Wednesday, Nov. 19, 2008 | As the denizens of City Hall search every financial nook and cranny for ways to close the city’s gaping budget hole, some sights have been set on the DROP program, the now famous pension perk that has long been the target of fiscal reformers.
The city could save in the neighborhood of $750,000 annually if the 13-member board of the San Diego City Employees’ Retirement System votes to cut in half the guaranteed 8 percent interest rate paid on money city employees have in the program, according to a back-of-the-napkin estimate by Joseph Esuchanko, the city’s actuary.
Though this savings would represent less than 2 percent of the city’s $43 million midyear budget deficit, it would be equivalent of saving several libraries or recreation centers that Mayor Jerry Sanders has proposed closing to close the budget gap.
And it would reduce a risk-free perk for city employees nearing retirement that many say is over the top, especially given the financial crisis the world is living through now.
However, the pension board, made up of a mixture of current and former city employees and mayoral appointments, has consistently shot down proposals to lower the interest rate. The board is scheduled Friday to consider lowering it to 7.75 percent. Board member William Sheffler has said he will propose that it be lowered several percentage points further.
A long-held opinion held by Sheffler and others who want the rate lowered is that the employee-board members vote as a block to keep the interest rate where it is. Mark Sullivan, a San Diego Police detective and pension board vice president, called that belief a “myth.”
In 2005, the city ended the Deferred Retirement Option Program, or DROP, for new employees. And both Sanders and City Attorney Michael Aguirre have tried unsuccessfully to eliminate the program altogether.
The program allows employees with five or fewer years left until retirement to keep working and collect a monthly pension payment based on their salary and years of service at the time they enter the program. The pension money is deposited into an account controlled by the pension system, which pays an 8 percent return no matter what is happening in the financial markets. When the employee does retire, he or she can roll the entire balance of their DROP account into an individual retirement account or annuity.
In exchange, employees freeze the salary that their pension calculation is based on the moment they enter DROP. So, when an employee gets a raise after they enter DROP, the employee’s pension payment will always be based on the salary at the time the employee entered the program. And, if the pension investments earn more than 8 percent in a year, the city earns money on that spread.
DROP is often cited as exhibit A when people complain of the benefits city employees receive while the city swims in red ink. For example, an employee who has a $50,000 annual pension payment would walk away in five years with a lump sum in his or her DROP account approaching $300,000. There are currently more than 1,000 employees in the program.
“If DROP is a risk-free investment, then it should have a risk-free return,” said city Chief Operating Officer Jay Goldstone. He recently appeared in front of the pension board and argued that DROP interest rates should be tied to the rates paid by short-term treasury bills, which normally pay less than 4 percent interest.
Paying DROP participants the unconditional 8 percent is particularly galling to Goldstone now, as it means adding tens of millions of dollars to a pension deficit that is ballooning because of the crashing stock market.
On Oct. 31, the pension deficit stood at $2.78 billion — more than double what it was a year ago, according to Esuchanko. If the market does not recover relatively soon, the city’s yearly contribution to the pension system could jump from $161 million this fiscal year to over $200 million in the coming years, according to Sanders’ five-year budget outlook.
Figuring out exactly how much the city could save annually by reducing the DROP interest rate is difficult because of the way the pension system reports its numbers. If the rate was reduced to 4 percent, Esuchanko’s best guess is that the city’s annual contribution would decrease by $750,000.
Sheffler, who is also an actuary, said he will cite the expanding pension deficit on Friday when he makes another pitch to reduce the rate, but he is not optimistic.
“For the last three years we have been debating it,” Sheffler said. “And every time it comes up there has been some reason why the board has not taken a prudent step to reduce it.”
Sheffler and former board member Peter Q. Davis say a block of current and former city employees have kept the vote from swinging their way. The 13-member board includes five members who are elected by city employee groups, and six who are appointed by the mayor.
“The problem is that labor tends to vote as a block,” Davis said. “But the rest don’t — they are all over the place.”
Sullivan, of the San Diego Police Department, said the long-held belief that union members vote together is no longer true. “We don’t really vote as a block on anything — we are very independent,” said Sullivan, who is currently a DROP participant.
Sullivan added that he and the other two board members who are in DROP — John Thomson and Steven Meyer — have recused themselves from DROP-related votes since the board’s council advised them last year that participating would be a conflict of interest.
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