Encinitas’ unfunded pension liability pegged at $39 million

ENCINITAS — The city is on the hook for $39 million in unfunded pension liability, according to a new analysis ordered by the city and presented at a March council meeting. 

The $39 million figure is an estimate of how much Encinitas will have to pay to cover its pension obligations over the long term.

This week, Mayor Teresa Barth said that the city’s unfunded pension liability is a topic that demands regular council attention. But she cautioned against “doom and gloom,” noting that Encinitas doesn’t have to pay the bill tomorrow.

“This is overly simplistic, but I tend to think of the topic like a home mortgage…to be paid off in the long run with careful planning,” Barth said.

She also said that many cities are in peril because of pension costs, but said that Encinitas is in better shape. This is in part because the city’s burden for medical costs isn’t as great as most California cities. And the city is in a better position to contribute more toward pensions if need be, because Encinitas’ revenue hasn’t declined as much as other cities during the economic downturn, Barth said.

“I fully recognize that there are a lot of cities in trouble right now,” Barth said. “We’re not one of them.”

Barth said that pensions would likely be an issue discussed during budget workshops in the next few months; the topic isn’t on a future council agenda.

Encinitas has 237 full-time employees, and they’re divided into four categories. Of them, lifeguards’ unfunded liability clocks in at $300,000, the San Dieguito Water District totals $4.2 million, firefighters are at $12.6 million, and a miscellaneous category, a group that includes 152 employees, represented $21.9 million.

City Manager Gus Vina said that he ordered the analysis on pensions after councilmembers asked how much the city’s unfunded liabilities added up to.

Vina said he expects the unfunded pension liability to fall over the long term thanks to the city passing pension reform last year. As a result of city action, retirement benefits were reduced, particularly those who retire before the age of 63.

“We’re on an improved trajectory,” Vina said.

Further, the state recently passed a similar law called AB 340 that went into effect at the beginning of the year for most cities. For Encinitas, the law went a step further than the city’s pension reform by cutting retiree benefits slightly more.

With both state and city reform, the city now has three tiers for its pensions.

To illustrate the differences, consider a 30-year-employee earning $70,000 who plans to retire at 60. If hired before 2012, this employee would draw a $56,700 pension each year.

But new city hires under the same circumstances who are already a part of the state’s pension system would draw a $39,600 pension. If they aren’t already enrolled in the state’s pension system, new hires would get a pension of $35,640.

Another reason Vina said unfunded pension liability would decrease in the future: All employees will be required to pay more toward their pensions.

In the past, Encinitas paid half of the employees’ 9 percent contribution to the state’s pension system. When that contract expired, Encinitas renegotiated so that all employees will have to pick up their full share.

Vina noted that the city isn’t borrowing money to cover unfunded pension costs.

This year, revenues in Encinitas are $52.5 million and expenditures are $49.9 million. More than four-fifth of the city’s revenue comes from sales and property taxes.

The city’s pension costs have increased during the past five years. The city contributed $2.9 million in 2008, $3 million in 2009, $3.2 million in 2010, $3.3 million in 2011 and $4 million in 2012.

Last year, 13 employees retired.

Vina said that the city plans to pay off its pension liability in about 21 years; however, that’s a moving target. Unfunded pension liability fluctuates depending on investment returns.

Encinitas is part of CALPERS (California Public Employees’ Retirement System). CALPERS investments must grow by an average of 7.5 percent for the system to stay in the black. But CALPERS’ investments came in much lower than that during the recession, dramatically driving up cities’ unfunded pension liability.

However, with the economy improving, CALPERS posted a 13.3 percent rate of return in 2012.

Some, including Ed Wagner from the Encinitas Taxpayers Association, argue that CALPERS’ expected rate of return is too high given the volatility of the market.

Wagner, a chartered financial analyst who manages stock market money for mutual and pension funds, said that Encinitas should consider the possibility of a 4 or 5 percent rate of return since poor investment returns may continue in the future. Using what he believes are conservative return assumptions, he estimates Encinitas’ pension liability could be as high as $74 million to $85 million.

Wagner said the analysis given to council in March was a welcome development. But he’d like to see another expert analyze Encinitas’ pensions to show, “just how large the hole is” if strong investment returns don’t happen.

“Encinitas deserves an honest look at its pensions,” Wagner said.

To bring down pension costs, Wagner recommended a hiring freeze as a short-term step. Long term, he said that the city should develop a financial plan to pay off unfunded liability under a range of investment return scenarios, and possibly switch to a 401(k) plan for new employees.

According to a San Diego Taxpayers Association report issued in February, out of 17 cities ranked for unfunded pension liability per household, 10 cities ranked higher than Encinitas.

However, the report used a different accounting method than the analysis that was presented to the city.

The analysis presented to the city didn’t specify where Encinitas ranked in the region.

John Bartel, who presented the overall picture of the city’s pension situation at the March council meeting, credited Encinitas’ pension reform last year with improving the city’s budget outlook.

Bartel said the city shouldn’t immediately sound the alarm over its unfunded pension liability, but rather look at it as a long-term obligation.

“What I am suggesting is that you ought to have a plan for paying it off over a reasonable period of time,” Bartel said at the meeting. He’s a professional actuary who has analyzed more than 70 cities’ pensions.

If CALPERS investments perform poorly and Encinitas fails to cut its unfunded pension liability, there could come a time in a decade or two when payments ramp up, Bartel said.

“It’s like paying the minimum on your credit card,” Bartel said.

Although his presentation was largely to educate council, he also presented several recommendations. Namely, he said that over the next decade or two the city should look at reigning in expenditures and using money saved to pay down the unfunded pension liability. It’s all about finding a balance because the city has to maintain a healthy level of services and build new infrastructure.

He noted that pension reform is challenging in light of the fact that pensions promised to employees are a “vested right” under California and federal law. That’s why pension reform generally targets new employees.

“The California Supreme Court has, by and large, said when you hire an employee they must be entitled to the benefit formula that they have when you hire them for the rest of their career, unless you give them something of equal or greater value,” Bartel said.

Consequently, the savings from pension reform will be felt down the road, he said.