San Jose pension plans face perilous future in COVID-19 economy

The coronavirus pandemic has already wreaked havoc on the city’s financial health, with officials tightening their belts last month to make up for a $71 million shortfall in its $4.1 billion budget this year.

But questions remain about how the budget crisis will affect the city’s pension system, which has an unfunded liability of $3.4 billion over the next decade. The City Council took a risk, when it approved the budget in June, hoping it could make up for more than 10 percent of the budget gap this year by investing early in the city’s retirement accounts — potentially reducing the city’s required contributions to the funds, if the gamble pays off.

City Manager Dave Sykes told San José Spotlight the city saved $7.4 million by making its pension contributions at the start of the fiscal year.

“One of our budget balancing strategies to help resolve the General Fund shortfall was the pre-funding of a large portion of the city’s retirement contribution at the beginning of the fiscal year, as opposed to bi-weekly payments throughout the year,” Sykes said in a statement. “The required contribution from the city to the retirement systems is potentially lower if a portion of the contribution is paid up front.”

In the last fiscal year, San Jose paid more than $369 million into its federated and public safety pension plans. The city made contributions each payroll period, the same way employees pay into the retirement system. Last year employees contributed nearly $53 million to the pension plans, according to city budget documents.

This year, the city is expected to contribute nearly $397 million to its pension plans. But instead of doling it out little-by-little every two weeks, the budget passed by the City Council included a mix of cash reserves and short-term loans to give the funds more than $359 million up front, Sykes said.

But, pre-funding pensions doesn’t guarantee savings in the budget, said former mayor Chuck Reed, who advocated the practice in his budget proposals a dozen years ago.

“When you give a pension plan its funds early in the year, it can be invested in the market immediately and the savings in the budget comes from returns,” Reed told San José Spotlight. “But, if the plan loses money in that year, you’ve really gone backwards.”

Losing money is a real possibility for the funds. In the first three months of 2020, both funds posted negative returns on their investments — losing between nine and 11 percent of their value. By the end of June they had rebounded to where they were at the end of 2019.

But even with the uncertainty in the market amid the pandemic, the city officials who administer San Jose’s pension plans say they are confident that the pension boards have responded appropriately by shifting investments and acquiring assets “cheap” as other investors flooded the markets in the early days of the pandemic.

“We feel strongly that over the long term we are making the right decisions,” said Roberto Peña, chief executive officer of the city’s retirement system.

But the city’s pension plans will be stretched thin as the economic downturn continues, Reed says, because pension plan obligations only go up — even as the value of its investments yo-yo.

“In the COVID economy, pension plans are going to be stressed because returns are not very good and are likely to get worse,” Reed said. “The biggest problem is that pension costs continue to go up every year and as revenues go down that means that there will have to be cuts in lots of other places in the budget in order to meet the obligations.”

Still, the administrators of the pension plans say they follow the guidance of the boards who make investment decisions, including having ample “cushion” with lots of liquid or nearly liquid assets and “insulation” from the daily fluctuation of the markets with low-risk, short-term investments.

“We are risk takers but we have to respond to the realities of the market,” said Prabhu Palani, chief investment officer for both pension plans. “We’ve put aside money to pay our obligations for the next five years, so we don’t need to indulge in a fire sale.”

It is impossible to know today how much the city’s pension obligations will grow next year, according to the city manager.

“It is important to note that, each year, pension contributions are based on an actuarial analysis performed by the city’s independent boards overseeing the Federated and Police and Fire retirement systems that is based, in part, on the status of the retirement systems for the preceding fiscal year,” Sykes said. “Given the impacts to the markets over the past several months, we expect required retirement contributions to increase in 2021-2022, though it is unknown by how much.”

The city may have been able to make up for a part of this year’s budget shortfall by pre-funding pensions, but the full impact of the economic downturn on the city’s finances hasn’t been felt yet, Reed says.

“The financial crisis from COVID-19 is just beginning, and won’t really start hurting until the next fiscal year,” Reed told San José Spotlight. “Local revenues tend to lag and at the beginning of the crisis you can do all the creative stuff with the budget to make up the difference, but eventually you run out of options, and you have to start making cuts.”

Contact Adam F. Hutton at [email protected] or follow @adamfhutton on Twitter.