Another Pension Fund in the RED

Wednesday, August 17, 2005 | This is part one in a four-part series.

In the shadow of the fiscal scandal that has left San Diego's City Hall in a legal and political quagmire is another billion-dollar pension problem.

This one sits just down the road at the county of San Diego.

A review of San Diego County's financial records and interviews conducted by the Voice of San Diego suggests the county's pension situation may be putting as much of a basic financial burden on its government operations as the city's has without the legal scandal and allegations of misconduct to accompany it.

A massive pension enhancement for county employees in 2002 torpedoed the once surplus-heavy San Diego County Employees' Retirement Administration. Three years after that benefit increase, the county's $1.2 billion shortfall in its pension system continues to worsen even as officials invest far more taxpayer dollars into the fund than they did over the entire past decade.

And the costs of that investment are clear. The county, in 2001, only needed to set aside 7 cents in the pension for every dollar it paid sheriff deputies in their salary. This year, however, the county is putting 29 cents in their pensions for every dollar it pays them as a salary.

Supporting the pensions of the county's other employees has come with a similarly dramatic increase in cost over the same period.

But increased taxpayer contributions to the pension fund haven't been the only part of the county's obligations to it in recent years. County taxpayers will now have to pay off $1.19 billion in debt from pension obligation bonds - and will still be making payments on some of it for 27 years.

It's a dramatic change from yesteryears. For two years - 1999 and 2000 - the county was so confident of its pension system's health that it did not put any taxpayer funds into the retirement savings pool.

But because of the benefit increases, investment losses and mistaken assumptions, the pension deficit forced the county to dip into taxpayer funds. In fiscal year 2004, the taxpayer payment to the pension fund was $194 million - almost the exact cost of the county's entire public works department this year, which manages airports, street lights and infrastructure for the vast unincorporated area of the county.

In September of that same year, budget cuts forced the supervisors to eliminate 300 vacant county jobs.

"Perhaps, in hindsight, maybe we should not have been as complacent as we were during the better years," said Supervisor Greg Cox, who represents the southern district of the county. "Right now, we should stay focused on what the contributions should be."

This year, the county made an advanced payment to its pension system of $271 million.

That's 18 times the size of the average taxpayer contribution to the pension fund during the years from 1995 to 2003.

And yet, even with this investment - the taxpayer contributions and the sale proceeds from the pension obligation bonds - the county's pension deficit is projected to continue to grow for the next few years because of its financing plan.

For the third time in four years, the county pension's funded ratio is expected to dip below 80 percent. The county's official advisors have warned that funds with ratios below 80 percent are considered to be in the "red zone."

The pension fund's advisors, in fact, recommended a change to the county's assumptions this year that would have immediately dropped the funded ratio into the red zone.

"The county has been the beneficiary of the fact that the city has been gobbling up all the publicity about pensions in the area," said Rick Roeder, who was the county's official pension actuary for 14 years until 2004. "But the county has made its required payments. You wouldn't say that a person who has been making his payments every month on his mortgage is in financial dire straights."

Those payments, however, have never been as high as they were the last two years.

What happened?

By all indications, the county's pension system was very healthy - if not exemplary - throughout the decade ending in 2002. But in February 2002, county supervisors granted themselves and their employees a pension enhancement that not only benefited workers from that day forward but retroactively as well.

The benefit increases that year were considerable. Employees who had been working under the presumption that they would receive 2 percent of their highest average salary multiplied by the number of years they worked, suddenly had the opportunity to opt in to a program that gave them 3 percent.

For an employee who had worked 25 years and expected a final average salary of $40,000, that meant her expected annual pension instantly went up from $20,000 to $30,000.

"If people say that city employees have Cadillac pensions than they should say that county employees have Rolls Royce pensions," said Michael Conger, a lawyer who has carved a niche in the local legal environment successfully suing public pension systems.

Applied to the entire county staff, the 2002 deal immediately pushed the pension fund into a deficit of $1.25 billion. Suddenly, a fund flush with cash dipped more than a billion dollars into the red.

The funded ratio of the county's plan - a measure of how much assets it has compared to liabilities - plummeted from a healthy 106.8 percent to 75.4 percent in one year after the benefit enhancements.

Why did the Board of Supervisors decide to take on such a massive obligation?

County staff explained then that "approval of the recommended actions will significantly enhance the county's ability to attract and retain the best and the brightest employees," according to records of meetings in February 2002, when the board approved the measure.

Cox said the county had trouble keeping quality employees.

"The pensions we offered prior to 2002 were adversely affecting our ability to recruit and retain upper level managers," Cox said. And, moreover, employees working next to each other were sometimes expecting wildly different pension benefits.

"We needed to try to bring everyone up to the same level," Cox said.

But the most immediate effect of the benefit enhancements was actually a mass exodus of employees.

An average of 30 employees had retired from the county every month until the retirement enhancement took effect March 7, 2002. From March 8 to June 21 of that year, 813 employees decided to cash in.

The retirees' new benefits pushed a debt onto the county's balance sheet that it hadn't seen before and the county reacted immediately by seeking a loan - specifically, the sale of $737 million in pension obligation bonds. No public vote was needed because pension obligation bonds fall under one of the few exceptions to the California Constitution's requirement that residents sign off on bond issuances.

The bonds allowed the county to avoid a massive payment to the fund in 2003, but in 2004 the county's advisors requested that it inject millions more in taxpayer dollars than it ever had.

So, just like two years before, the county again went to Wall Street. The loan's proceeds came just in time as the county was only days away from having the effects of a large investment loss further worsen the shortfall between how much the county owes retirees and how much it owns in pension fund assets.

But the two trips to visit bond buyers have left the county with a separate debt of $1.27 billion.

Not so for the county, which still enjoys exceptional credit ratings.

Taking on the extra debt hasn't been a problem either, said Don Steuer, the chief financial officer for the county. Steuer said he and the other administrators have had no trouble absorbing the massive bill sent to them by the retirement system.

That's another difference between his operation and the city, which orchestrated a deal with its pension board to avoid a massive payment to the pension system. That deal is now being reviewed by multiple criminal investigators.

Steuer said that for the county, there was no sticker shock when the pension bill came.

"We planned for it. It is a percent of payroll and we assess the cost of it across the entire enterprise," Steuer said.

And the county, Steuer said, was able to take advantage of a strong credit rating to sell pension obligation bonds, which provided the county with "significant economic savings."

In fact, low interest rates did allow the county to invest in its pension plan and save an estimated $132 million - money that would have gotten sucked away by the fund's ever growing liabilities.

Pension obligation bonds have been seen by many across town in the city of San Diego as a way to put to rest some of its constituents' and retirees' worries about that pension plan. Many in the city long for the day when it can again approach Wall Street to talk about things like pension obligation bonds.

But those bonds are not without their costs.

San Diego County now pays a yearly bill on its pension obligation bonds of more than $63 million.

Added up, the annual cost of the county's pension system has reached a much higher level than the supervisors were told it would when they approved the 2002 benefit enhancement.

That year, county staff reported that the fiscal impact of their decision would mean an ongoing payment of $32 million that would begin in fiscal year 2003-2004.

That turned out to be about a seventh of the true bill.

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Part Two: San Diego County gambles on Wall Street .