CalPERS announced this week that it is making changes to the amount that cities pay to maintain employee pensions, and this made news because there will be a significant increase in those payments starting in 2015-2016. It’s worth discussing what this means in general and to Sunnyvale.
There are a number of reasons for CalPERS’ change, but the big one has to do with “smoothing”. CalPERS has historically “smoothed” payments over 15 years (much like our budget stabilization fund, but much longer-term). When investments have spiked higher or dropped dramatically, CalPERS hasn’t immediately adjusted cities’ short-term payments. Instead, it averaged the increases or decreases out over 15 years, to prevent cities from having budgets that vary wildly. Having 3% less to spend on services in a single year is a tough pill to swallow for cities. But it turns out that smoothing is rather devastating when a major event happens, such as the Great Recession. Such a deep and sustained dip created a huge amount of unfunded liability for cities (some $87 billion). And the 15-year smoothing prevents CalPERS from making much of a dent in that unfunded liability for a decade or more. Currently, CalPERS is only 70% funded, and “fully funded” is obviously the goal. Note that this smoothing was an issue once before – during the dotcom bubble. At that time, there was an investment surge, and it reduced some cities’ payments to zero (including Sunnyvale) before sanity returned. Nobody complained when the smoothing was good for cities, but now that it’s bad, it’s a big issue.
So CalPERS has adopted new calculations for cities’ payments which will cause the pension system to be fully funded in 30 years. This is obviously a good thing, but it requires an increase in cities’ CalPERS payments. And you can guess how much cities like the notion of having to increase their CalPERS payments by millions. Columnist Daniel Borenstein recently blasted cities for the way they’ve treated their CalPERS obligations. And he was right to do so. Cities have known that this is a problem, and it’s their own fault if they did nothing about it. Fully funding pensions and guaranteeing stability is a good thing, and you either commit to that or you get out of the pension business. In cities’ defense, I’ll just point out that for the past four years, most cities have struggled to just keep the lights on (and two or three have failed even at that simple task), so spending millions to ensure long-term stability just wasn’t an option for them.
So what does this CalPERS change mean for Sunnyvale?
Little if nothing. The City Manager discussed this in some detail in his latest bi-weekly blog.
Sunnyvale is one of the few cities that has anticipated these changes and we have already built those rate changes into our two-year budget and our 20-year financial plans. Like Borenstein said, our Finance Department (led by the wonderful Grace Leung and Drew Corbett – give them a hand, please) saw this coming a mile away, and they recognized the accounting and actuarial problems in CalPERS’ methods. They used our own independent actuarials to determine what Sunnyvale should properly be paying, towards the goal of “full funding” . And our budgets and our 20-year plan already include making those larger payments. This is exactly why we overpaid our CalPERS contribution this year by 19% and why we’ve been overpaying CalPERS for a while now – because we knew CalPERS was full of it, and we were determined to protect our own fiscal future. And our budget reflects this. We couldn’t determine the exact amount that CalPERS would decide on, so there may be some minimal adjustment if we calculated a little low. But my guess is we’re pretty much spot-on, and we won’t need to do much of anything to deal with the increased rates. We’ll see in a month, when we look at the budget.
In order to actually reduce pension and retirement costs by a significant amount, we adopted two-tier pensions over the past couple of years (actually three tiers). This is also a long-term fix, because we make progress on reducing our pension costs only as we replace retiring employees with new ones. Over the next 30 years, we should see a dramatic decrease in pension costs, as the second and third retirement tiers provide new employees with substantially lower pensions. I believe the difference in cost to the city is $3000 per new employee, which is a huge amount to save in pension costs as we go forward. But it will take time to realize that savings, of course. We’re already seeing some of that savings, but it speeds up over the next few years.
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