Sunday, October 10, 2010

Why We Have To Make Tough Choices on Pensions

As you may have noticed, things are not going well between the city and our unions.

We have not reached agreement with our labor unions on new contracts, even though for most of the unions (including the police union and the Service Employees International Union) the contracts ran out last summer. Last week, all of our unions crowded the City Council chambers to speak about the value of their work and their concern about our negotiating position; and on Monday, SEIU plans a march on City Hall before the council meeting.

While I can’t speak publicly to the specifics of the labor negotiations going on right now, I can talk about what is on the public record – the changes in the compensation policy that the City Council approved last spring. I’d also like to take some time in this blog to explain why I supported those changes – and why I think those changes are important in order to actual protect our ability to pay out good wages, benefits and pensions to our city employees in the long run.

I know that our city employees are very unhappy with the City Council’s bargaining position right now. Our city employees feel like they are being asked to bear an unfair portion of the burden of the financial downturn. They don’t feel as though we value them. And they feel we are being inflexible at the bargaining table. Under the circumstances, these are all understandable feelings and I respect those feelings, probably more than our employees know. I am sure that if I were a full-time city employee I would feel the same way.

But I do want to explain publicly why I supported the changes in the Council’s compensation policy. Frankly, I don’t expect that what I say in this blog will change how any our city employees feel about what’s going on. I totally understand that and I respect it. But I would like both our city employees and the rest of our constituents – many city employees are constituents – to understand where I’m coming from. It would be a disservice to all these constituents, city employees included, not to do so.

I am not interested in placing the burden on the employees just because I think they should pay more. Rather, my goal to make sure that our employees’ pensions are not at risk in the long run – and to make sure that we will have the money to pay competitive wages to our current employees even as pension costs go up.

Last spring, the City Council voted to change its official compensation policy to add two components – first, to ask our employees to once again pay their legally defined “share” of pension contributions (9% of salaries for public safety officers, 7% for everybody else); and, second, to seek a second, lower “tier” of pension benefits for future employees.

This move came as something of a surprise to a lot of our employees. Many were more than surprised; they were hurt. Oftentimes this summer and fall, they have sought me out to ask why we have chosen this path. Don’t we value them? Aren’t we worried about falling so far behind “the market” that it will be hard to recruit and retain talented employees? What’s going on?

I do value our employees – and I never say so often enough. Our city employees work hard serving the public, and most of them could make more money working for another city or public agency. Our public safety officers put their lives on the line for us, and most of the rest of our employees work hard during long careers for relatively modest pensions. And yes, I am worried that Ventura – a venerable city that prides itself on providing excellent service to the public – won’t be able to recruit great new employees nor keep talented ones we already have.

But I’m also worried about the long-term future of our City’s ability to pay pensions to our employees. As a member of the City Council, I am one of seven stewards of the employees’ retirement funds. One of my goals is to make sure that when they retire, 10 or 20 or 30 years from now, the money will be there to pay them the pensions they have earned. And that we won’t have to “short” our current employees in order to pay the pension bills.

This is something that is almost never discussed openly by the City Council or our employees. In our day-to-day conversations and our labor negotiations, we all assume that the money will be there when it needs to be. But as we have learned in the auto industry and other “mature” business sectors, this isn’t always the case.

Part of the reason I am worried is that the world of California public pensions used to be very simple, but now it has become very complicated in a way that places our ability to pay pensions at risk in the long run. At the very least, paying the pensions our current and recently retired employees employees have earned will become much more expensive – and that will make it much more difficult for us to pay our current employees competitive wages and, in fact, to provide public services of any kind.

In the old days, cities contributed money to a system such as CalPERS, the California Public Employment Retirement System, on a regular basis. PERS invested the money in safe things like bonds and averaged an investment return of about 4%.

Virtually all employees received a guaranteed pension, which was pegged to some variation of the 2% formula – you’d get 2% of your annual salary in retirement times the number of years you worked. Most employees retired at 60, though police officers and firefighters tended to retire earlier – at 55 or sometimes even 50 – because you didn’t really want those folks out on the streets at an advanced age. Somehow it all worked out – just like, somehow or other, Social Security always worked out.

But, like Social Security and most other things associated with finance, the world of public pensions has gotten a lot more complicated in the last 30 years.

At cities and other agencies that belong to PERS, salaries have gone up, retirement ages have gone down, retirees are living longer, and, in the case of public safety officers, the old 2% formula has been increased to 3%. Obviously, all these changes have increased the pressure for PERS to deliver greater investment returns – and turned PERS into a very different kind of investor than it used to be.

The whole PERS story is probably best laid out by Ed Mendel, an old friend of mine from my journalist days, who is now a blogger specializing in California pensions. In one recent blog, Ed noted that the world changed dramatically in 1984, when the voters passed Proposition 21, which repealed a law limiting PERS to investing only 25% of its portfolio in stocks. That opened the way for PERS to increase its investment returns by participating in the boom stock market of the ‘80s and ‘90s – which, in turn, increased the pressure to improve retirement benefits for California’s public employees.

As Ed points out in his blog, in 1980 PERS received twice as much revenue from member and employer contributions ($1.6 billion) than from investment returns ($800 million). In 1983, when the stock market started going up, that flipped; PERS got $1.8 billion from contributions and $2 billion from the portfolio.

PERS then rode the exploding stock market all through the ‘80s and ‘90s. By 1998, PERS got $3.7 billion in contributions and $23 billion in investment returns. To reiterate: In 1980, PERS got two-thirds of its funds from member contributations. Less than 20 years later, PERS got 85% of its funds from investment returns.

It was about this time that the state first permitted the 3% formula for public safety officers and also lowered the allowable retirement age for non-public safety personnel from 60 to 55. Most cities in the state quickly adopted both of these options, including Ventura (though Ventura adopted the 3% rule more gradually than most). However, because the stock market continued to skyrocket, cities did not have to pay any “price” at all for these increases – at least not right away. During the Internet boom of the early 2000s, investment returns were so high that PERS actually didn’t require cities to make contributions – at the exact same time that pension benefits were going up and retirement ages were going down.

Then, of course, came the Internet crash and the whole rocky period of the ‘00s, when everybody got caught in the housing bubble. The net result of this is that CalPERS has not been getting the same return it used to – even though costs are now much higher, based mostly on the assumption that returns will remain high.

According to Ed Mendel, CalPERS returns have averaged only 3.1% for the last decade. Yet PERS continues to operate on the assumption that its long-term rate of return will be 7.75%.

Even if investment returns do total 7.75% from now on – extremely unlikely, in my view – our PERS cost is going to go up, because PERS has to cover the cost of investment losses the last couple of years. My best guess for what’s going to happen in the next few years is this: Even if our city revenue starts going up again in a couple of years, those revenue increases will be completely eaten up by increased PERS costs.

Under the circumstances, I think the only responsible position to take is that, whether we like it or not, we will have less money available for salaries and pensions over the next few years – not more, or not even the same amount we have now, but less.

And if investment returns are lower – say, 3% or 4% or 5%? Then the bill from PERS goes way, way up – far more than our revenue. This will affect not only our ability to pay pensions to those who are retired, but also our ability to pay competitive wages to those who still work for us because more and more of our money will go to pay pensions.

If you’re a taxpayer advocate, this is probably a satisfying “I told you so” moment. But even if you believe – as I do – that public employees do important work and deserve a good pension, you’ve got to be really worried.

What happens in, say, 2030, when many of our current employees will be expecting their hard-earned pension checks? When we have 1,000 or 1,200 retirees instead of 600? When we may have to balance the cost of those increased pensions on the backs of people working for the city at that time? And when PERS investment returns have not come anywhere close to 7.75% for years or maybe decades?

How big will the bill be then? Will we be able to afford to pay that bill – and still also provide police and fire service, and pave the streets, and run the parks, and everything else? And provide good wages and benefits to the dedicated employees who do the work?

I don’t know the answer to that question. The fact that I don’t know the answer to that question worries me a lot. And I believe it should worry our city employees a lot as well.

I know that the current labor negotiation is an extremely emotional issue for everybody. I know that many city employees are worried about how they’re going to pay their mortgages or their rent in the future. I know they do not feel valued and they fear we will lose good employees to other cities. All these things concern me too -- a lot. Our employees do great work and everyone in town needs them to continue doing so. And most of our employees are great citizens of our community and we want to continue that too.

But the one thing, I have noticed, that the employees do not seem to be worried about is whether the money will actually be there to pay their pensions in 2020 or 2030 or 2040. Our employees tend simply to assume that they will receive what they are legally entitled to.

But in my opinion, there is no guarantee the money will be there and there is considerable risk that it won’t be. Furthermore, for younger employees, providing those pension benefits to retirees in the future will mean we probably won't be able to provide wage and benefit increases for those still working. This is something that should concern all of us just as much as taking a pay cut now – maybe more. And as one of the seven stewards of the city’s pension system, I believe we must pay attention to this festering problem.

That’s why I believe it’s necessary to take steps to restrain long-term pension costs now – in order to make sure that our current and future retirees will get their pension checks far into the future and our current city employees will not have to pay the price for increased retirement costs. Yes, there are costs and risks to this approach. In the short run, our employees will have to give something up and it will be that much harder to pay the mortgage or the rent. But I believe it is equally important to make the tough choices now to ensure that our employees actually receive their pensions decades from now. And to make sure that we will be able to pay our current employees good wages and benefits, instead of sacrificing their well-being to pay the PERS pension costs for those who are already retired.

One of the things I hear most often from our employees is why we in Ventura seem to be worried about this when nobody else is. After all, most public employee labor contracts negotiated in the last year have had something between a 0% raise and a 3% giveback. If we cut compensation more than that, they say, we will become less competitive and we will lose good employees. So why are we seeking higher compensation cuts when nobody else is?

This is a good question. My answer, frankly, is that I don’t think the other agencies are looking at these issues straight-up – or they’re not being straight-up with the employees.

At Ventura County (which has its own separate retirement system), most employees agreed to start paying 3% of their retirement cost. That’s great. But the county retirement system’s investment portfolio has lost something like 25% of its value, and with lots of retirements in the offing, county pension costs are estimated to increase 50% in the next five years. Clearly, more givebacks will be necessary.

Another tactic we often see is for a city to promise future increases in salary -- say, 2-3-4% in the "out years" of a five-year contract -- in exchange for zero increase or a giveback in the early years. But this doesn't really solve the problem, because other cities are going to be facing huge increases in PERS costs just as we are. When you ask the elected officials in these cities how they are going to pay for the future salary increases, they'll say: “We don’t know.”

In such a situation, the price of short-term labor peace is to kick the can down the road, assume that somehow or other more money will be available in the future, and ignore the fact that there are looming long-term risks.

I cannot, in good conscience, do the same. Our employees are entitled to these pensions and they deserve them. But they also deserve straight talk about the future from their City Council.

It would be very easy for me to pretend there is no long-term problem and therefore no reason to make tough choices now, just as our neighboring city did. Even though this would make me more popular with the unions, it would be fiscally irresponsible of me – and, frankly, pretty unfair to our hard-working employees. Because, in the end, I won’t pay the price for that fiscal irresponsibility. That cost will be borne by our employees, both current and retired.

Simply put, it would be wrong of me to reap the short-term political benefit of pretending there’s no problem, and then dump the problem on my successors and on our employees themselves in the decades ahead.

As I said, I know our city employees are unhappy with what’s going on and angry at me and my fellow councilmembers. I don’t expect my explanation here to change that. But I do hope both our employees and our other constituents recognize that making tougher choices now will create a more solvent city – and a more stable retirement system – in the future, and that everyone – most of all employees – will benefit from that stability.