The Morning Report
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Monday, April 20, 2009 | It’s been a while since a San Diego mayor has been accused of tampering with the pension system.
But Mayor Jerry Sanders’ recent announcement that he is replacing three pension board members appointed before he took office has raised concerns that Sanders is angling to revise a relatively unknown aspect of the pension system.
Eliminating a provision known as “the corridor” could save the city tens of millions of dollars on its annual pension payments during upcoming years, softening the blow to the city’s budget at a time the city is dealing with flagging tax revenues. But it also raises fears that the city could repeat the mistakes of notorious deals that led the city to underfund the pension system.
Then, like today, the city was reeling with budget problems. City officials looked to the pension fund to ease its immediate financial problems, ultimately worsening the long-term health of the fund — and the city.
William Sheffler, one of the three pension board members who won’t be reappointed, said he found it curious that Sanders proposed replacing the trustees around the same time his staff started discussing the provision.
“It kind of smacks of an attempt to influence the board,” he said.
Sanders’ chief operating officer, Jay Goldstone, said the replacement of the board members had nothing to do with the corridor, noting that the mayor had called for the trustees to resign shortly after he took office.
The corridor has been in place since at least 2005, though officials with the San Diego City Employees’ Retirement System don’t know exactly when it took effect.
City officials say the pension board, while considering the effects of its decision on the retirement plan, should also account for the effect on the city.
April Boling, an accountant who led the Pension Reform Committee, said the same rationale was used to justify the pension underfunding deals known as Manager’s Proposals 1 and 2, the now-infamous pension funding agreements of 1996 and 2002.
“That was exactly the argument in MP-1 and MP-2,” she said.
The city’s annual payments to the pension system are based on the fund’s unfunded liability as of June 30 the previous year. To temper wild swings caused by especially bearish or bullish markets, the system employs a common actuarial technique known as smoothing to flatten out the peaks and valleys of its investments.
Smoothing means that during a typical down period, the actuarial value of the pension system’s assets will be higher than the market value of assets, the amount the pension system would receive if it sold off all its holdings. Smoothing ensures a smaller unfunded liability — and therefore a smaller annual pension payment — when the pension fund’s assets are down.
The corridor is meant to make sure the smoothing doesn’t mask a significant decline in the pension fund and that the actuarial value of assets doesn’t get too far out of line with the market value. It requires the actuarial value to be between 80 percent and 120 percent of the market value. When the pension fund’s assets are hard hit, the corridor requires larger pension payments than would be calculated without a corridor.
Boling believes if the board got rid of the corridor, it would be akin to MP-3.
“SDCERS should not lower the bill it presents to the city on the grounds that it can’t pay the bill,” she said.
The city’s pension payments are being closely watched because of its budget crisis. The pension system’s losses since the end of the financial year June 30 won’t affect the city’s payment for the 2009-10 budget year.
But the recent losses will be factored into the city’s annual pension payment for the 2010-11 financial year. Depending on how the market performs, that figure could climb to $250 million in 2010-11, nearly $100 million more than in the upcoming budget year.
Getting rid of the corridor could shave tens of millions of dollars from that figure, a provision that proves attractive as city officials are already dealing with lackluster sales and property tax revenues.
The corridor could come up when the pension board hears a report from its actuary later this year on how other government pension systems are dealing with the financial crisis, said David Wescoe, the system’s administrator and CEO. But he said no votes are scheduled on the corridor.
Goldstone said he has queried SDCERS staff members about the effects of the corridor. He said he hasn’t talked to any board members and the mayor hasn’t taken a position on the issue.
“I’m just trying to at least gather enough information so if we want to make a recommendation to the SDCERS board when they’re considering this issue, we’ll at least have some facts that can support our position,” Goldstone said.
Goldstone said he has been asking about the corridor in conjunction with the pension system’s schedule for paying off its debt. Goldstone said he’s asked what the effect would be if the city adopted a longer schedule, such as that used by the California Public Employees’ Retirement System, and maintained a corridor, or if the city kept its current schedule and dropped the corridor. (He said the city isn’t advocating for a longer payment schedule.)
The argument about the corridor is essentially whether the city should pay more now or pay more later. Dropping the corridor would lower the city’s annual pension payments in the short term. But it would increase them in the long run and ultimately, that would likely be more expensive because the city wouldn’t be earning returns on the money that wasn’t invested into the pension system.
This comes after years of reforms of the pension system geared toward undoing costly decisions that pushed the system’ burdens into future years to save present budgets.
Sheffler said changing the corridor at the city’s request would diminish the pension fund’s assets.
“It takes a whole lot longer to recover and get back to the whole funded status if we are not putting as much money into the plan as we should,” he said.
Boling recently spoke out about the corridor to the retired employees association. Her concern, she said, “is that this whole calculation is so arcane, new board members who may not be familiar with how this works could be convinced it’s not necessary.”
Goldstone said the new board members, whose appointments must be approved by the City Council, will pick up the issues quickly. He said the corridor is nothing like the pension underfunding deals.
“We will not be making deals or trading off decisions like was done in the past,” he said.
While corridors are standard practice in the private sector, Goldstone noted, they’re less common in public pension plans. He said adopting such conservative measures can hamper city services such as running libraries and parks and lead to higher water and sewer rates.
Goldstone said pension board members have a fiduciary responsibility to the city while, though not as great as their responsibility to plan participants, requires them to balance having sufficient assets with the financial pressures on the city.
Boling said the pension board’s fiduciary responsibility to the city should rank last among its considerations and well below its responsibility to the retirement plan and its participants.
“If there is a conflict between those two,” she said, “you must always come down on the side of the plan and the plan participants.”