The Morning Report
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Thursday, May 18, 2006 | Obscured by months of criminal intrigue and roiling political drama, a number of accounting and economic reforms important to repairing the city of San Diego’s battered pension system remain simmering on the backburner.
There appears now to be momentum building to begin addressing the catalogue of causes of the city’s $1.4 billion pension deficit, a debt accumulated through years of accounting gimmicks and pension dealings. However, as the City Council moves to finalize next year’s budget, the city and its retirement system will move into fiscal year 2007 with many of the same underlying assumptions still in place at the pension trust.
Most, if not all, of the overriding concerns are technical but when taken together would have a tangible impact on both the size of the pension deficit and how much of the city’s annual operating budget gets funneled toward the pension trust.
A committee of the San Diego City Employees’ Retirement System on Wednesday addressed one of the more famous devils in the pension system’s details: the so-called waterfall. Under the waterfall, earnings from the pension systems investments have been used in one way or another for more than two decades to pay for extra employee benefits that are kept separate out of the normal system.
The structure has allowed the city to essentially forgo paying for employee benefits from its annual operating budget, as is recommended. The effect: it has siphoned off earnings in good market years that are supposed to be squirreled away to make up for bad years. The absence of this buildup of earnings is cited as one of many causes of the pension shortfall.
“I haven’t seen anything this egregious with earnings in my 42 years in the business,” said Peter Preovolos, pension board president.
It is one of many examples of how the city over the years found ways to grant employees better benefits without paying for them, a habit that has left recent years’ budgets strained in attempts to make up for the resulting shortfall.
The structure ultimately led to the degradation of the pension system and “contradicts general accounting and economic concepts,” said Steven Stanton, managing partner of Navigant Consulting, the firm that conducted an investigation into the historical ills of the pension system.
Although pension officials spent the afternoon Wednesday dissecting the history and effects of the waterfall, all parties agree that it is ultimately the responsibility of the City Council to do away with the structure – which has been scrutinized publicly for years now.
Council members addressed the issue in passing this week, and Council President Scott Peters said he was waiting on the City Attorney’s Office to author an opinion on the issue.
City Attorney Mike Aguirre said in an interview Wednesday that by the end of the week his office will release a legal opinion saying that the waterfall must be terminated. Mayor Jerry Sanders’ office has also signaled its intent to abolish the waterfall structure in the coming fiscal year.
The city attorney said he will also recommend a comprehensive review of the $162 million bill presented to the city by the pension system. Aguirre and others believe the figure to be artificially low, because of structures such as the waterfall, and many experts with knowledge of the pension system agree that the pension deficit will continue its gradual growth should the city only allot the fund $162 million in the fiscal year 2007 budget.
The pension system’s actuary is scheduled Friday to release the full report explaining the background detail of how he arrived at the $162 million figure.
Reports by consultants such as Navigant have found that the city and the pension system employed a number of methods throughout recent decades to temporarily ease the burden of new benefits on city budgets and use aggressive accounting to make its debts appear smaller.
The waterfall is one of those structures. The pension system assumes an 8 percent annual return on its investments. The first 8 percent that is earned goes directly into the pension system. After that, a long list of supplemental benefits fall next in line to divvy up the earnings – which were often referred to as “excess earnings,” though experts agree that there is nothing excessive about them.
Ideally, any earnings above 8 percent are kept within the pension fund in order to make up for the inevitable years in which investment earnings fall below 8 percent or in which investments actually lose money.
Pension trustees present at the meeting Wednesday signaled their desire to have the benefits paid for by the waterfall tucked into the pension fund, where they would ostensibly be properly accounted and paid for like other benefits.
The waterfall was one of many issues delivered to pension board members by consultants from Navigant, who released their report in January. The committee that met Wednesday is tasked with further analyzing the issues raised by Navigant and taken action to remedy them when appropriate.
Thomas Hebrank, a pension board member, said the committee needs to start implementing changes, as it had been asked to do. He listed a number of other issues similar to the waterfall that need to be examined. They include: the pension fund’s assumed rate of return, which some say is too high; the amortization schedule used to pay off the pension deficit; and other accounting methods.
New retirement Administrator David Wescoe is scheduled to appear to before City Council on Tuesday to discuss the pension bill, and a Peters spokeswoman said it was possible that other issues such as the waterfall will be discussed.
Please contact Andrew Donohue at