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San Diego steers a dangerous course by underfunding workers' pension plan

The first rule for getting yourself out of a hole is, "stop digging."

San Diego is looking at its pension plan statement. It has a $283 million deficit and owes another $25 million to $75 million this year because its funding has fallen through an alarm level set in 1996 at 82.3 percent of the amount the City Actuary says is minimally necessary to provide the pension benefits it has promised to retirees.

The city's water and sewer infrastructure needs millions in repairs, normal operating expenses are required to keep the city running, and a $100-plus million judgment could be fully payable at any moment. The state has a $20-plus billion deficit and will likely cut the city's funding severely for the next few years.

The city just borrowed $190 million to build a lovely ballpark, wants to borrow another $200 million to build a new library, and has other wishes.

Since it can't pay for everything, what should the city not pay? According to the City Council's vote last week, it's the workers retirement benefits that will not be paid.

This is like not fixing your roof, postponing your kid's braces and defaulting on your mortgage so you can buy the Harley you've always wanted. What could possibly be more fiscally irresponsible?

On Nov. 18 the City Council voted to approve an agreement it reached with its labor unions to intentionally underfund for another seven years the already underfunded retirement plan. Why seven years? Coincidently, every member of the City Council voting for that measure will be term-limited out of office by then, so the next council will have to deal with the problem.

Employee benefits have been increased, but the city has not been paying into the system to fund them. Couple that with a tough bear market, and unacceptably poor past investment performance, the result is a pension plan that has only about 82 percent of the money required to ensure that city employees can retire securely. It is ranked as one of the worst funded plans in the state of California.

According to the fund's independent experts, the payment deferral (with the deficit accruing annual interest at 8 percent) will cause the pension plan to fall so low that by 2009 it will likely have only 52 percent of the money required to pay the claims of city retirees. The unlucky City Council of 2009 will face the sticker shock of owing up to a staggering $2.8 billion to bring the plan up to full value.

These same experts confirm that by 2009 the city's annual retirement contribution may be as high as $250 million. In 2001 the city had revenues of about $710 million and expenses of about $687 million. Assuming city revenues continue to annually grow at 8 percent, it could take more than 30 percent of the entire 2009 city budget just to cover the $250 million annual pension contribution and the debt service on the $2.8 billion owed (assuming it can be financed).

Some argue this is just a doom and gloom scenario and that a hoped for bull market will replenish the fund without the city having to make its payments; (remember, however, the 1973-1974 recession was coupled with a 50 percent decline in the stock market that took eight years to recover). Some have said that travel and tourism taxes will increase enough to provide for these payments. Others believe that since cities exist into perpetuity, retirement payments can be put off for future generations of taxpayers and politicians.

But according to former U.S. Department of Labor Secretary, Robert Reich, "Under funding poses an unnecessary and unacceptable risk for workers and retirees."

It also threatens bond ratings and ultimately may end up costing the city, employees and taxpayers much more money both in the short and long run.

Equally troubling as the decision was the process used to allow this vote to occur. During last May's "meet and confer" negotiations between the city manager and union representatives (who are also trustees on the Retirement Board), a deal was cut to increase current employee benefits "conditioned upon" the Retirement Board approving the agreement for reduced pension funding. In June, the city manager came before the Retirement Board with the agreement asking for approval.

The Board's Actuary and Fiduciary Council opined against it both for financial reasons and due to the ethical questions regarding trustees votes exchanged for current labor benefits.

The city responded by modifying the agreement to a minor extent and providing a written indemnification and hold harmless for all Pension Board members so they could vote without the potential liability which accompanies intentional under-funding of a pension plan. But the material concerns of the actuarial expert remained and he stated, "from a pure actuarial viewpoint, it would be best to hold the city to the existing Manager's Proposal."

On Nov. 15 the Retirement Board voted to approve the city's agreement anyway, with the dissent of two trustees, that of police representative Tom Rhodes and myself. The following Monday it was approved by the City Council, 8-1, with only Donna Frye in opposition.

For those of us in the investment industry, pension funding and management is serious business. There are no shortcuts to doing it the right way. Because so many people depend on the city's retirement system we must take the necessary corrective measures so beneficiaries will not be disappointed and future generations will not pay for past follies.

Shipione has sat on the City Funds Commission and Retirement Board since 1997. She is an investment advisor in La Jolla and has been in the financial services industry for more than 15 years.

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