The money that San Jose is paying to fund pension plans for employees is on a major upward trajectory that’s taking a larger share of the city budget, largely because depressed investment return forecasts have city retirement plans lowering their expected rate of return.
Payments to retirees of the two pension plans, the Police and Fire Department Retirement Plan and the Federated City Employees’ Retirement System, already consume more than 20 percent of the city’s $1.4 billion general fund.
The city contributes $339 million for the current fiscal year that ends on June 30.
On July 1, the city will need to contribute an additional $26 million because the two pension boards approved a decrease in the expected rate of return from 6.875 percent to 6.75 percent. The board actions in December is expected to increase the pension system’s almost $3 billion unfunded liability by close to $200 million.
Forecasts for the San Jose pension systems, and others nationally, show expected investment returns over the next decade to be more in the range of 6 percent.
“What I can say is I think at this point the decision to go to six and a half is certainly not only reasonable decision, but also one that is supported by the data provided to the pension boards,” Roberto Peña, the city’s retirement services director told San José Spotlight.
Peña said economic forecasts show it will be difficult for the San Jose pension system to meet the current expected rate of rate of 6.75 percent on average in a given year. He said a full report from the two pension systems’ actuaries will be presented to the pension boards this fall.
Peña said no decision will be made by the boards until after that report is released.
Mayor Sam Liccardo said lowering the rate of return “won’t come without more short-term pain.”
“Ratcheting the fund’s investment assumptions downward will cost the General Fund more now but will save taxpayers far more in the long run,” Liccardo said in a statement to San José Spotlight. “Making these and other actuarial assumptions more realistic will also ensure the solvency of the plans, so the promises made decades ago to employees will be kept when they retire.”
San Jose Councilmember Johnny Khamis said he is concerned.
“I don’t think the city could afford such a major increase in system funding,” he said.
Khamis said he doesn’t want a repeat of the last pension crisis when the city couldn’t afford to hire police officers or fire personnel and had to cut maintenance at playgrounds.
San Jose was thrown into the national spotlight after former Mayor Chuck Reed lead an initiative ultimately approved by voters in 2012, to cut pension benefits of employees to counter rising retirement costs.
Police officers and fire firefighters left the city in droves to work for higher salaries and benefits in nearby cities. Four years later, a Superior Court judge struck down much of the law and the city negotiated a settlement that restored many of the lost benefits for workers.
While the drama played out in the years following the fiscal crisis, when city was in a much weaker financial condition, some of the same issues are in play today regarding the funding of the pension plans.
The problem is neither the $3.6 billion Police and Fire Pension Plan or the $2.2 billion Federated City Employees Retirement System pension plan is fully funded. The two pension plans have an unfunded liability of almost $3 billion, the shortfall to pay retirees pension benefits over the long term.
A key part of the problem is the pension systems over the years have fallen short of their expected rate of return. Ten years ago, both pension systems estimated they could earn 8 percent a year in investment returns on average.
In reality, the federated plan made only 4.1 percent on average per year in the ten-year-period ending June 30, 2018 while the police and fire plan made 4.6 percent, show pension plan statistics.
Longer life expectancies for retirees and the fact that the ratio of active workers equals retires have also contributed to the underfunding.
If the decision is made to lower the expected rate of return to 6.5 percent, the unfunded liabilities of almost $3 billion could increase by close to $500 million.
Public pension plans across the United States have lowered their returns assumptions because investment consultants predict the days of the overheated stock market advances are over and interest rates on core bonds remain low.
The San Jose pension systems are among just a few in the U.S that have gone below 7 percent in their terms of their expected rates of return.
Joe Nation, a public pension expert and professor at Stanford University, said San Jose retirement officials should be commended for considering lowering the rate of return to 6.5 percent.
“Now is the right time to do it, before there is a crisis,” he said.
In California, courts have ruled that promised benefit benefits are guaranteed, so it’s ultimately San Jose taxpayers that will have to foot the bill.
Contact Randolph Diamond at [email protected] or follow him @RandyDFinanNews on Twitter.