go with regard to Pension Solvency, and they are naive if they think this will go away without PAINFUL cuts to the city budget (and therefore services).

MPFPD and WBSD both have set aside adequate reserves to make sure their employees enjoy the benefits they deserve (and should be commended). the rest of the agencies need to get on that train and save, save, save. Because the State and CalPERS are NOT their friends and will force them to deposit reserves and operating budgets with the State at some point......leaving them with deficits that can only be offset by reductions in services.

Roy Thiele-Sardiña

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