Guest Opinion: Palo Alto's new labor contract is suicide economics | October 25, 2006 | Palo Alto Weekly | Palo Alto Online |

Palo Alto Weekly

Spectrum - October 25, 2006

Guest Opinion: Palo Alto's new labor contract is suicide economics

by Dick Rosenbaum

You can't pick up a newspaper these days without seeing an article about the crisis in municipal finance brought about by the escalating cost of pensions and health-insurance benefits for current and retired employees. It's a problem both nationally and right here in Palo Alto.

The two Sacramento Bee columnists who specialize in state affairs, Dan Walters and Daniel Weintraub, each have had columns this past month. A month earlier, there was a three-part series in the New York Times.

A recent AP story reported: "Union officials say it's not their fault municipalities put themselves in a hole by promising more than they can deliver."

"This is a monumental problem and government is going to have to deal with it," one union official was quoted as saying.

Well, that's exactly right. All labor contracts must be approved by a city council. The Palo Alto City Council recently approved a new contract with the city's largest union. Let's see how well they did in dealing with these critical issues.

The contract increases pension benefits for someone who retires at age 55 by 35 percent. A 55-year-old with 30 years of service will receive an annual pension equal to 81 percent of his or her last year's pay, a benefit unheard of in the private sector. The increased benefit begins on Jan. 1, 2007. A 55-year-old who retires on Jan. 2, 2007 will receive 35 percent more than had he retired on Dec. 28, 2006.

This windfall for the retiree creates an instant unfunded liability of $25 million for Palo Alto -- half the estimated cost of a new police station.

With respect to health insurance costs for current employees, the contract does eliminate the very expensive PERSCare option. Unfortunately, only 7 percent of the city's 1,000 employees take that option. Costs for the other 93 percent of the employees will rise by roughly 13 percent in 2007.

Next year's cost for an employee and family using the Blue Shield plan will be $15,000. Employees make no contribution toward the cost of their health insurance.

The council has not instituted any systematic way to limit future increases in health care costs. This is a three-year contract; in the last two years of the contract, costs will go up without limit for all 100% of the employees.

The City pays 100 percent of the health-insurance costs for a retiree. Money has never been put aside for this expense. The estimate of the unfunded liability for retiree health costs is more than $100 million. The contract increases this unfunded liability.

If you make it more attractive to retire at an earlier age, then more employees will retire at an earlier age, increasing the number of years that their health costs must be paid.

Council members I spoke to hung their hat on the following argument, made in the staff report: "The City is balancing its risk between medical and pension costs by capping its medical premiums while enhancing the pension plan. Since CalPERS manages the pension fund and has a 9.2 percent rate of return over the last 10 years, it is a more predictable expense versus extremely volatile health care expenses."

This argument is wrong on both counts. Health insurance costs aren't volatile; they just go up. The council did not effectively limit those costs this time, but they at least will get another shot at it in three years when the contract expires.

On the other hand, pension benefits once granted are guaranteed. There is no going back. It is a fool's argument to claim that investment performance over the last 10 years is somehow a guarantee of future performance of the pension fund. When the stock market tanks, as it inevitably will, the city will be required to increase its annual payment to whatever amount CalPERS says is necessary to meet the pension obligation.

This is the heart of the matter. Defined-benefit pension obligations are guaranteed. Future performance of the stock market is not.

In summary, this contract increases pension liabilities, does not effectively limit increases in health care costs for active employees and exacerbates the problem of unfunded liability for retiree health costs.

These are suicidal actions for any organization, never mind a city that is struggling to come up with enough money for routine infrastructure maintenance.

These obligations are going to eat us up. Given the circumstances, this is the most irresponsible financial action by a City Council in the 35 years that I have been observing and participating in city affairs.

Dick Rosenbaum served on the City Council from 1971 to 1975 and 1991 to 1999. He has had a long-time interest in municipal finance. He can be e-mailed at Comment on this column on Town Square,


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