San Diego accelerates pension debt payoff with aggressive new policies

New policies adopted Friday by San Diego’s pension board accelerate paying off the city’s $2.76 billion pension debt and rein in a controversial policy that has allowed the city to significantly delay paying off increases in the debt.

The changes follow moves by the board in 2016 and 2017 to more accurately project the city’s pension debt by adjusting life expectancy assumptions for pension-eligible employees and making the pension system’s projected investment returns less optimistic.

The new policies are all part of a comprehensive effort to avoid repeating the pension underfunding schemes from the early 2000s that earned San Diego the nickname “Enron by the Sea.”

The board voted unanimously on Friday to set a minimum annual pension payment for the city of about $350 million until the debt shrinks to zero, a significant departure from previous plans to let the annual payment drop to $250 million in 2029.

The more aggressive approach seeks to reduce the debt to zero by 2037, 11 years earlier than projected under the previous plan.

The board’s actuary will still calculate each year what the city’s payment should be based on a variety of factors.

If the number is above the floor of about $350 million, the city will pay that amount. But if the number is below the floor, the city still must pay the minimum contribution set by the board on Friday.

Given the new approach, the city will have more predictable annual pension payments, which will make it easier to craft an annual budget and negotiate contract extensions with labor unions.

“It gives the city a set payment they know they’re going to be making every year,” board member Bill Haynor said during the board’s Friday morning meeting in downtown San Diego.

While future pension boards have the discretion to veer from the new policy and revert to a less aggressive approach, board members said such a move would likely face harsh criticism.

“It would shine a light on some very bad policy,” board president Valentine Hoy told his colleagues.

The board also voted unanimously on Friday to prohibit softening the impact of increases in the debt caused by changes in long-term projections, such as how well the stock market will perform in coming years or how long retirees will live.

Lower investment returns hike pension debt because the greater the return on pension system investments, the less taxpayer money the city needs to spend in the long haul covering pension payments to retired employees.

The city has previously been allowed to spread the impact of higher employee longevity or lower investment returns over 30 years, but the board voted on Friday to shrink that to 20 years in all future instances.

The change brings the city in line with best practices throughout the state for delaying such impacts, which is called “smoothing.” Officials said most pension systems in California use 20 years, and that only four systems use 30 years.

Multiple organizations made up of actuaries and government finance officials also recommend 20 years as the maximum length for smoothing efforts.

Critics have blamed the city’s use of 30-year smoothing for San Diego’s previous pension problems, contending it has allowed city officials to falsely contend that they are adequately funding the system when they are not.

Officials said the new approach also boosts the pension system’s “intergenerational equity” because employees working for the city when new debts are incurred will now be more likely to still be with the city when those debts are being paid off.

The board, however, rejected on Friday a proposal to get even more aggressive by retroactively amending some previous debt smoothing efforts.

The proposal would have required all ongoing smoothing efforts to conclude by 2038, and any subsequent smoothing efforts would also have needed to conclude by that date.

Pension system officials said the policy had the potential to create high volatility in the city’s annual pension payments.

Board members said that despite the appeal of saying “the debt will be gone in 20 years,” they are reluctant to tie any policies to a specific target date, such as 2038, because there is so much uncertainty in the economic factors affecting pensions.

They also said a future board would likely veer from the proposed new policy if it forced an extreme spike in the city’s pension payment, which would be likely if there is a significant economic recession before 2038.

An economic recession wouldn’t affect the new policy setting a minimum annual pension payment, because a recession would push the city’s payment higher than the minimum, making the policy a non-factor.

The city’s projected pension debt has increased from $1.2 billion to nearly $2.8 billion since 2007.

Because of that increase and other factors, the city’s annual pension payment is projected to range from $337 million to $355 million over the next 10 years, about $100 million more than usual.

The first spike was the stock market crash of 2008 and 2009, which accounts for $754 million of the increase in pension debt – formally called “unfunded actuarial liability.”

The second spike was a new demographic study in 2016 showing that city employees with pensions are projected to live longer than expected, which accounts for $568 million.

The third spike was two recent decisions to lower the city’s investment return projections based on long-term concerns about stock market performance, which accounts for $549 million.

The city lowered the expected investment return rate from 7 percent to 6.75 percent, and then to 6.5 percent, the lowest in the entire state.

While such increases in debt could be characterized as bad news, officials have said it’s a positive thing to have a more accurate and realistic projection of what long-term financial challenges the city faces.

The new policies come as the city waits for a state appeals court to determine how to deal with a state Supreme Court ruling in August that pension cuts approved by city voters in 2012 were not legally placed on the ballot.

The ballot measure replaced guaranteed pensions with 401(k)-style retirement plans for all new hires except police officers, but the court could force the city to allow those employees into its pension plan.

The new policy adopted Friday that sets a minimum pension payment actually only sets a minimum for the part of the payment earmarked for pension debt.

For example, the city’s pension payment this budget year is $350.5 million, which includes $275.5 million to pay off debt and $75 million to cover the “normal costs” of providing benefits to eligible retirees.

The new policy mandates that the $275.5 million number not decrease until the debt is paid off. That means the overall payment mandated by the new policy will be about $350 million each year, because the normal costs typically remain similar from year to year.

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