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James Carville had a great line in the 1992 election: “It’s the economy stupid.” Carville used the line to remind folks that the most important issue facing the country at the time was the economic downturn. If you didn’t solve that, nothing else really mattered.

The same can be said of San Diego’s pension deficit. 

A dark cloud will hang over the city’s financial future until we can devise a comprehensive solution to reform the cost of pension benefits going forward — and to pay-off the $1 billion accumulated pension debt for past benefits granted.

There are some who argue that we should pump more money into the pension system and that if we make our payments for the next 20 years, all will be fine. 

I completely disagree. Pumping more money into a broken system merely compounds the problem. We have to reform the pension benefits themselves and reduce the cost of pensions to the taxpayer (and city workers.) 

Skyrocketing labor costs are at the root of many of the city’s financial and operational problems. A big driver of the “giant sucking sound” I referenced in the last post relates to the high cost of fringe benefits (pension, health care, etc.) in the city of San Diego. 

Organizations with a high cost of labor (high salaries, high fringe costs) have fewer employees than organizations with low costs of labor. Translating to city government, if we give the city’s 894 firefighters a raise of 2 percent, that will cost the city $2 million. If we decided to not give a raise, but still wanted to spend $2 million on public safety, we could hire 25 more $80,000 firefighters and provided expanded fire protection for our neighborhoods.

Sounds simple, but those $80,000 firefighters actually cost the taxpayer more when you add in their benefits. For each firefighter you hire at $80,000, you have to put aside monies for pension, healthcare, and other employee benefits. In the financial management world we call these costs the “fringe rate” for your workforce expenses.

What is the “fringe rate” for the city of San Diego?

Take a look at these numbers from the mayor’s five-year financial forecast:

The first line deals with salaries paid to city workers in the General Fund. The next four line items constitute expenditures for fringe benefits for the workforce. 

Taken as a percentage of city payroll, the city’s fringe rate is a shocking 57 percent of payroll.  In other words, for every $1 we pay a city worker, we have to set aside $0.57 for pension, health care and other benefits. 

Mind you, most private sector and non-profit organizations start worrying when their fringe rate exceeds 35-40 percent.

So using our firefighter analogy, with the $2 million in revenue, we wanted to hire 25 new $80,000 firefighters. But because our fringe rate is so high, each firefighter put on the street actually costs $125,600 ($80,000 salary plus $45,600 for fringe). 

Instead of 25 firefighters, we can only hire 16. That means less fire stations can be staffed for our communities.

While 57 percent may shock you, the numbers get much worse over five years — spiking to a mind-numbing 67 percent in FY 2012. 

How can we control these fringe costs and perhaps even reduce them down to the national average of 40 percent? The largest cost in fringe benefits relates to employee pensions — which consumes 32 percent of payroll for the SDCERS contribution and the SPSP contributions. And with a higher cost for pension benefits, the average city employee feels the pinch in take-home pay. 

That’s why pension reform is so important. If we do not reform the pension benefits, we will not be able to provide the quality of services our residents ought to receive. If the city’s fringe rate goes from 57 percent to 67 percent in the next five years, the cost of labor skyrockets.  In the end, the taxpayer is paying more and getting less. It should be the reverse.

It has been five years since the Pension Reform Committee issued the call to reform pension benefit formulas. Those formulas were the “spikes” in benefits granted employees in the notorious 1996 and 2002 pension under-funding schemes. 

Public safety employees currently can retire at age 50 on an allowance that is 3 percent of their highest one year salary times the number of years served. General city workers can retire at 55 and get 2.5 percent of their highest one year salary times the number of years served. 

That’s not all. Due to various legal settlements, “compensation” is not merely salary, but a number of other elements. Thus the actual retirement allowance is higher than 100 percent of the highest salary for some city workers. SDCERS is currently paying out pensions that exceed the Internal Revenue Code’s regulations and caps for pension formulas — representing a liability of $22 million.  In addition, city retirees are provided free health insurance for life. And all pension payments receive annual cost-of-living adjustments. 

(Aside: Next time you hear a city employee emphatically claiming no one gets a pension higher than 90 percent of their highest salary, ask them about the IRS S 415 regulation and how much the SDCERS pays in benefits above the IRS’s maximum benefit cap.)

Unfortunately, the pension formulas have not been reformed — and in the time since the Pension Reform Committee issued their recommendations more than 600 new city employees have joined city employment and are eligible for those spiked formulas.  Those employees are lucky — they got on the gravy train.

Until we reform pension benefits, the city will continue digging a deeper hole financially. It does not matter how many millions of new tax revenues we divert into the old pension system, we have to transition out of the old plan and into a new one.

Some call for a defined contribution system. I’m game for that, but would like to propose a middle-ground plan that offers a reformed defined benefit plan that is affordable to city workers and taxpayers alike — but opens the door for city employees to “opt out” of defined benefit and enroll in a defined contribution plan. 

Here are the four key features of a reformed “defined benefit” plan:

  • Contributions: End the notorious “employee offset” whereby the city picks up a portion of individual employee contributions to the system. From now on pension costs should be split 50-50 (dollar-for-dollar match) between the city employee and the taxpayer.
  • Formulas: Require that a maximum cap of 65 percent of highest total compensation be established for life-long retirement benefits. 
  • Retirement Age: Raise the public safety retirement age back up to 55 (where it was before the benefit spikes from the under-funding packages) and peg the general city worker retirement to be the same as Social Security. 
  • Service Commitment: Defined benefit plans offer retirement benefits for life. In order to qualify for life-long benefits, an individual should have to serve 20 years to qualify. 

If San Diego city government is to win the war for talent we will have to offer flexible retirement packages. After all, the new labor market is defined by a new generation of worker who changes jobs more frequently. They seek pension portability. 

That’s why I support the creation of a defined contribution 401-K plan for city workers in lieu of the defined benefit plan. Let’s reform defined benefits, but offer the flexibility for workers to opt-out into a defined contribution plan if they so choose.

My proposal for a reformed defined benefit plan with a defined contribution option is one idea, but I’m sure there are other ideas. Regardless of what the final pension reform package looks like, the most important thing is that we actually have real pension reform in San Diego. 

“It’s the pension stupid.” 

CARL DeMAIO

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