Menlo Park has an estimated $54.5 million in unfunded pension liability for city employees, including public safety staff, and must pay $5.1 million this fiscal year in pension costs, which are expected to rise in the years to come.
On Nov. 13, the Menlo Park City Council discussed, without taking action, a range of options to keep the city financially healthy while facing the uncertainty created by changing policies within the California Public Employees Retirement System, or CalPERS.
Cost increases ahead
CalPERS has made a number of policy changes in the last several years that are increasing pension costs for cities across the state, Doug Pryor, vice president of Bartel Associates, explained to the council. He emphasized that Menlo Park is not alone in facing these challenges.
"I don't know if it's good or bad news, but you're not that different from what most agencies are facing," Pryor told the council. "The good news is, you have company. The bad news is the whole state has this problem that they're dealing with."
According to Dan Jacobson, the city's finance and budget manager, some factors that have a major impact on CalPERS' costs to cities are outside of the city's control, like the retirement system's investment strategy, what the market returns are each year, what benefits are paid to current and future retirees, and certain actuarial assumptions the retirement system makes.
Over the last decade, the retirement system has generally earned returns that are lower than predicted, Pryor said. When the agency's assumptions are wrong, the burden falls on cities to pay for the difference, which is considered an "unfunded pension liability." 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.
Further reductions in that assumed rate of return may lie ahead. Pryor reported it is likely that the system will lower the assumed rate of return to 6 percent over the next 20 years or so. The retirement system is also requiring cities to pay off their unfunded liabilities within 30 years.
CalPERS is taking steps to decrease the risk in its investments with a "risk mitigation" plan.
Menlo Park has taken some proactive steps to limit its pension liabilities and costs. It has a practice of dedicating 25 percent of its general fund surpluses toward a "strategic pension reserve," which now has about $4.6 million in it. To further reduce costs, the city maintains a cost-sharing program to split the pension costs with employees, and offers multiple tiers for pension benefits, meaning it can reduce pension costs for employees who transfer to the city from other agencies.
Among the city's options are to make supplemental payments to CalPERS, create what's called a "Section 115" trust dedicated to paying pension costs, develop a plan for the city's existing strategic pension reserve, or consider a pension obligation bond.
One consideration that may deter Menlo Park from acting independently from other cities, Mayor Peter Ohtaki said, is that offering less generous pension benefits puts the city at a disadvantage when it comes to hiring staff. He said he'd prefer to see the city pursue legislative advocacy with other cities, which would level the "playing field" across cities. He said he does not favor the notion of an obligation bond to fund pension costs, which Redwood City had considered. He added that he wants to look at the question of how to address the city's pension needs as part of the city's overall budget.
The city's latest budget update, also released Nov. 13, was promising: Assistant City Manager Nick Pegueros reported that the city has $5.18 million in net revenue in the general fund from the 2017-18 fiscal year. However, Ohtaki noted, there are a number of other capital projects on the horizon that are likely to require major city funding moving forward, like the bike and pedestrian Caltrain crossing at Middle Avenue or the Belle Haven Library upgrade.
Ultimately, the council directed staff to work with the city's Finance and Audit Committee to come up with recommendations for how to address the unfunded liability problem, and how to spend the city's dedicated strategic pension reserve.
In the meantime, the city should continue to put funding into the strategic pension reserve as it has in the past, Ohtaki said.