City Hall's Shell Game
By Larry M. Edwards
The city’s retirement system is broken, and only drastic steps, not Band-Aid solutions, will solve a crisis that threatens to bankrupt San Diego—or require a taxpayer bailout. With a projected $1.5 billion deficit in its pension plan for the coming fiscal year, and an additional $1.1 billion deficit in promised retiree healthcare benefits, the city has dug itself into a deep financial hole. The only way out may be extreme measures, its harshest critics say.
The “B” word—which raises the specter of Orange County a decade ago—is not something you’ll hear anyone at City Hall utter publicly, but it certainly is being whispered. If not bankruptcy, how about a tax hike in the form of a pension levy that needs, by one interpretation of the city charter, only city council approval, avoiding that pesky little hiccup known as voter approval.
Through a sophisticated shell game that leaves even veteran financial analysts’ heads spinning, the city has, in the most charitable terms, obfuscated how pension and healthcare benefits are booked. And it has flat out lied about it in financial disclosure statements. Hence, the inquiry by the Securities & Exchange Commission and the criminal investigation by the U.S. Attorney’s office.
How did this happen? Faced with revenue shortfalls and budget deficits, the city robbed Peter to pay Paul, and the retirement system took the hit. It was exacerbated by a falling stock market, or so the city says.
San Diego is not alone in this. The debacle mirrors what’s happening throughout the country, in both the public and private sectors. San Diego County has a similar problem, as do other municipalities throughout the state. At the county, supervisors last month decided to issue $400 million in bonds to cover part of its own $1.4 billion pension fund deficit. It’s the third time in 10 years the county has borrowed to meet unfunded pension liabilities. And that $1.4 billion deficit doesn’t count nearly $700 million in investment losses, which may or may not be offset by investment gains in the next few years.
Meanwhile, within the private sector, large corporations are faced with multibillion-dollar retirement system deficits. Most companies no longer offer the expensive, defined-benefit plans the city has, instead opting for defined-contribution plans, such as a 401(k), where the sponsor’s liability is reduced substantially.
There often is more wiggle room in the private sector, so companies are dumping retiree healthcare benefits to prop up their bottom lines. The city of San Diego may not have that option.
In early March, Mayor Dick Murphy touted a program he says will get the city back on its feet, stemming the flow of red ink from its pension fund—red ink that was intentionally hidden not only from taxpayers but the city’s bondholders. But that program—secured by $500 million of city property—was put in place only after a figurative gun was pointed at the city’s head, a gun in the shape of a retiree class-action lawsuit and a downgrade in the city’s credit rating.
San Diego is now embarking on a five-step recovery program that ends the chronic underfunding that began in 1996 (and was reauthorized in 2002) and wipes out the $137 million shortfall created by the underfunding. The city claims the shortfall is only $98.1 million, but that figure is a year old and doesn’t include the $38.8 million that wasn’t paid into the system this year. The cumulative shortfall, combined with a shortsighted investment strategy and double-entry bookkeeping, has resulted in the projected $2.6 billion-dollar deficit.
The settlement did avert bankruptcy, at least for now, says attorney Michael Conger, who litigated the retiree lawsuit. “Without the city starting to deal with this underfunding problem, it would have been in bankruptcy in this decade,” he says. Conger also represents two retired probation officers who are suing the county for underfunding its pension plan. “For [county supervisor and mayoral candidate] Ron Roberts to criticize Dick Murphy over the pension problems is the pot calling the kettle black,” he says.
Meanwhile, the city’s settlement agreement only defers the problem until 2009; it is not a long-term solution, says Diann Shipione, a member of the San Diego City Employees Retirement System board of directors. By then, the current administration at City Hall will be gone, passing the buck—or lack thereof—to its successor, which is why Shipione cast the lone “no” vote when the settlement was presented to the retirement board for approval.
“It’s moving deck chairs on the Titanic from the right side to the left. The thing has already hit the iceberg,” she says.
It was Shipione, the only member of the board with a financial services background, who last September blew the whistle on the city’s phonied-up financial disclosure statements to bond rating agencies. While acknowledging the agreement to stop the underfunding is a positive step, she says it doesn’t address the $1.2 billion deficit, which she predicts will grow to $1.5 billion when the figures are recalculated on June 30, the end of the current fiscal year. The settlement only buys a few years before an even larger crisis surfaces, she says.
Critics like Conger and Shipione believe the city purposely let the problem get out of hand so it would have no choice but to take extreme measures—a tax increase or bankruptcy—rather than make the politically difficult decision to cut services, lay off employees and curtail the spiraling increase in employee retirement benefits. That’s why the notion of a tax hike is not farfetched, Shipione says.
City Attorney Casey Gwinn, who declined to be interviewed for this article, has been asked to investigate whether Section 76 of the city charter allows the city council to levy a pension tax “in the event of any great necessity or emergency” without voter approval. Conger believes that is the case, acknowledging the bankruptcy option could also resurface.
Another question under investigation by the city attorney’s office is whether city employees are vested in the healthcare program. Either way, it’s a Hobson’s choice, Shipione says. If employees are vested, the city will likely be sued by bondholders for not disclosing the $1.1 billion liability. If they are not vested, the city could be sued by the employees, many of whom value the lifetime healthcare benefit more than the pension itself.
“It would be nice if we were told [by the city manager] we were headed toward a crisis before it happened,” says District 6 representative Donna Frye, who in November 2002 was the lone councilmember opposed to increasing employee benefits and continuing the underfunding. (City manager Michael Uberuaga announced his resignation on March 16.) One thing the city must stop immediately, she says, is using closed sessions and secret memoranda of understanding and start discussing the pension system woes publicly. “Bottom line, we’re just going to have to be more honest. That’s probably the thing that’s in the shortest supply,” says Frye, noting the city is facing a $50 million budget shortfall for fiscal year 2005.
In April 2003, Frye asked for an audit of the retirement program, but she says the mayor refused to docket that subject for council discussion, effectively sweeping it under the carpet for another six months. Murphy declined to be interviewed, but said, following the lawsuit settlement, that the city pension plan “is secure and continues to be secure.”
Not so, says Shipione. The city has yet to address the $1.1 billion healthcare deficit, and that house of cards could tumble. Nor did the settlement roll back the increase in retirement benefits engineered by current employees, some of whom will retire in the next few years.
Ron Saathoff, for example, will not only be getting a pension for serving as a firefighter, he will get a pension for being president of the Fire Fighters Union, Local 415. Combined, he will get more than $100,000 a year when he retires, according to Conger, even though his salary as a firefighter is about $80,000 a year.
For most retirees, there is a retirement benefit cap of 90 percent of one’s highest salary, and a city worker retiring this year will receive, on average, a pension of $53,000 a year.
How did Saathoff get such a sweetheart deal? As a member of the retirement board, he was able to ensure that benefit. Although it was approved by the city council, it was contingent upon the retirement board voting to continue underfunding the pension plan, and he was in the majority that voted to do so.
Saathoff says the increased benefits were simply to bring the pensions of the city’s safety employees up to par with their counterparts in other cities. He also says that he per-sonally pays the full contribution for the union portion of his pension plan.
A fundamental flaw in the retirement system, critics say, is an inherent conflict of interest of the majority of the retirement board’s 13 members. And for any meaningful change to occur, the board must become fully independent. Today’s problem was created, in part, by having employee representatives negotiating increased retirement benefits, then voting to continue underfunding the pension plan as members of the board. “Other than Diann Shipione, every single one of them ought to resign,” Conger says.
Saathoff insists there is no conflict of interest and that Shipione and Conger have blown things way out of proportion. “It’s disconcerting to me and other members of the board that we have a member out there literally decrying this whole process, [saying] that the sky is falling,” says Saathoff, who blames the three-year slump in the stock market for the pension fund deficit. “The system is well-managed; it’s certainly well-invested.”
Conger disagrees. He contends blaming the stock market is “another complete falsehood by the city.” Over the past 10 years, he says, the pension board has announced a 9.11 percent annual return on its investments. Because the actuarial assumption calls for an 8 percent rate of return, the fund should actually have a surplus. How did it fall so far behind? Intentional self-deception. That rate of return also assumes reinvestment of capital gains.
But the city declares a surplus any year the rate of return exceeds 8 percent and siphons off that surplus to pay contingent retiree benefits and health coverage, rather than leaving it in the fund to make up the slack during lean years. Under this policy, the city actually needs a 12 percent return on its investments to keep from accruing a deficit, according to Conger.
“This year, they are going to siphon about $120 million right off the top if they [have a surplus], and they project they will,” he says.
Long term, the city is looking to the Pension Reform Committee to come up with alternatives. The committee’s report, due later this month, will examine the unfunded liability, the structure of the retirement board, the type of benefits the city offers and what the city can afford, as well as the possibility of future employees joining the state’s CalPERS retirement system.
Will anyone be listening? “If history repeats itself, then the committee’s recommendations will fall on equally deaf ears,” Shipione says.
“The Blue Ribbon Committee gave loud warnings about pension-plan problems in February 2002, and those warnings were completely disregarded by the mayor and council in November 2002,” she adds. “What you’re faced with here is that words don’t change the numbers, and the numbers are very bad and getting worse.”