Seeking to settle the city's astronomical pension bill, Palo Alto is preparing to adopt a policy that would commit the city to higher annual contributions — and possible service reductions — to reduce the backlog.
The new pension-funding policy, which the City Council's Finance Committee considered on Tuesday night, is the latest in a series of reforms that the council advanced in recent years as part of a renewed effort to lower the pension bill. Mayor Eric Filseth, a leading proponent of the effort, made the case for pension reform in his "State of the City" speech earlier this year. While the city's shift on pensions will require larger payments in the near term, Filseth argued that it will also make the local pension systems "fully secure."
The biggest issue that the Finance Committee struggled with on Tuesday was: How much short-term pain should the city inflict on itself to achieve this long-term security? Councilwoman Alison Cormack borrowed advice from yoga to explaining her position.
"You don't want to be in pain, but you want to feel it," Cormack said.
The committee considered four different scenarios for moving forward, ranging from the bare minimum required by CalPers to an aggressive funding plan that would require the city to pay about $19 million annually for pensions, which would settle the pension bill within 10 years.
Cormack said she favored a scenario with contributions somewhere between current level of $5 million and $13 million. The goal would be to pay off about 90% of the bill within 10 to 15 years.
"We're reducing the risk to future residents, employees, council and staff, who are in this room 15 years from now," Cormack said. "We're not eliminating the risk, we're reducing the risk."
Vice Mayor Adrian Fine also favored a moderate approach and said he is concerned that the city may end up overpaying if it moves too aggressively. Meeting higher pension targets would require cuts elsewhere, he said.
Fine also suggested that a 10-year timeframe for paying off the bill may be too aggressive, considering that it took the city about 20 years to fall into the current pension hole.
"We've got to be careful not to be goring too many oxen to push this one policy," Fine said.
The city's pensions were fully funded in the early 2000s, Chief Financial Officer Kiely Nose said. Since 2009, only 60% of the city's unfunded pension liability had been funded.
Some of this can be attributed to the Great Recession, Nose said. In addition, Palo Alto approved more generous benefits for employees in the early 2000s, increasing the city's obligations for future years.
The new pension policy is the latest in a series of reforms pursued by the council. In recent years, the city has renegotiated contracts with all labor groups to require employees to pick up the full share of their required pension contributions (in past years, the city had picked up the employee's share of the pension payments). Palo Alto has also established an irrevocable trust dedicated to pensions. Known as the Section 115 Pension Trust Fund, the fund now has more than $22 million.
The council also agreed last year to base its pension budget on a more conservative rate of return than the one used by CalPers, the giant state fund that administers pension programs for Palo Alto and other cities. While CalPers has recently reduced its anticipated rate of return (or "discount rate") from 7.5% to 7%, Palo Alto agreed to budget for what officials deemed to be a more realistic rate of 6.2%. That rate was based on an estimate by Wilshire Associates, a consultant for CalPers.
The change in methodology, which council members believe reflects a more realistic discount rate, had added about $6.2 million to the city's contributions to the fund in the current budget year.
Despite these steps, the city remains hundreds of millions of dollars in the hole. Under the existing 30-year amortization schedule, the city would have to pay $354 million for its public-safety employees and $523.4 million for its "miscellaneous" employees (all those not in public safety) to pay off its bill by 2046. Under a more aggressive 10-year amortization plan, the city's bill is estimated at $291.2 million for public-safety employees and $400 million for the "miscellaneous" group.
A key goal of Palo Alto's new pension policy is to fund 100% of the pension liabilities. The policy would establish the city's desired timeline to meet its funding targets and establish clear parameters to guide staff. In supporting the policy, committee members acknowledged the funding target could be difficult in economic down years. Committee members favored a policy that would require the city manager to bring forward a plan for making the necessary payment but give the council the option of rejecting or modifying the plan.
The pension policy aims to institutionalize the council's recent effort to tackle pensions, turning it from a series of ad hoc actions to an annual budgeting tool (and mandate). Finance Committee Chair Tom DuBois said he supported requiring mandatory annual contributions to the pension trust and limiting the ability of future councils to raid the pension fund to address short-term budgetary needs.
At the same time, DuBois said he is hesitant about sending CalPers more money than required. Rather, he favored requiring the council to make annual contributions into the pension trust. He and Cormack both agreed that the trust should serve a "hedge" against larger-than-expected CalPers bills.
"If we have a strong policy, I think we'd be less likely to get surprised or get hit with a large payment," DuBois said.
The committee also rejected some of the most aggressive policies on the table, including a "Fresh Start" approach in which the city signs a formal agreement with CalPers committing it to higher payments and a faster amortization schedule. Instead, it favored exploring "Fresh Start in concept," a process in which the city would voluntarily pursue a faster schedule without making firm commitments with CalPers
The council will consider the new pension policy later this year.