Growing budget item looms large
More than a year after the San Mateo County Civil Grand Jury first underscored the threat rising pension costs present to the county’s 20 cities, the issue remains front and center for Peninsula finance officials aiming to address this growing budget item and maintain basic services for residents.
Establishing and maintaining pension trust funds to prefund pension obligations, making additional payments beyond their annual required contributions to the California Public Employees’ Retirement System, or CalPERS, and exploring and implementing strategies for boosting city revenue are among the steps Redwood City, San Mateo and South San Francisco officials have weighed or made progress on in recent years.
Despite a statewide economic expansion over the last decade and the state Legislature’s efforts to reform state and local pension benefits for employees hired after Jan. 1, 2013, San Mateo County’s 20 cities have been feeling the weight of the rising cost of their pension plans. Lower-than-expected investment returns on retirement funds and longer life expectancies are among the factors that have contributed to growing unfunded pension liabilities for cities across the state.
According to the grand jury’s 2017-2018 report “Soaring City Pension Costs — Time for Hard Choices,” the county’s 20 cities spent a total of $102 million on their pension plans in the 2016-2017 fiscal year, representing on average 13.6% of their general fund expenditures. Acknowledging CalPERS’s projections that the $3.1 billion in pension costs paid by its member cities in the 2017-2018 fiscal year will nearly double by the 2024-2025 fiscal year, the report aimed to foster discussion about the possible effects of rising pension costs, including challenges with maintaining public services, reduced compensation or layoffs for employees and the potential for residents to be asked to pay more in taxes.
According to the report, CalPERS’ 2016 decision to lower its discount rate from 7.5% to 7% is also expected to increase the unfunded liabilities cities are responsible for as well as the contributions they must pay. Expected to reduce cities’ pension costs in the long run, the agency’s 2018 decision to decrease its amortization period from 30 years to 20 years will increase their contribution payments in the short term, according to the report.
Redwood City
The grand jury’s urgent recommendations to city officials to prioritize the issue was not lost on Kimbra McCarthy, an assistant city manager for Redwood City who has in recent years been focused on creating a 10-year forecast for the city’s General Fund and scoping several measures aimed at stemming the effects of the city’s rising pension costs. McCarthy said the city’s pension obligations are in large part what is driving projections that the city could experience a deficit, which the city’s 10-year forecast showed could reach $1 million in the 2021-2022 fiscal year and nearly $18 million in the 2028-2029 fiscal year.
McCarthy said the city currently dedicates some 16% of its General Fund toward paying down its pension benefits. According a budget message drafted for the city’s June 10 budget discussions, Redwood City’s General Fund revenue is expected to reach $158.8 million in the 2019-2020 fiscal year, and its General Fund expenditures are estimated to be $136.6 million the same year.
Though the portion of the city’s General Fund dedicated to pension benefits has hovered around 15% for the past few years, it is expected to grow to nearly 24% in the next 10 years, said McCarthy. According to the budget message, the city’s required annual CalPERS contributions are set to rise from $27.8 million estimated for the 2019-2020 fiscal year to more than $47 million in the 2030-2031 fiscal year.
Acknowledging the problem is one that cities across the state are facing, McCarthy said city officials have been studying future projections and taking the steps they can to curb the effects of rising pension costs.
“We’re really taking a strategic, hybrid approach to tackling the pension obligations,” she said.
McCarthy acknowledged the 2018 passage of Measure RR, a half-cent sales tax hike expected to generate some $8.7 million in the 2019-2020 fiscal year, will bring relief to the city’s finances in the coming years. But she said officials are continuing to look at containing costs and boosting revenue, noting the City Council opted earlier this year to dedicate some 80% of the city’s $5.6 million operating balance in the 2018-2019 fiscal year to its pension obligations, including a $3.6 million transfer to the city’s Section 115 pension and retiree health trust accounts and a $600,000 payment directly to CalPERS, according to the budget message.
McCarthy said the City Council’s decision in 2017 to establish the Section 115 pension trust has allowed the city to invest funds set aside for its pension obligations and use the trust’s investment earnings to pay for future pension costs. Included in the city’s 10-year forecast are General Fund contributions toward the city’s pension liability beyond the annual required payment, including direct payments to CalPERS of $500,000 and annual contributions of $1.1 million to the Section 115 pension trust.
San Mateo
Rich Lee, San Mateo’s finance director, joined McCarthy in emphasizing the importance of projecting future costs and taking steps that can pay off for the city later. He said San Mateo’s required annual contribution reached more than $16 million in the 2019-2020 fiscal year and is expected to exceed $27 million in the next 10 years. According to the city’s adopted 2019-2020 budget, the projected increase in pension expenditures means pension costs will constitute a greater share of the city’s General Fund to the point where San Mateo’s annual pension expenditure will exceed its projected local 1% sales tax, the city’s second-largest General Fund revenue source.
At some $16 million, the city’s General Fund pension expenditure is 81% of the $19.5 million in projected local 1% sales tax revenue in the 2019-2020 fiscal year. The city’s General Fund in the 2019-2020 fiscal year is estimated at $128.7 million. Estimated at $27 million in the 2029-2030 fiscal year, San Mateo’s General Fund pension expenditure is projected to be 118% of the projected local 1% sales tax revenue that year, which is estimated to be $22.8 million, according to the budget.
According to the San Mateo County Civil Grand Jury’s follow-up report on city pensions in 2018-2019, San Mateo’s pension contribution costs, at $19,699,000, were nearly 18% of the city’s General Fund spending in the 2017-2018 fiscal year.
Lee said the city has taken on a number of strategies in recent years to address the city’s escalating pension costs, such as pre-paying a portion of the city’s statutory contribution, negotiating cost-sharing with its labor unions and continuing to pay on average $2 million more to CalPERS than the city’s required statutory contribution annually for the next 10 years.
Acknowledging the city’s rising pension costs will outstrip the resources currently available to the city, Lee noted the City Council has directed staff to explore several revenue enhancements, including increases to the city’s transient occupancy tax, business tax and real property transfer tax. He said polling would be conducted in the coming months to gauge community support for the tax hikes, which would require measures to be placed on the ballot and approved by a vote.
Lee said an increase in the city’s transient occupancy tax from 12% to 14% could result in an additional $1.4 million in revenue annually and the property transfer tax revenue could double if proposed measures are approved by voters. According to the city’s budget, San Mateo’s 2019-2020 fiscal year transient occupancy tax revenue is estimated at more than $6.5 million and its property transfer tax revenue for the same year is estimated at $8.5 million.
South San Francisco
According to the grand jury’s 2018-2019 report, South San Francisco’s pension contribution costs, at nearly $15.5 million in the 2017-2018 fiscal year, were 16% of the city’s General Fund spending that year, which Janet Salisbury, the city’s finance director, said was largely on par with other cities. According to the 2018-2019 report, the city’s pension contribution costs are expected to rise to $24.91 million by the 2023-2024 fiscal year.
Salisbury said the general trend among local governments in addressing these costs has included working with employees on cost-sharing and monitoring CalPERS’ discount rate, which she noted has a dramatic effect on city’s required pension contributions. Though she declined to comment specifically on the steps South San Francisco might take in the future, Salisbury noted setting aside funds in a Section 115 pension trust, making contributions in addition to the city’s statutory contribution and negotiating with unions to achieve higher employee cost sharing are among the strategies finance officials weigh in scoping ways to address future pension costs.
“It is not one of those things that you can … lose in your rear-view mirror if things go south,” she said, noting growing unfunded pension liabilities are always part of cities’ financial discussions. “It’s just part of our projections and normal conversations that we know that that is something that is going to be addressed in the future.”
According to the grand jury’s 2018-2019 report, South San Francisco is not currently making additional payments to CalPERS beyond its annual required contribution, but the city allocated $4.5 million to an internal pension stabilization reserve in the 2017-2018 fiscal year and officials have scoped plans to transfer another $1 million to the reserve in the 2019 fiscal year.
According to the report, the South San Francisco City Council discussed a staff recommendation to move the $5.5 million in the reserve to a Section 115 pension trust to earn higher returns on the funds in November of 2018, and expressed concerns about loss of control over the funds if they are put into a Section 115 pension trust. In April, officials also weighed expanding the city’s revenue and tax base, transferring General Fund surpluses to the pension reserve, expanding cost-sharing with employees and continuing to consider establishing a Section 115 pension trust, according to the report.
In November of 2018, South San Francisco residents approved a ballot measure increasing the city’s transient occupancy tax, a measure expected to boost city revenue by approximately $5.9 million annually, according to the report.
San Mateo County strategies
San Mateo County Budget Director Roberto Manchia also acknowledged the role pension costs play in county officials’ financial decisions, noting even small changes to the discount rate the San Mateo County Employees’ Retirement Association, or SamCERA, sets for the retirement fund it administers for the county can result in tens of millions of dollars in increased pension costs. SamCERA also administers the retirement fund for the San Mateo County Superior Court and the San Mateo County Mosquito and Vector Control District.
Manchia said the specter of rising pension costs drove the Board of Supervisors’ approval in 2013 of a policy mandating the county to set aside funds in excess of the county’s statutory requirement to significantly reduce its unfunded pension liabilities by the 2022-2023 fiscal year. In recent years, the county has been able to contribute on average $20 million to $30 million in addition to its statutory contribution, which is estimated at more than $215 million for the 2019-2020 fiscal year, according to the mid-year budget report for the 2018-2019 fiscal year.
According to the mid-year budget report, the county’s unfunded actuarial accrued liability dropped from its valuation for the 2012-2013 fiscal year of more than $841 million to some $619 million, the valuation estimated in June of 2018 for the 2019-2020 fiscal year. The funded ratio of the county’s unfunded actuarial accrued liability rose from 84.3% in 2017 to 87.5% in 2018, an increase largely attributed to employer contributions and strong market performance, according to the report.
In June, the Board of Supervisors approved a $3.2 billion recommended budget proposing a $50 million investment in affordable housing, dedicating more than $15 million to early childhood education and plans to monitor health care expenses and unfunded pension liabilities.
Acknowledging other counties and cities in the state have had to pursue bonds or tax measures to address rising pension costs, Manchia said the county has been able to manage these costs within its budget so far. He credited supervisors and county leadership over the years for maintaining their commitment to policies aimed at addressing them, noting budgeting for increasing pension costs can be challenging when facing several other projects and priorities with their own merits.
“The county has really put together some great financial plans to make sure that we can do as much as we possibly can with the funds that we have and managing them appropriately,” he said. “I think that’s something that has been done in this county for a very long time and I think it’s something that the county and the residents should be very proud of.”
Cities are not alone
McCarthy acknowledged the benefits of having more residents and agencies turn their attention on an issue that will continue to be a priority for cities and engage in conversations about how they can continue to manage pension costs in the future. She said Redwood City is committed to looking long term and scoping fiscally-sustainable strategies, but noted it is an issue affecting every city in the state and tackling it will require the support of state officials and agencies as well.
“I do think that for all of the cities in the area this is one of the key policy challenges that we have to tackle,” she said. “This is not an issue that cities can solve by ourselves. It’s going to take everyone wrapping their head around this and coming to the table … cities are definitely not in this alone.”
December 2, 2019
The Daily Journal
By Anna Schuessler
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