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Publication Date: Wednesday, November 19, 2003

Pension problem Pension problem (November 19, 2003)

Rapidly rising costs of public pensions drain funds from government services

Some think of it as a storm out at sea, gathering gale force as it heads for shore. Others say it is merely a giant wave, demanding great effort to ride out, but survivable in the end.

Whatever the choice of metaphor, many agree that the budgetary bite of steeply rising pension costs for public employees will for some time to come erode spending for public services and programs typically provided by cities, law enforcement agencies and fire districts.

Those costs are soaring at a time when revenue for government agencies is falling -- and when pension benefits in the private sector are declining or disappearing.

The collapse in the stock market from its year 2000 high is part of the reason for the rising costs -- since a portion of pension assets is invested in the market. But a 1999 change in California Public Employees Retirement System (CalPERS) rules may, in the end, have the most dramatic impact on how much money cities and other government agencies pay for pensions.

The CalPERS change has led to a 50 percent hike in pension benefits for most public safety employees -- primarily firefighters and police officers -- and, consequently, a significant boost in labor costs to their employers.

Although the change has been in place locally for only two or three years, the impacts are already being felt. And because the costs to public agencies is only expected to increase -- significantly -- in the foreseeable future, a number of government officials are nervous.

"I really think there is a firestorm brewing, and we have to be very prudent about how we move forward," said State Sen. Jackie Speier, D-Hillsborough, who voted for the state legislation that allowed the increase in benefits. She acknowledged that changes are in order, but said those changes may have to be put in place primarily by local governments.

In the red

The city of Menlo Park and the Menlo Park Fire Protection District -- both of which had built healthy reserves during the recent economic boom -- are now facing the prospect of operating in the red next year if they don't significantly cut costs.

Officials from both the city and the fire district point to soaring retirement costs as the chief cause of the budgetary strain.

Menlo Park is expected to pay $260,000 in retirement costs for its employees this fiscal year, said City Manager David Boesch. Estimated costs jump 573 percent to $1.75 million in fiscal year 2004-05, and then another 25 percent to $2.2 million the following year.

With an annual general fund budget of about $26 million, Menlo Park is certain to feel that loss sharply. "It has an overall effect on the budget; it leaves less money available for programs," Personnel Director Glen Kramer said.

The Menlo Park fire district estimates a potential deficit of about $1.5 million for the next fiscal year, but officials say they plan to cut costs rather than operate in the red. They are considering taking a fire truck out of service to save about $1 million over the course of a year, and are looking at other ways to cut spending, said Fire Chief Paul Wilson.

The district's pension costs have been climbing since 2001-02, when its payments to CalPERS totaled about $290,000. That figure rose to about $2 million in 2002-03, and to a budgeted cost this fiscal year of about $2.4 million, according to business manager Leanna Edens. In 2004-05, the cost is projected at $3.7 million, and the following year, $4.3 million. That's a 1,382 percent increase over four years.

Other local towns and agencies are feeling the pinch as well, with some officials looking bleakly ahead at the impacts of pension costs in the long term, and others saying they expect the pain to subside once the economy rebounds.

Some say any solution to the looming problem must come from the state Legislature, which in 1999 authorized the boost in pension benefits for public safety employees with Senate Bill 400. But repealing or "sunsetting" a law -- particularly one that benefits those who risk their lives and health in protecting the public -- would undoubtedly be an uphill struggle.

Why the cost increase?

Burgeoning pension costs to local governments are the result of two dovetailing developments: the economic downturn, and the boost in benefits to public safety employees under the "3 percent at 50" plan approved by the state in 1999.

CalPERS manages retirement accounts for most municipalities and other public agencies in the state. Contributions to CalPERS are percentages of an employee's salary, and are shared between the employer and the employee.

The employee's contribution tends to be fixed while the employer's varies, reflecting changes in investment performance and the level of benefits. The fund management determines the exact percentage an employer pays, often on an annual basis.

During the boom years, when the return on CalPERS' investments led to a multi-billion-dollar surplus, the benefit was passed on to employers by way of lower or zero contributions. Employees continued to pay into the system, set by PERS at 7 percent of salaries for most employees and 9 percent of salaries for public safety employees.

But just as they shared the profits of CalPERS investments, public employers now are sharing the pain of investment losses.

For example, in 2001-02, the Menlo Park Fire District paid to PERS an amount equal to about 3 percent of firefighter salaries. This year, the figure is about 26 percent, said Chief Wilson. In 2004-05, the rate rises to about 36 percent, and the following year, it is projected to hit nearly 40 percent.

'Three percent at 50'

Before the dot-com bubble burst, "It looked like CalPERS could do no wrong, and we had a surplus of $10 billion," said Sen. Jackie Speier, whose 8th Senate District includes Woodside and Portola Valley.

So when CalPERS asked the Legislature for authorization to increase allowable pension benefits for the state's public safety workers, there was little if any resistance.

With SB 400, local agencies were given the choice to increase those benefits by 50 percent.

Under the old restrictions, CalPERS allowed public safety workers to retire at the age of 50 at a percentage of their top salary, calculated by multiplying 2 percent points times the number of years worked. So, those who worked 30 years could get 60 percent of their top salary for life, if those terms were agreed upon by their employers.

The new law changed the formula to 3 percent at age 50. That means that a 50-year-old firefighter or police officer who worked for 30 years could retire and collect 90 percent of his or her salary until death.

For example, a 50-year-old firefighter retiring in January 1, 2004, as a captain after 30 years of employment with the Woodside Fire Protection District, at a top monthly salary of $7,989, would bring home just under $7,200 a month under the 3 percent at 50 formula. Annually, that's a retirement benefit of $86,281, based on a $95,868 annual salary.

Under the old 2 percent at 50 formula, that same firefighter would receive much less -- about $4,800 a month, or $57,521 a year, in retirement benefits.

Under both formulas, the benefits would be adjusted annually for inflation using PERS' own method of calculation.

Both Assemblyman Joe Simitian and Ted Lempert, the former assemblyman, said they support higher retirement benefits for public safety workers. The two are rivals in the March primary, both seeking the Democratic nomination in the race to fill state Sen. Byron Sher's seat in November.

Mr. Simitian, who has been endorsed by the state's firefighters' union, noted that there is "a growing concern" over the issue in the Legislature, but that he's not on the relevant committees that might be discussing the matter at this point.

Retirement provisions should be different for employees whose jobs involve risk and physical demands, said Mr. Simitian, who wasn't in the Assembly when SB 400 passed.

Mr. Lempert voted for SB 400 when he was in the Assembly in 1999. He said that the Legislature should work with local governments to help them with the financial impacts of the pension program. Although the decisions to boost benefits were made by individual local governments, the state's law that opened the door for such an increase made it "nearly impossible to say no" to doing so, he said.

"I'm very sensitive to what cities are going through," he said, "but firefighters need a strong retirement."

All local agencies in Atherton, Menlo Park, Portola Valley and Woodside providing public safety services have adopted the 3 percent at 50 formula, although the county's conversion doesn't take effect until January 2005.

Most employees of the Woodside and Menlo Park fire districts are covered by the 3 percent at 50 formula, so those agencies are harder hit financially than cities and the county, whose work forces include non-safety employees who don't receive the enhanced pension benefits.

The towns of Portola Valley and Woodside have seen a small increase in their payments to PERS recently, but because they don't have police departments -- they contract with the county Sheriff's Office -- those increases haven't caused much pain.

Woodside Town Manager Susan George noted that the higher PERS costs were inevitable, and that Woodside "kept a hedge in the five-year forecast against the potential for rate increases."

Menlo fire district: Facing spending cuts

Last week was not a good time to question local firefighters about the wisdom of higher pension benefits. A contingent of officials and front-line employees of Peninsula fire districts on November 12 headed north to attend the funeral of Novato firefighter Steve Rucker, who lost his life fighting the wildfires in Southern California.

Harold Schapelhouman, a division chief with the Menlo Park district, was part of the contingent. He noted that while firefighters have to face the possibility of never returning home to their families every time they leave for work, the risk of death is not the only on-the-job hazard they face.

The current pension-benefit package makes sense, given the physical and mental demands of the job, he said, offering example after example of near-accidents at freeway-collision scenes, on rooftops of burned-out houses, and in burning houses themselves, where firefighters search for residents thought to be trapped inside.

On-the-job injuries, lung damage, exposure to toxics, high levels of stress, and the demand for peak physical performance make early retirement the best, if not only, choice for many firefighters, he said. "It's an inherently unhealthy lifestyle," he said.

At the same time, he added, most firefighters don't retire at 50 if they can still keep up with the physical requirements because they love their jobs.

Noting the physical demands of the job -- demands that many older people have difficulty meeting -- Chief Paul Wilson said it's often in the best interest of the employee and the community for a firefighter to retire in his or her 50s.

Cutting costs

Chief Wilson said that so far the efforts to deflect the budgetary hit from rising pension costs have included not filling positions and having firefighters work overtime instead.

Next year, taking a fire truck out of service would help, but more cuts would be needed, he said. Those cuts might involve services. "You just can't make up for half a million dollars by not buying paper clips."

Of this year's $18.4 million budget, retirement costs represent 13 percent.

The district board has made it clear that it doesn't want to renegotiate the contract with firefighters to change the retirement benefit package, Chief Wilson said. The contract expires in 2006.

Woodside fire district: Still 'in good shape'

The Woodside Fire Protection District began offering the 3 percent at 50 retirement benefit to firefighters in July 2001. The district's four miscellaneous employees receive a lower retirement benefit plan.

Although the employer contribution has risen significantly since then, Woodside fire Chief Mike Fuge said there are no regrets about offering the more expensive retirement plan. "The timing was right. We got caught in a revenue glut like everyone else," he said.

Firefighters didn't even have to negotiate for the better benefits, they just received them, he said.

In 2001, the fire district contributed 8.8 percent of an employee's salary into the retirement system. That contribution rate is now at 19 percent, is expected to increase to 31 percent in the next fiscal year, and is projected to rise to 34 percent in 2005-06, said Kate Fraumeni, the district's accountant.

Retirement plan contributions now make up about 19 percent of the district's $8 million budget, she said.

Cutting costs

One way the district is saving money is by fielding a smaller workforce. The district has 42 safety employees, down from 46 in 2000. By making up for the extra shifts with overtime, the district saves on medical and workers compensation insurance, as well as on retirement contributions.

Rather than firing employees, the district downsized by not filling vacant positions, said Chief Fuge. The district had been losing people because of the high cost of living in the area, so by working overtime shifts, firefighters boost their salaries and have a better chance of being able to afford to buy a house, Chief Fuge said.

Chief Fuge said he doesn't believe that the employer contribution to PERS will continue to rise indefinitely. "I've heard some reports that they will start to go back down, as the economy gets better," he said.

In a worst-case scenario, the district would probably try to renegotiate contracts and go to a tiered program, leaving older firefighters with the better benefits and offering a less expensive plan to new employees, Chief Fuge said.

Renegotiating is not something the Woodside district will have to worry about anytime soon. Based on current estimates of property tax revenues from the county, the fire district is doing better than expected. Though the current fiscal year has probably been one of the district's poorest in terms of revenue, and firefighters have not asked for raises or any cost items, it looks as if the district will still be able to give them a raise, he said.

"We're in good shape," Chief Fuge said.

City of Menlo Park: Spending cuts in place

During most of the 1990s, the city's contributions to CalPERS varied, said Glen Kramer, Menlo Park's personnel director. For miscellaneous employees, the city paid between 5.2 and 7.3 percent of their salaries. For public safety, the figure ranged between 7.7 and 19.5 percent.

In 1998 the city paid nothing into the system because those costs were covered by the booming stock market. The city's contributions have remained at zero -- but they won't stay that way for long.

In 2003-04, the city is expected to pay 5.51 percent for public safety employees and nothing for miscellaneous staff, Mr. Kramer said. In 2004-05, the figures jump to about 6.24 percent for miscellaneous and 21.6 percent for public safety.

The city agreed to more generous pension benefits for its sworn police officers in 2000, with a "3 percent at 55" plan that year and "3 percent at 50" beginning June 30, 2004.

So a Menlo Park police commander making the top commander salary of $115,044 could retire next July at the age of 50 after 30 years with the department and continue to make 90 percent of his or her salary -- $103,539 -- every year, adjusted for the cost of living starting in the second year of retirement, Mr. Kramer said.

A police officer making the top officer salary of $66,480 and retiring at 50 next year after 30 years of service would also get 90 percent of that figure every year, $59,832, adjusted for the cost of living.

Non-sworn police department employees, such as dispatchers, have a 2 percent at 55 plan, as do miscellaneous city employees.

Police Chief Chris Boyd said that increasing the pension benefits was a good move for the city. In 2000, the city needed to stay competitive in the hiring field at a time when public- and private-sector jobs were plentiful and costs of living very high, he said.

"At the time, nobody saw what was to come with this unprecedented economic downturn. We all thought this was affordable; investments looked good," he said.

These days, the enhanced retirement benefits are still key for Menlo Park to stay competitive because so many other cities offer 3 percent at 50 packages, Chief Boyd said.

Many believe that it makes sense for public safety workers such as police officers and firefighters to retire in their 50s, and in fact Menlo Park officers tend to retire between 51 and 55, Chief Boyd said.

"It's demanding. It's physical," he said of the work. "If you look at our injuries and our disabilities over time as an industry, I don't think we would do well having a system where we kept most officers working into their 60s. We'd see the cost of injuries and disability retirement possibly shooting past retirement costs."

Personnel Director Kramer noted that, in the long run, CalPERS costs are comparable to what the city would be paying to Social Security. Non-permanent employees of Menlo Park have their retirement benefits covered by Social Security instead of CalPERS. For those employees, the city pays between 6 and 7 percent of their salary for retirement benefits, he said.

In a normal year, he said, the city pays about the same amount into the state system. It's just that the roller-coaster years from 1998 to now have been anything but normal.

"We were getting a pretty good deal for a period of time," he said. "Now the miscellaneous group is going back to what it would ordinarily be, and the public safety group is going up because of the new benefit enhancements (in the 2000 contract)."

The city can act like other stock market investors: ride out the tough times under the assumption that the economy will rebound. "We can't manage using hope, but that doesn't mean it's hopeless," City Councilman Paul Collacchi said.

Cutting costs

Meanwhile, several members of the council said, every hiring decision should undergo heightened scrutiny.

While the City Council managed to avoid calling for layoffs during the spring budget hearings, other deep cuts were made, including eliminating the police department's traffic unit and reducing library hours.

City officials agreed the cuts had to continue to keep the budget balanced, and in the ensuing months, city and union officials worked together to whittle down the city workforce by offering early retirement and reduced-hour packages. Eleven employees resigned, reduced their hours or took early retirement.

These most recent staffing measures, along with reducing library, community services and City Hall hours in December, are expected to save $250,000 this fiscal year and $400,000 in 2004-05.

But staff had originally estimated $1 million of cuts would be needed in 2004-05, so council members agree that cuts will have to continue.

In the face of increasing retirement costs and other pressures, Mr. Collacchi said, the cuts will continue to get harder and residents will see reduced levels of service, such as less trash-removal in parks.

As for future layoffs, he said, "I think they're almost certain."

City Manager Boesch said renegotiating contracts to lower pension costs to the city is possible, but would be extremely difficult to pull off at the bargaining table.

"It's hard to undo benefits once they've been awarded through contracts. Those employees and future beneficiaries feel like that's a commitment that's been made to them," he said.

Some assistance could theoretically come from the state, Mr. Boesch speculated. For example, the Legislature could place a statewide "sunset" on the 3 percent at 50 plan, saying that anyone who is hired after a certain point would no longer get the benefit, he said. That way, no one city would be less competitive.

Although Mr. Boesch said he hadn't seen any signs that this would happen, he added: "In light of this benefit having become the norm and the standard, and in light of investment losses in PERS, there's a heightened sense of awareness and angst.

"How long can we continue to provide benefits like this? At some point, something's got to give."

Atherton: Parcel tax renewal is key

The town of Atherton devotes about 10 percent of the current year's $7.4 million general fund budget to pension expenses, said Finance Director John Johns.

"Increasing pension costs combined with relatively modest growth (in revenue) do present a problem for Atherton," Mr. Johns said.

Financial projections estimate that the town will have to tap into its reserve funds to the tune of $600,000 in fiscal year 2005-06 to make ends meet. If voters fail to renew the town's special parcel tax, which expires in 2005, the town faces a $1.6 million deficit.

Atherton's 21 public safety employees have been part of the 3 percent at 50 plan since July 2002. Previously, it was 2 percent at 50. The 30 miscellaneous employees' benefits were improved from a 2 percent at 60 plan to a 2 percent at 55 plan in 1999, Mr. Johns said.

In addition to what CalPERS bills Atherton for its share of employer costs, the town also pays more than half of the public safety employees' contribution (the town pays 5 percent of the salary and the employee pays 4 percent), he said. The town picks up the entire employee share for miscellaneous town staff, which is factored into employees' salaries, in order to make Atherton more competitive with neighboring municipalities, Mr. Johns said.

The most dramatic increases in employer contribution levels are for public safety employees. Atherton now pays an amount equal to about 31 percent of those salaries, and that amount is expected to increase to about 34 percent in 2004-05, Mr. Johns said. For miscellaneous employees, it's much lower -- 5.7 percent this fiscal year and 9.1 percent next year.

In the short-term, the town's contribution rates to CalPERS will almost certainly increase, he said. CalPERS' estimates of future employer contributions show rates more than doubling by fiscal year 2006-07, and continuing to increase the following year.

"Any increased costs obviously are of concern to the town, but we've incorporated PERS expenses within our long-term financial plan," said City Manager Jim Robinson.

So far, Atherton has dealt with declining revenues by reducing town staff -- leaving one police officer position unfilled, and using contract workers rather than replacing retired park supervisor Joe Mercer -- as well as making other budget cuts. The town hasn't begun negotiations with the police, whose contract expires in 2005, so the possibility of changes to the retirement benefits hasn't been considered, he said.

San Mateo County: Has own pension program

San Mateo County may be better off than some other agencies in dealing with soaring retirement costs, because it operates its own pension plan, called San Mateo County Employees' Retirement Association, or SamCERA.

Nevertheless, it is facing a double whammy -- from a new retirement package that upped benefits for more than 5,000 employees; and from losses in the investment pool due to the declining stock market.

County retirement costs rose by $24 million, or 68 percent -- from $35 million to $59 million -- from the fiscal year that ended June 30, 2002, to the present budget year, said Deputy County Manager Reyna Farrales.

That increase represents 25 percent of the $80 million deficit that county budgeteers faced going into the 2003-04 fiscal year. In September, the Board of Supervisors adopted a $1.27 billion budget for the county.

County employees can choose among several plans, each with a different level of contribution by the employee and by the county. Payments include a cost-of-living adjustment, which varies from 2 to 5 percent depending on the plan.

The county contribution to the retirement fund each year is likely to continue to rise. "It's not going to go down any time soon," said Sid McCausland, SamCERA's chief executive officer.

Supervisor Rich Gordon is worried about the long-term costs to the county. "It's a ticking time bomb," he said. "There is not enough return on investment in the current market to sustain the retirement benefits that have been granted."

Mr. McCausland believes the county's retirement fund can ride out the current downturn. "We're disappointed in the investment results; we're not crippled by them," he said "We don't have a crisis on the horizon."

Higher retirement benefits for public safety employees working for the sheriff and probation departments account for about 36 percent of the county's increase in retirement costs, Ms. Farrales said. In the most recent contract, deputy sheriffs, probation officers, and other sworn peace officers received substantially higher benefits than the bulk of other employees covered by SamCERA. They will get additional increases starting next spring.

While the county's budget situation remains uncertain due both to the economy and the uncertainty about what the state will do, no official sees any likelihood of reversing labor costs. "Labor costs are going through the roof," Ms. Farrales said. "If we can't raise revenue, the only place we can cut is costs."

Supervisor Rose Jacobs Gibson seemed resigned. "We are prepared to absorb the increase," she said. "It has a tremendous impact on our budget, but we have no choice."

Supervisor Gordon suggested that, in the next round of labor negotiations, benefits will have to be tempered. "There won't be a rollback of what has been granted; that's established in contract," he said. But when contracts come up for renewal, "we're all going to have to be careful about how much further we go."

"This ball got rolling at state level when PERS was doing exceedingly well at a high point in investments and a high point in return on investments," he said. As increased benefits were granted to public safety employees by one jurisdiction, others followed. Then other groups of employees wanted more.

"Everybody just did the me-too game."


News Editor Renee Batti supervised this report. Design Director Bill Murray was in charge of the graphics. Reporters contributing included Rebecca Wallace, Andrea Gemmet, David Boyce, Marion Softky and Marjorie Mader.


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