San Diego City struggling with unfunded liability

SAN DIEGO — Resolving the San Diego City Employees' Retirement System's unfunded liability could require at least $200 million in pension obligation bonds, a charter amendment restructuring the pension board, and mortgaging city real estate.

The plan has $3.2 billion in assets and an unfunded liability of at least $1.1 billion.

All this for a plan that's had stellar investment performance over the three- and five-year periods ended May 31, according to recent investment operations audit by Mercer Investment Consulting, New York.

The retirement system hired both Mercer Human Resource Consulting and Mercer Investment Consulting Inc. last month to perform a three-part audit: an actuarial review, an investment operations audit and a "best practices" review to determine the cause of, and solution to, the unfunded liability.

The first of the three — the investment operations audit, dated May 18 — will be presented to the board this month. It praises the investment program as providing "superior performance" but offers some recommendations to lower costs, including the addition of index funds.

The fate of the city's pension system appears to rest on the work of the pension reform commission, created by Mayor Dick Murphy last July. The unfunded status loomed even larger then, when the fund had $2.7 billion in assets.

The commission was set up in response to trustee Diann Shipione Shea's complaints of underfunding, alleged investment irregularities and the city's alleged failure to disclose the funded status of its pension plan in proposed bond issuance.

Some of Ms. Shea's charges resulted in investigations of the city and the pension fund's consultant, Callan Associates Inc., San Francisco, by the Securities and Exchange Commission. Also, the U.S. Attorney General's office investigated the city.

The pension reform group has not yet finalized its recommendations to the City Council, said April Boling, who chairs the commission. She's also treasurer of Mr. Murphy's re-election campaign.

According to the most recent actuarial valuation, from June 30, 2003, the city plan is underfunded by $1.1 billion. Ms. Boling said the city needs to contribute at least $203 million this year just to keep the liability from growing further assuming no additional gains or losses.

But the city is expected to contribute only $130 million. And that's about $16 million more than its scheduled contribution. The $130 million is the result of a proposed agreement to settle a class-action lawsuit brought by city retirees.

The pension commission is expected to recommend that the city also issue $200 million in pension obligation bonds by the end of 2004.

In all, the commission plans to recommend that the city contribute $600 million over three years, Ms. Boling said, and it expects to recommend the bonds this year because of favorable interest rates.

In the next two years, the commission might recommend that the city use either pension obligation bonds or trust deeds secured by city real estate assets, Ms. Boling said.

Issuing the POBs might be daunting for the city, which was put on watch for a potential downgrade with a negative outlook by Moody's Investors Service in April. The report noted the downgrade was partly due to "questions about the city's financial management and the significant budget deficit the city was likely to face in fiscal 2005 as a result of the potential for significantly increased pension contributions."

Ms. Boling said the commission also agreed to recommend that the city's retirement board be reorganized, a move that would require a ballot measure to change the city charter.

Commission officials would reduce the 13-member board, whose members include employees and retirees, to seven, all of whom would be appointed by the mayor and the City Council, she said.

"They would all have a minimum education or experience in a relevant profession and could not have a vested interest in the plan," Ms. Boling said.

There is disagreement about how the fund got into this position.

"There's been differing opinions on what caused our system's liability," said Paul Barnett, assistant retirement administrator.

According to pension plan officials, the unfunded status is the result of benefit increases and a three-year market slump.

Some San Diego pension officials also differ with committee members on the actuarial formula used to determine the plan's funding level.

Also, some say city and plan officials should merely hold tight and let the plan's investment performance sail them out to calmer waters.

On June 30, 2000, the system was 105% funded, although the Ventura decision, a lawsuit affecting most of California pension plans, combined with a local court action, suddenly changed that number to 97%, Mr. Barnett said. (Under the Ventura decision, the California Supreme Court determined that increased employee pension benefits should be based not only on workers' salaries, but also on items such as car allowances and bonuses.) Both decisions had the effect of increasing the benefits.

At the same time, the three-year stock market decline hit the pension system hard, he said.

By last June, the plan was 67.2% funded. Since then, the market has improved, but even so, it will take another five years of improved market returns for the plan to be close to fully funded, because plan officials smooth fund liability over a five-year period.

Meanwhile, Ms. Shea and Ms. Boling contend the city has been systematically underpaying its contribution to the plan for years.

In 1996, the city and the pension agreed the city would increase its contribution by a half percent over the prior year as long as the funding ratio did not fall below 82%, Mr. Barnett said.

"In 2002, the floor of 82% was fast approaching and the city was concerned that if it fell below the floor, it would have to put in a lot of cash," he said.

So, they entered into a second agreement under which the city would begin making its full contribution in 2009, Mr. Barnett said.

"My concern is that since 1996 the plan has been intentionally underfunded," said Ms. Boling, who is chairwoman of a San Diego taxpayer association and a certified public accountant. Mr. Barnett disagrees.

In addition, rich pension benefits have contributed to the problem, Ms. Boling said.