Friday, May 19, 2006 | The board of administration of the San Diego City Employees’ Retirement System (SDCERS) is about to hand its 2007 bill to the mayor and City Council. Stand by for a barrage of opinions about whether the actuarial assumptions incorporated into that bill are or aren’t reasonable.

One of those assumptions, the 8 percent earnings rate, deserves particular attention because it is commonly misunderstood.

It is not, as one might think, the true gross return on investment. It is actually net of both investment advisory fees and the entire overhead administrative budget of the SDCERS system. These are the first amounts taken out of the gross return. If the remaining net return exceeds 8 percent, then the balance (the notorious “excess earnings”) is subject to the provisions of the “waterfall” where even more of the return is siphoned off for various uses unrelated to payment of the actual pension benefits.

Going back to that initial 8 percent number, netting the investment advisory and management fees out of gross earnings makes a lot of sense to me. If you have to pay 1 percent to get 12 percent, then I fully agree that your true return is 11 percent.

On the other hand, the notion of burying the entire SDCERS administrative budget in the earnings makes no sense to me whatsoever. That funding mechanism simply allows the SDCERS administrative budget to be downplayed. Last year, the City Council (particularly Donna Frye) asked questions about the administrative budget during a hearing. While the specific words were never spoken, the message came through loud and clear: “It’s not in the city’s budget, so it’s none of your business.”

While it may not be a line item in the city’s budget, it most certainly is the mayor’s and City Council’s business. Why? Because the bill that SDCERS hands them each year incorporates the 8 percent assumption. To the extent the net earnings (net of both investment and administrative costs) do not hit 8 percent, that difference gets added to the unfunded liability which is, in turn, a liability to the city.

Conversely, if the administrative budget constricts, there should be an actuarial gain available to help pay down the existing unfunded liability (subject to the waterfall, which is a different topic).

The related concern is that the net 8 percent used this year is based on historical information. In this particular case, that historical information would only include experience through June 2005. It does not take into consideration the money already spent in 2006 or to be spent in 2007 for legal fees authorized by the SDCERS Board to defend its indicted former employees.

In the end, the notion that those legal fees are being paid “by SDCERS” is just misleading. Those fees find their way into the unfunded accrued actuarial liability (the UAAL) and are ultimately borne by taxpayers.

One of the few bright lights of the SDCERS system is that the true return on investment (gross return reduced only by investment fees) is excellent. The problem is that by the time other expenses (administrative and waterfall) get pulled out, the unfunded liability goes up and it gets blamed on the 8 percent assumption.

It is high time that the component parts of the 8 percent assumption be acknowledged, segregated and discussed separately. While discussion of the waterfall is critical, let’s please not forget to shine some light on the ever-increasing SDCERS administrative budget.

April Boling is an accountant. She was the vice chairwoman of the Blue Ribbon Committee on City Finances and was later president of the San Diego County Taxpayers Association. Agree? Disagree? Send a letter to the editor.

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