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Saturday, January 21, 2006 | Political dealing and accounting gimmicks allowed the city of San Diego to divert money from its pension system and boost employee benefits for more than a decade, practices that an investigative report released Friday blames for the city’s unsound pension fund.
The 240-page report, sanctioned by pension trustees, is tame by the standards of San Diego’s pension drama, but states that the pension board has the obligation to remedy the “serious under funding and actuarial unsoundness” of the San Diego City Employees’ Retirement System and recoup the money the city shortchanged the pension system dating back to 1996.
The report from Navigant Consulting adds to the growing library of studies on the city’s pension and financial disclosure problems. And although it came to many of the same conclusions as previous reports, it provides few new revelations on a subject that has been central to city finances and politics for more than two years.
The report released Friday provides a broad, detailed chronology of the factors that led to the pension fund’s financial imperilment dating back to 1991, but for the most part it declined to opine on individuals’ actions and delve beyond overarching statements on past practices.
In all, the report found that: previous pension boards violated numerous local and state laws in approving funding schemes; the pension system’s financial disclosures to investors contained misleading information; and deals and accounting maneuvers have jeopardized the system’s tax-exempt status.
“The new board needed to find out as definitely as it could if there was wrongdoing … so that this board could take remedial action to correct it,” said Bruce Ashton, an attorney for the pension board who prepared the report’s legal analysis. “This board wanted to know what their predecessors had done to learn about the past, about whether there were mistakes done in the past.”
The report also comes with a litany of suggestions for the future of SDCERS. Members of the new pension board hailed the report as the foundation of its rebuilding effort.
“If nothing else, it gives us a path to follow,” said trustee George Murray.
However, others saw a cover-up.
Diann Shipione, the pension trustee who first drew attention to the system’s problems in 2002, pointed to the first two conclusions of the report. She said the positive statements about the system’s funding and investments echoed those of early defenders of the pension under funding.
“It’s just another whitewash,” Shipione said. “I think the report could have been written by the retirement system’s staff because that’s what they’ve been trying to do for a long time: try to convince everybody that everything’s fine.”
The pension system has been at the heart of the city’s fiscal and legal ills for more than two years. Its deficit is expected to approach $2 billion this year, and the city’s annual payment into the system threatens to dominate city budgets for years to come absent significant reform.
The city’s failure to properly disclose its pension liabilities has spurred a Securities and Exchange Commission investigation and led to the suspension of the city’s credit rating. The U.S. Attorney’s Office and the District Attorney’s Office have brought criminal corruption charges against eight former pension officials.
Pension board President Peter Preovolos said he and his colleagues wanted to learn “what this institution has been through and whether it truly is responsible for every sin ever created by the beginning of man by this city.”
He declined commenting on specifics of the report, having not had time to digest the thick report.
Preovolos and a majority of his colleagues are new to the board, as voters approved remaking the board in November 2004 over concerns that labor and city officials weren’t looking out for the best of the $4 billion fund.
The report sidesteps dealing with criminal legal implications. It does states that the board must determine whether the pension-benefit boosts given in 1996 and 2002 are legal, an issue which is currently in court. City Attorney Mike Aguirre contends the benefits are void because they were created illegally and hopes to shave hundreds of millions from the pension deficit by doing so.
Navigant consultants detail in the report a number of pension dealings dating back to 1991 and focused on the creation of surplus accounts described as nothing more than accounting gimmicks used to pay additional benefits for employees.
Pension deals in 1996 and 2002 – known as Manager’s Proposal 1 and Manager’s Proposal 2 – have grabbed much of the attention in the pension crisis. In those deals, the pension board voted to allow the city to push its immediate pension debts into the future, while at the same time, the city granted benefit boosts to unions. Prosecutors have called the 2002 deal criminal because of the alleged tradeoff; consultants from Navigant found it nonsensical.
“MPI and MP2 did not make economic or actuarial sense because the agreements decreased the City’s contributions to SDCERS at the same time the City granted more costly retirement benefits to City employees,” the report states.
The report goes past those infamous deals to trace the city’s first under funding of the pension system to 1991, a detail that had received little scrutiny prior to the report.
At that time, according to the report, the city granted unions increased benefits upon the condition that the pension system would switch the manner in which it accounted for its annual pension costs. The pension system changed its accounting later that year, thereby pushing its current debts onto future taxpayers in exchange for immediate payment relief.
The practice would be repeated throughout the next decade and a half. However, the affects of the funding practices were obscured for years by a wildly successful stock market. When that market cooled down in the early 2000s, investment returns could no longer prop up a neglected fund.
The system also engineered other ways to siphon money from the fund, according to the Navigant report.
The plan’s investment earnings, which are normally stored away to keep the fund healthy, have been regularly diverted to pay for extra employee benefits. The funds were kept in separate reserves before being paid to retirees in the form of such things as a cost-of-living boost and a yearly bonus.
“The reserves created the impression that the contribution shortfalls were being covered when they were actually accounting entries that had no financial substance,” the report reads.
The reserves hold money skimmed off investment earnings and don’t collect any cash from the city or its workers to pay for the benefits down the line.
Navigant recommended that the city discontinue paying benefits from separate reserves.
“To the extent that this practice continues, the SDCERS’ Board may consider eliminating the creation of these reserves,” the report states.
Additionally, Navigant recommended the board get more involved in the everyday operation of system, hiring staff with no prior work history with the city, and creating stronger internal auditing of the retirement fund’s books.
Navigant also suggested some unquantifiable switches, from creating a definition of “actuarial soundness” to hiring an expert to “evaluate the effectiveness of the Board in its working relationships within the Board and as it relates to other externally.”
Despite the details described in the report, critics such as Aguirre said it didn’t delve deep enough into a troubled system.
“It admitted what was undeniable but broke no new ground and made erroneous conclusions to keep the same structure in place,” Aguirre said.
In general, trustees were pleased with the report handed to them Friday morning.
“I was very pleased with what I have been able to grasp,” Murray said.
Trustee Bill Sheffler said the report was detailed and provided a lot of background, allowing the reader an understanding of what happened in the past. However, he said it could have been sharper on its legal analysis.
“I was a little bit disappointed that they did not take clearer stances on some of the legal issues. They didn’t say ‘We believe this was an illegal an act,’” Sheffler said. “Their findings seemed somewhat passive – it was a little thin in that respect.”
The report took about five months and $2.7 million to complete. On Friday, the board also created a new committee to address the Navigant report and any additional work that could be necessary.
The city had a similar report prepared when its financial disclosure issues arose in early 2004. That report was rejected by its outside auditors, despite its authors having billed the city $6 million. Two years later, a separate group of consultants are still trying to complete the investigation on a $16.2 million budget and the audit remains delayed.
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