Dick Murphy resigned on April 25 as the mayor of the second largest city in California, San Diego, which has become the poster child of public defined-benefit pension plan abuse.
San Diego has been referred to as “Enron By The Sea” by the New York Times, and Murphy’s lack of leadership and complicity with its pension plan travails caused Time magazine to recently recognize him as one of the three worst mayors in the country. A nearly $1.4 billion pension plan underfunding can do this to a mayor.
With Orange County looking at its pension plan being underfunded by as much as $1.5 billion by the first of July, it would serve us well to take notice of what’s happening south of our county’s border.
The participants of defined benefit pension plans will lay the blame on recent poor market performance. But one would be wise not to hang one’s hat on this excuse. An analysis of Contra Costa County’s underfunded pension plan found that only 2% of its $1 billion liability was due to market performance.
Another well-worn excuse is that every other pension plan in the country is facing the same underfunding issues. Well, not everyone is.
The state of Georgia’s two major public pension plans, the $42.4 billion Teachers Retirement System and the $12.4 billion Employees’ Retirement System, are fully funded, 101.1% and 100.5%, respectively (Institutional Investor, February 2005).
The state of Georgia is succeeding because it utilizes conservative asset allocations and actuarial assumptions. But what makes Georgia stand out is a statutory requirement that any increase in retiree benefits be immediately funded after they are authorized by the state Legislature. Brilliant!
In August 2004 the Orange County Board of Supervisors approved another extremely generous retroactive benefit that created another $300 million pension plan funding obligation. If the county had an ordinance in place requiring immediate payment, I sincerely doubt that it would have been approved.
I am reminded of the time I counseled a client who was living large and was complaining about being financially strapped. I casually mentioned that I followed the principal of not borrowing money to purchase depreciating assets, like an automobile. “Are you crazy? If I had to pay cash, I would never have purchased my new Corvette.” Exactly.
Here in California we have been adding and adding generous retirement benefits to public defined-benefit plans and doing it with a credit-card mentality.
The city of San Diego has done some serious soul searching. In September, its Pension Reform Committee released the following recommendation, among many:
“The city charter should be amended to require that for all new pension benefit improvements the plan will use an amortization period no greater than five years for any past service liability, effective immediately.”
That’s a little more generous than the state of Georgia. But the county of Orange relied on a 30-year amortization period for its most recent pension plan enhancement.
That means the $300 million obligation will cost another $450 million in interest by the time the last payment is made in June 2036. If it were paid off in five years, the interest costs only would be about $72 million, or $378 million less! Such is the joy of not paying off your debts earlier.
The Orange County Employees Retirement System board of directors changed the amortization period for any plan enhancements to 15 years at its April meeting. Unfortunately, this only applies to future increases and not the one that becomes effective in July.
Thanks, but I believe the horses already are out of the barn. They did not approve my five-year amortization proposal. San Diego also is using a 30-year amortization for its enhanced benefits.
San Diego also sold additional retirement credits (years) on the cheap, over the protests of its actuary. This is another area where public defined-benefit plans can be abused.
Mayor Murphy purchased five years for $71,760. He’ll receive an additional $17,500 per year for this maneuver. He’ll recoup his investment in only four years. This small detail was released on Friday, April 22. The following Monday morning he stepped down.
The big killer for San Diego, however, was the use of assumptions that were not conservative. It raised its assumed rate of earnings (known as the interest-rate assumption) well over 8% in order to overstate the plan’s funding level, which lowered its employer contributions. Thus compounding the underfunding problem.
When the Orange County Employees Retirement System board conservatively voted to lower its interest rate assumption to 7.5% a couple of years ago, two OC supervisors publicly criticized it. However, the California Public Employees Retirement System recently followed suit and lowered its rate to 7.75%.
If California and its municipalities had followed Georgia’s conservative approach to managing defined-benefit pension plans, we would not be debating about pension reform.
Our state’s elected officials must stop the over-promising. They must stop the many forms of abuse that a defined-benefit plan is vulnerable to. And they must purpose to pay for new enhanced benefits immediately.
Short of this, the car keys must be taken away. And defined-contribution plans will become the norm for new employees joining the municipality workforce.
Taxpayers still will have the large rat of costs, foisted on us by our elected leaders, going through the proverbial python. But, revving the car at too high an RPM level eventually will kill the engine from stress.
Mayor Murphy is our first victim. Before we have any more we had better learn from our successful neighbors in the Peach State.
Moorlach is the Orange County treasurer-tax collector.
