Friday, Feb. 20, 2009 | Pension board members voted 7-2 today to essentially halve the rate of return for employees who take part in the city’s deferred retirement option program, known as DROP.

Instead of the current annual 7.75 percent rate, those participating in the plan will receive a 3.54 percent annual rate of return on their pension payments, which are deposited in their DROP accounts while they take part in the program.

The new rate is based on average interest rates for the five-year indices for U.S. Treasury securities, Individual Retirement Account Certificates of Deposit, and high-quality corporate bonds. The rates for Treasury bonds and CDs were each weighted twice as much as the corporate bonds, which carry higher interest rates than the other investments.

The board also voted 8-1 to lower the rates for annuities created when DROP participants convert their DROP accounts into annuities with a guaranteed return rate. Those rates will drop from 7.75 percent to 5 percent on July 1.

Board members said they wanted to calculate those rates the same way they did for the regular DROP accounts, but using longer-term indices to reflect the fact that annuities are a longer-term investment than DROP accounts, which span at most five years.

Calculated that way, the rate would have been 5.59 percent. However, if the pension system pays less than 5 percent in a regular DROP account, the rate of return for a DROP annuity is capped at 5 percent under the city code.

Board member Franklin Lamberth said the rate for regular DROP accounts should remain at 7.75 percent. He said if the board members believe the pension system as a whole will rebound from its current losses, it shouldn’t overreact to the recent downturn by lowering the DROP rate.

The board members who voted for the measure said it was essential to ensuring the stability of the pension system as a whole. They cited the fact that DROP was meant not to cost the city money. Board member Peter Preovolos doubted the idea that DROP could ever be “cost neutral,” calling that idea a “myth.” But board member Susan Gonick said members had to at least keep that in mind as a goal.

Pension board members had previously indicated they would likely approve a lower rate of return. Today’s discussion centered mostly on whether to average the Treasury, CD and corporate bond rate or exclude the higher-yielding corporate bonds altogether.

With the corporate bonds included and given the same weight as the safer securities, the rate of return would have been 3.98 percent; without them, it would be 2.9 percent. Both proposals failed to gain the needed votes, and the idea of including the corporate bonds but giving them less weight was introduced as a compromise measure.

The 13-member pension board includes five trustees who represent current or former city employees. Three of those five had to recuse themselves from the vote because they are DROP participants. The other two, Lamberth and David Hall, voted against the lower interest rate for DROP accounts, though Hall voted in favor of the new annuity rate. The seven members who voted in favor of both measures are all mayoral appointees. Mayor Jerry Sanders had advocated tying the rate only to Treasury securities.

The exact financial effects of the lower interest rate are hard to gauge. The pension system’s actuary has indicated that lowering the DROP rate would reduce the pension system’s expenses by tens of millions of dollars, just counting the current DROP members, who now number about 1,100.

The city’s chief operating officer, Jay Goldstone, estimated that dropping the rates to 4 percent would reduce the city’s retirement payment by about $3 million a year. However, there are several complicating factors that make it difficult to determine the exact effect on the city’s bottom line.

The change will likely lead many current DROP members to retire and sink that money into annuities. If they do so before the new rate takes effect July 1, they can lock in the 7.75 percent rate for the life of the annuity. (Their other option is to withdraw the DROP money from the pension system when they retire.)

Police and fire officials predicted an exodus of veteran public safety workers, though the city may have to intervene to raise the rate.

Brian Marvel, president of the police union, said an informal poll suggested that between 40 and 70 police employees now in DROP would retire before July 1. He said that could cause a staffing crisis down the line, especially since he said the department is losing officers every month. The city also voted recently to cut the size of police and fire academies in half.

“You’re eventually going to reach a breaking point,” Marvel said.

(Correction: The original version of this story incorrectly stated Franklin Lamberth’s last name. We regret the error.)

Please contact Rani Gupta directly at rani.gupta@voiceofsandiego.org with your thoughts, ideas, personal stories or tips. Or set the tone of the debate with a letter to the editor.

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