As public pension costs soar, some Southern California agencies turn to controversial borrowing to fill deep holes

The little agency responsible for killing mosquitoes and rats in the Coachella Valley will see its bill for worker pensions nearly triple over just four years.

Payments will also nearly triple for Cal-OPTIMA, Orange County’s health care system for low-income people, seniors and those with disabilities, as well as for the Los Angeles Memorial Coliseum Commission, the folks who bring events to the historic stadium in Exposition Park.

They’ll more than double for the Orange County Transportation Authority, which runs buses and builds highways, and for the Los Angeles County Development Authority, which works on affordable housing and economic development.

The list  goes on. As the most severe economic crisis since the Great Depression bears down on public agencies, California’s cities and special districts are slated to pay $5.03 billion to fill outstanding holes in their pension plans in 2022, a painful hike of 43%  over what they paid to fill those holes in 2019, according to data from the California Public Employees’ Retirement System.

That’s on top of the “normal cost” they pay to cover pensions each year. And it will get worse before it gets better: Agencies will kick in even more over the next five or so years to make up for losses suffered during the last recession.

‘Unwelcome news’

“California cities are facing multiple pressures on their budgets, and so projections of increased pension obligations are certainly unwelcome news,” said Bijan Mehryar, a legislative representative for the League of California Cities, in a statement.

“Cities in California are already facing a $7 billion general revenue shortfall resulting from the COVID-19 economic shutdown. … Any additional costs will make it extremely difficult for cities to maintain core services to residents.”

Older cities with their own fire and police departments have particular challenges, because public safety pensions are the most expensive. Cities also are far more dependent on local sales and hotel bed taxes, which have taken a beating in the pandemic. Water, sewer and other special districts generally have much steadier revenue streams from property taxes and service fees, and aren’t under much strain, said Dillon Gibbons of the California Special Districts Association.

CalPERS, for its part, said it recognizes the financial impact that the current environment has placed on employers. “We continue to work closely with our employers to provide them with the tools they need to help them better understand their costs and prepare for the future during this difficult time,” it said in an email.

There are some agencies, however, that dramatically buck the trend — shrinking outstanding pension bills even as costs skyrocket for others. They include cities like Irvine, Inglewood, Riverside, Ontario and Monrovia, as well as districts like the Riverside County Transportation Commission and the Riverside Transit Agency.

Sometimes, though, cities do this by issuing pension obligation bonds, which depend on arbitrage — borrowing low and investing high — to work, passing today’s costs on to tomorrow’s taxpayers.

What’s happening?

Big pension debts are a function of generous retirement formulas approved by state and local officials in the halcyon days after 1999, when markets were booming, retirement systems were “super-funded” and actuaries said sweetened benefits would cost next to nothing, because earnings on investments would essentially pay for them.

Officials signed on with gusto, especially in the wake of 9/11, when they were “stepping over each other to bestow wage increases and higher pensions to all first-responders,” said Marcia Fritz, former president of a California pension reform group. Toss in “pension holidays” (when funds looked so healthy that officials quit putting money into them, sometimes for years), a crippling recession, lengthening life spans, a spike in retirements and reductions in what pension plans expect to earn on investments, and you get a hole hundreds of billions of dollars deep. Or deeper.

Stanford University’s Pension Tracker looks at the hole through two different lenses.

• The rosier one, used by California officials, assumes that investments will earn returns of about 7%. That puts unfunded liabilities at $352.5 billion statewide, or the equivalent of $27,187 per household.
• The darker one, used by Stanford’s Joe Nation, a former Democratic state assemblyman and professor of public policy, assumes the much lower return rate of 3.25%. That pegs unfunded liabilities at nearly $1.1 trillion, or $81,634 per household.

If that hole isn’t filled up with meatier earnings and heftier contributions from public agencies and their workers, taxpayers will be called upon to fill it directly.

Some argue that’s already happening. In 2020, there were at least 99 local sales tax measures on the ballot in California. None of them said, “We need more money, in part, to pay for spiking public pension costs,” but they did say things like “for municipal services, including emergency response, public safety, clean drinking water, local businesses, street repair, after-school, youth, disabled and senior programs, and addressing homelessness” and “for general city services.”

While many results are not yet final, it appears that at least 72 of those sales tax measures passed, including in Long Beach, Bellflower, Beverly Hills, Carson, Commerce, Culver City, Gardena, Hawaiian Gardens, Lake Elsinore, Lakewood, Lancaster, Lomita, Long Beach, Los Alamitos, Montclair, Montebello, Norwalk, Palmdale, Paramount, Redlands, San Bernardino, San Fernando, San Gabriel and Signal Hill.

Another 26 appeared to fail, including in Artesia, Avalon, Bell, Cerritos, Corona, Diamond Bar, Fullerton, Menifee, Monterey Park and San Dimas.

This is where reformers start talking about “generational equity,” as the cost of services enjoyed today are passed down to future generations.

Paying it down

Irvine continues its streak as the healthiest large city in America when examined through the lens of long-term fiscal soundness, according to Chicago-based watchdog group Truth in Accounting. It has curtailed spending, frozen vacancies and asked its vendors and contractors for price reductions — and most of them actually said yes, said Marianna Marysheva, Irvine’s interim city manager.

The city has managed to shrink unfunded liabilities by 23% over four years, making millions of dollars in additional payments annually.

“We’re somewhat unique in that,” Marysheva said. “Some of that is paying off, but so much is working against it.”

Pushing costs up are annual cost-of-living increases, employees working for more years, retirees living longer than the funds planned for, and the mediocre performance of the CalPERS portfolio, she said. While the giant retirement system plans on a 7% return on its investments, it returned just 4.7% this year.

CalPERS says it’s “successfully executing on our investment strategy to achieve strong returns and full funding over the long term,” and that while employer costs are slated to increase for a few years, “achieving our target return will provide a slow and steady decline in rates in three to five years.”

Irvine’s Marysheva is very cautious. “The next four to five years are going to be challenging, with prolonged impact from the pandemic on sales and hotel taxes,” she said.

Many cities and districts are using “pension rate stabilization plans” to ease long-term burdens, similarly kicking in more money than required each year to shrink liabilities — the Orange County Vector Control district among them. But others have reduced bills via a more controversial strategy, by issuing the pension obligation bonds. That’s essentially borrowing money at a low interest rate, investing it to earn a higher interest rate, then reaping the difference. Finance types call it “arbitrage.” Others liken it to gambling.

Lemonade from lemons

“POBs involve considerable investment risk, making this goal very speculative,” says the Government Finance Officers Association, which frowns upon them. “Failing to achieve the targeted rate of return burdens the issuer with both the debt service requirements of the taxable bonds and the unfunded pension liabilities that remain unmet because the investment portfolio did not perform as anticipated.”

In recent years, agencies across the country have faced increased financial stress as a result of reliance on such bonds, demonstrating their significant risks, the organization says. Stockton and San Bernardino, which recently endured bankruptcies, are among them.

But sketchy results spring from ill-advised timing, writes Girard Miller, former chief investment officer for the Orange County Employees Retirement System and author of “Enlightened Public Finance,” in the journal Pensions & Investments. If done properly, when money is cheap to borrow, POBs are “a worthwhile public finance strategy and instrument that may be able to come to the rescue of public employers,” he wrote. “It’s finally now time for public pension funds and their sponsoring employers to make lemonade from lemons.”

This year, the city of Ontario issued POBs — and arranged internal borrowing — that is projected to save $170 million over the next 30 years, said spokesman Dan Bell.  Its annual payments for unfunded liabilities are slated to plunge from  $15.3 million in 2019 to $1.7 million in 2022.

“Saving money seems to be fiscally sound,” Bell said. “This has put us in a good position. And if the PERS rates go up again and again over time, what we’re saving would be even larger.”

Monrovia issued POBs in 2017 that are projected to save it $43 million, said City Manager Dylan Feik. Its bill for outstanding liabilities is projected to plunge from $5.9 million to $578,487.

But still, Feik said, its unfunded liabilities are expected to rise. It also also increased hotel bed taxes and negotiated greater worker contributions to CalPERS. It’s setting aside money in a pension trust fund and considering payoff plans every time the unfunded liability rises. “The employees, Council and community seem to have bought into the approach and we hope to see long-term stability in the not-so-distant future,” he said.

Cities are being creative and innovative, but there’s only so much they can do. “The latest CalPERS projections further highlight the need for all stakeholders to evaluate the current system and have an honest conversation about how we achieve a system that is both sustainable and affordable, and that any systemwide changes, such as lowering the discount rate, do not rely exclusively on employers paying more,” said Mehryar of the League of California Cities.

Click to access Southern-California-agencies-UAL-payments-to-CalPERS-2019-and-2022.pdf

Source: Orange County Register