Pension reform in San Diego.

• Author: Goldstone, Jay M.

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During the dot-com boom, the stock market was mushrooming and there was no end in sight. The euphoria was so great that people forgot about market cycles and corrections. As a result of rising stock prices and strong real estate growth, public pension plan assets grew, often to a point where plan assets exceeded plan liabilities, creating the misconception that employers could increase retirement benefits with no budgetary impact. Some employers increased retirement benefits to attract workers and other employers followed just to keep pace. It was a cycle that was doomed from the beginning.

One of the mistakes made at this time was the widespread practice of increasing the pension multiplier to give an employee a greater retirement benefit while at the same time lowering the retirement eligibility age. This provided a greater opportunity to retire earlier at a time when people are living longer. Instead of providing the incentive for early retirement, employers should have been encouraging employees to work longer.

During the frenzy in California, the state was eager to give employers the option of increasing benefits, and employers were eager to provide better benefits at no or low cost to the employees. Sometimes these improved retirement benefits were awarded in lieu of salary increases, and typically no one at the local level fully understood how the costs of these benefits are calculated and how much added financial risk they were assuming and passing on to future generations. Decision makers were probably told at the time that their pension plans were super funded and that they could use their surplus funds (assets in excess of liabilities) to pay for these added benefits far out into the future. And since plan assets were theoretically paying for the benefits, unlike salary increases, there would be no budgetary impact. It looked like a win-win situation: a great perk for employees and a freebie for the city

Now the euphoria is over. Fiscal year 2009 has closed, and officials at many jurisdictions are going to be surprised by their upcoming pension bills. While many governments are still feeling the budget stress caused by lower tax revenues in the past year, their annual required contributions (ARC) could increase by up to 25 percent over the ARC for fiscal 2010, in some cases, or even more. For many jurisdictions, that will mean millions of dollars going toward the pension payment instead of police, fire, libraries, park and recreation, and other vital services.

SAN DIEGO'S STORY

The decisions made by the City of San Diego in the mid 1990s regarding employee retirement benefits were probably not much different from those made at many other public agencies. The steps taken recently to start addressing San Diego's burgeoning pension costs will be steps public employers across the country will have to consider.

The problem actually began when the city faced a budget shortfall and elected to underfund its pension obligation as a means to balance the budget. This did not happen once; it happened twice. The results were disastrous. In the long term, these decisions led to a securities fraud investigation by the Securities and Exchange Commission, numerous lawsuits, and necessary corrective actions taken by the city to ensure this situation will never happen again. It ended up costing the city tens of millions of dollars, and San Diego became the poster child for bad pension decisions and inadequate pension disclosure.

It all started as a simple way of balancing the city's budget without making the tough budget decisions. The city sought approval from its pension board to pay less than the full ARC. The board was dominated by organized labor, and to secure their support, the city agreed to increase pension benefits--a deadly combination. To exacerbate the problem, the city never properly disclosed its pension deals and its true pension liability to credit rating agencies, issued...