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Thursday, Sept. 17, 2009 | There may come a day when decisions involving arcane pension rules don’t mean tens of millions of dollars to the city of San Diego’s bottom line and likely the jobs of city employees.
That day is not Friday.
The concept, not paying today’s pension bill until some other tomorrow, has spurred opposition to recall the underfunding plans of a not-too-distant past, schemes that put the city on a path to fiscal ruin and national embarrassment. Indeed, the change that the board of the San Diego City Employees’ Retirement System is considering Friday will weaken the pension plan.
Yet proponents of the accounting change say it recognizes the catastrophic hits to investments taken by the stock market’s recent collapse; other public pension plans have already made similar decisions.
And without the change, City Chief Operating Officer Jay Goldstone said, it is likely to compound the number of city employees that will lose their jobs in the next budget cycle.
“There would be $30 million of budget cuts we’ll have to make,” Goldstone said.
Though the Mayor’s Office claims its staying away from SDCERS’ decision, it sought to form a private commission to study the effects of changing the accounting rules earlier this year. It is unclear what, if anything, that commission found.
The accounting change involves two words that mean something different to actuaries than anyone else: Smoothing and corridor.
Running Down the Corridor
Like politicians, actuaries don’t like surprises. Unfortunately, the bears and bulls on Wall Street are full of them.
Actuaries assume investments will increase and they value pension assets and liabilities accordingly. But return isn’t constant every year. Actuaries can correct for this volatility by phasing investment gains and losses into the values of pension plans over time. It’s called smoothing.
Actuaries like smoothing because it keeps a pension plan’s value from zigzagging based on Wall Street’s whims. Politicians like smoothing because it keeps their payments to the pension plan from zigzagging as well. How much a pension plan’s sponsor owes depends on the plan’s liabilities. When there’s a drop in investment returns, smoothing means a sponsor pays for that drop over time instead of all at once.
But smoothing can get out of hand. In times of recession, smoothing could mask substantial decreases in a plan’s value instead of leveling normal losses. The value that actuaries give to a plan would differ too much from the plan’s worth on the open market.
A second mechanism, called a corridor, keeps smoothing in line with reality.
In economic downturns, the corridor requires the actuarial value of the pension plan to be no more than 120 percent of its market value. Eclipsing that ratio means the pension’s sponsor, in this case the city, must correct it. Oftentimes, that leads to a lump sum payment.
The city of San Diego has breached its corridor, and as a result next year’s contribution to the pension fund is estimated at $224.8 million.
The Corridor Means the Pension Plan Is Stronger
In July, SDCERS’ board heard a presentation from its actuary on ways other public pension plans were dealing with their corridors and options it had if it wanted to make changes.
The reason? This is the first time San Diego has confronted its corridor and board members should learn what it’s about, said Mark Sullivan, SDCERS board chairman and a detective sergeant in the San Diego Police Department.
On Friday, SDCERS will consider essentially eliminating the corridor on a temporary basis, a plan endorsed by its actuary Cheiron. Doing so would lower the city’s payment to $193.2 million next year.
The reason? SDCERS board members should have a chance to make changes if they want, Sullivan said.
“There’s really nothing mysterious about it,” Sullivan said. “It’s just a matter of making a decision on something we’ve never faced before.”
It’s clear the pension plan’s strength, financial and otherwise, benefits from keeping the corridor as is:
- The plan’s actuary states it’s the more fiscally sound decision.
- The less the city pays into the plan now, the more it will give up in investment earnings. Those earnings will have to be made up later.
- If you think the stock market will rebound, an infusion of cash into the plan now is akin to the pension system “buying low” on its investments.
- Some of the city’s past pension reformers say changing the corridor goes against the protections they attempted to institutionalize. Two members of the 2004 Pension Reform Committee, Chairwoman April Boling and William Sheffler, have spoken out.
“This kind of tinkering was not anticipated with the pension reform committee,” said Sheffler, an actuary and former member of SDCERS’ board.
- Here’s the most elementary reason: What’s the point of a having a corridor if you just change it when the going gets tough?
The Corridor Means the City’s Budget Is Weaker
Anywhere from half to two-thirds of public pension plans do not have corridors, according to Keith Brainard, the research director for the National Association of State Retirement Administrators, a Texas-based nonprofit.
Some of those that do, such as the California Public Employees’ Retirement System, the state’s largest fund, have widened their corridors already this year. It’s a way, Brainard said, to recognize the impact of the market’s drop.
“In and of itself, there is nothing wrong with what the city of San Diego is trying to do, as long as they continue to make their contributions year after year,” Brainard said.
That brings up the question of what the city of San Diego is trying to do. At July’s presentation, listed as a “downside” for leaving the corridor as is, was that it “may force plan sponsors to take other actions that will be detrimental to SDCERS’ membership.”
Asked what that statement meant, Sullivan said that SDCERS should consider what happens if the city couldn’t make its required payment.
“Nobody wants to bankrupt the plan’s sponsor,” Sullivan said. “It does nobody any good.”
Sullivan emphasized that no one from SDCERS has had contact with anyone from the city about changing the corridor. All he’s learned about city finances has come from reports provided to his board and from the media.
That being the said, no one should underestimate the weight of the board’s decision. The city’s budget deficit will likely force layoffs of city employees next year regardless, Goldstone said. An additional $30 million hole unless the corridor changes will “exacerbate the situation,” he added.
“That is a detrimental impact,” Goldstone said.
In a speech on fiscal policy earlier this week, Mayor Jerry Sanders said the city would make its required pension payment “to the penny” and that the Mayor’s Office wouldn’t interfere with SDCERS’ decision.
Afterward he was asked how much the city owed on its pension bill.
“They’re going to make that decision on Friday, the pension board,” Sanders said. “The city can only get in trouble when it tries to move that one way or the other. We’ll make the payment they tell us we owe.”