By Ron Roberts

Certainly the most pressing concern is the underfunded pension system. Pension system funding is a legal obligation, and the City cannot continue to ignore its contractual responsibility to fund the pension. If the Mayor and City Council refuse to act, the courts will eventually step in and force them to do so. Ignoring the problem poses a threat to vital City services such as fire and police protection.

The City's pension system year after year has been allowed to be critically underfunded, while at the same time employee benefits have been increased without identifying a way to pay for them. Unlike corporate America , which is typically forced to start increasing contributions to a pension fund when its assets drop below 80 percent of its liabilities, a city's payments are at the discretion of the local government. Beginning in the mid-1990's, the San Diego Mayor and City Council began a policy of deliberately underfunding the pension trust as a way to obtain cash to balance the city's operating budget during a time of rising benefit increases. In essence, the City borrowed from the pension fund to meet its budget shortfall, a shortfall caused, among other things, by a new benefit package. As recently as November 18, 2002, the Mayor and City Council voted to defer full payments to the retirement fund until 2009, in order to balance the budget and make way for an attractive package of increased employee salary and benefits. By allowing special interests to dictate public policy, the Mayor and City Council created a situation in which the City's annual pension payment in the year 2010 will reach $242 million + an increase in the payment that is equivalent to the entire annual budget of the Fire Department. It is estimated that by 2011, payments will have grown to approximately 21 percent of the City's General Fund.

The decision to defer full payments owed to the pension fund until 2009 may have reduced payments now while this Mayor and City Council are in office, but it did not solve the problem of where to find the money to pay for the ever-increasing debt. The City paid only $83.2 million toward the pension fund in June, 2003, which represented a little less than half of what the actuary for the San Diego City Retirement System indicated was needed in February, 2003. This year, a legal settlement forced the City to pay $130 million into the fund, yet the actuarial recommendation was $170 million, and the City's own Pension Reform Committee recommended at least a payment of $273 million. Due to this kind of fiscal policy, the City has a $1.15 billion benefit debt. Coupled with a $1.1 billion unfunded retiree health cost, that deficit threatens the services and assets that this City's taxpayers have worked hard to create. If the City continues down this path, " San Diego 's underfunded pension plan will devour an enormous chunk of the city's general fund." ("Road to Recovery," San Diego Union-Tribune , December 30, 2003 ) In the end, this will result in significant cuts to police and fire services, roads, parks and sewer maintenance, and the destruction of quality of life for every city resident. Continually raiding the pension fund to make up the difference in the City's budget is like repeatedly paying off one credit card with another: interest compounds the original debt, the minimum payments become larger and larger, eating into your available spending money, until eventually, they become too big to handle .

Some city elected officials and administrators have argued that the stock market will rebound in its normal cycle, thereby replenishing the fund. The point is, only seven percent of the problem can be blamed on the stock market. A simple calculation shows that relying on winnings from the stock market will not solve the pension fund's problem. You can take the "long view" as some have suggested, but if the pension fund is $2.5 billion, with $1.5 billion in equities, you would need an unprecedented and nearly impossible increase in the Dow of 140 percent to cover the current deficit of $2.2 billion. The City cannot continue to dig itself into this pension hole, hoping that an improved stock market will lift it out.

The pension fund crisis is due to a lack of oversight from the people's elected representatives. As decisions were made, it has been clear that the Mayor and City Council have not fully considered the implications of their decisions.

Enhanced Employee Benefits

Despite the acknowledged underfunding of the pension system, the City has enhanced employee benefits over the years without identifying a way to pay for those benefits. Average annual retirement benefits have grown from $24,460 in 1996 to $48,864 in 2003, yet the pension fund has not kept up with the increases. Speaking in favor of making lower annual payments to the retirement fund in July, 2002, Deputy City Manager Bruce Herring is quoted as saying that the enhanced retirement benefits could go into effect so long as the Mayor and City Council approved a lower annual contribution. ( San Diego Union-Tribune , July 12, 2002 , B.2) That is, enhanced benefits could only be approved if the Mayor and City Council underfunded the pension fund. Despite this knowledge, the Mayor and City Council (all but Councilwoman Frye) approved the most recent benefit increase on November 18, 2002 . At the same time, in order to balance the budget, the Mayor and Council approved a revised pension fund contribution scale that put off paying for the majority of the losses and the new benefits until after 2009.

The City currently offers retirees free health care benefits. This benefit is financed by taking money from the pension system's earnings, rather than from the City's budget. In essence, the City has never funded this commitment, and this accounting maneuver has resulted in a long-term accumulated liability of $1.1 billion, in addition to the $1.15 billion benefit debt. If this pattern continues, the Retiree Health Insurance Reserve would be depleted entirely in the next couple of years according to a report released by the Retirement Board in February, 2002. When that happens, the City will need to find a new way to cover health care for all retirees, and to reimburse the fund. General funds will be a likely source for such a payment, and cutbacks in city services will ensue.

A little known City benefit is the Supplemental Pension Savings Plan (SPSP), a benefit that city employees are eligible for in addition to the City Employees' Retirement System benefits. The SPSP was established when the City withdrew from the Social Security System. Under the plan, the City matches 100 percent of employee contributions to the savings plan, with full vesting to occur within 5 years of employment.

Under the Purchase of Service Credit Program (PSCP), employees of the City may use "purchased" years to meet the ten-year vesting requirement for retirement under the current system. Employees may expand their retirement benefits by purchasing years prior to retirement, termination or entering into the Deferred Retirement Option Plan (DROP). For most employees, this means that they can purchase up to five years of service, thereby making the true threshold for retirement eligibility five years of service. As reported by San Diego Retirement Trustee Diann Shipione, more than 6400 such "virtual" years have been purchased, making it easier for employees to reap the benefits of retirement without providing service to the taxpayers. ( San Diego Union-Tribune , April 9, 2003 )

Another benefit, made permanent by the Mayor and City Council in 2002, is the Deferred Retirement Option Plan (DROP). Under this program, employees reaching retirement eligibility age may collect their full pension check for up to 5 years while continuing to work and receive their full paycheck. The pension checks are placed into a tax-deferred account, and after 5 years the retiree can exit employment with a lump sum often equivalent to 5 years of salary, plus a 2 percent annual cost of living adjustment, plus 8 percent interest annually. As of June, 2004, 1176 City employees were in the DROP program, and the total amount on "deposit" for those employees was $178 million.

The example of Deputy City Manager Bruce Herring raises questions concerning the pension system. Herring, 55, receives $12,033 a month in his DROP account, or approximately $144,396 a year, in addition to his full salary as Deputy City Manager. He will continue to amass money in this account, if he chooses, until he turns 60, at which time he can fully enjoy his retirement with a cash payment of $1.2 million, and an annual retirement benefit of $144,396 with cost of living adjustments and full health care benefits.

Today, City employees can retire earlier than their equivalents in nearly all private sector businesses, and have the potential to retire with an annual paycheck greater than they were making while doing their jobs. The Mayor and City Council agreed to this lavish benefit plan at the same time they agreed to defer annual payments that would pay for that plan. Despite the 10 percent increase in the revenue the City took in this fiscal year, the Mayor and City Council could not balance the City's budget without cutting into city services in ways that are deeply felt by our communities. Fee hikes and closed city pools and libraries are the direct result of the decision to increase benefits on behalf of special interests.

Bankruptcy Speculation

There has been much speculation in the national media and financial circles regarding filing for bankruptcy. While the City "is now caught in a financial crisis of colossal proportions" ( Los Angeles Times, September 1, 2004 ) , it is not close to defaulting on its creditors, and therefore does not need to file for Chapter 9 bankruptcy at this time. In fact, it is important for the City not to file for bankruptcy, as an incentive for the labor unions to work with City leaders to reach a solution to the fiscal crisis. If the City files for bankruptcy, all of the negotiated labor contracts are open for renegotiation. Renegotiating the benefits package is critical to a plan to pull the City out of its financial hole. Sec.1090 of the California Government Code may provide the basis for a renegotiation of the November, 2002 pension benefits and must be considered.

Deferred Maintenance and Other Unfunded Needs, Including Public Safety

The Pension System problem is emblematic of a broader failed financial/management system. The Pension System is just one area where legal, moral, and ethical obligations are not being met.

The Executive Summary of the City of San Diego Annual Fiscal Year 2004 Budget acknowledged the following unfunded "needs":

• Public safety fleet

• Basic operating needs- to provide customer service at expected levels

• Deferred maintenance

• The Strategic Framework - the infrastructure needed to support the "City of Villages " concept

• National Pollution Discharge Elimination System Permit- to fund efforts to meet permit requirements

• Underground storage tanks

• Public safety overtime needs

In a report dated August 30, 2004 , City Manager Lamont Ewell details the unfunded needs he has discovered in various City departments. He estimates that there are $531.6 million worth of non-public safety unfunded needs as of the end of Fiscal Year 2004. The report identifies $87 million in unfunded needs for Police, and $38 million in unfunded needs for Fire and Life Safety. With the public safety unfunded needs, the total reaches $656.7 million. As the report states, "The majority of these needs are for maintenance of current service levels." ("Fiscal Year 2004 Unfunded Needs Report," August 30, 2004 ) The $656.7 million identified as unfunded need only covers this year, and will only maintain service to the community at current levels.

In the face of these unmet needs, the City continues to pursue the Mayor's downtown library. The Central Library is a capital project that has been a vision for decades, and the architects indicate that they will be ready to break ground next summer. The main library is expected to cost $149.5 million to build. $20 million has been secured from state bond money, $30 million from private donors, and up to $50 million will be diverted from redevelopment funds. The remaining funding is supposed to come from a $188.7 million bond sale for the entire library system, a sale that is intended to be performed prior to next summer's groundbreaking.

In addition to payments on this debt, the City's budget will have to absorb the operating expenses for the library. In the current budget, the operating expenses are forecast for five years. In the forecast, operating expenses for the entire library system jump from $49.7 million in Fiscal Year 2007, to $57.5 million the next year, the year that the Central Library is expected to open for operations. While two new branch libraries and an expanded Kensington/Normal Heights branch library are also planned for opening that year, it can be presumed that most of the expected 40 new positions and additional $8 million annually will be used to operate the Central Library. At the same time that the Mayor and City Council move forward with the Central Library, they have cut hours at the branch libraries, cut personnel for ordering additional books, and cut personnel to do needed repairs at the local libraries.

Ballpark Bonds and High Interest Rates The City's experience in financing the downtown ballpark is indicative of the financial missteps that have landed the City in its current financial hole. Rather than seek creative ways to finance this hallmark public facility, the Mayor and City Council hastily pursued what has become a more expensive alternative. In Special Session on January 24, 2002 , the San Diego County Board of Supervisors acted to open negotiations with the City of San Diego to help the City with the bonds to fund the construction of Petco Park . The County suggested a cheaper form of financing that would bridge the gap until the City's legal situation would allow it to benefit from the low interest rates available at the time. Instead, the Mayor announced a plan to finance the City's ballpark obligation through the sale of $169 million in tax-free municipal bonds. The sale, executed by Merrill Lynch by February 16, 2002 , secured the financing for the ballpark, at a 7.66 percent interest rate. Those bonds, unlike the proposed loan from the County of San Diego , are non-callable, and therefore not eligible for refinancing. The annual debt payment for those bonds amounts to $15 million.

In July, 2003, Mayor Murphy announced the intention to refinance those bonds, thereby securing an annual interest savings of $3.6 million a year, an expectation that was built into the Fiscal Year 2003-2004 budget. In October, 2003, he again reassured the public that this refinancing was going to occur.

The refinancing of the ballpark debt has not occurred. The reason is that the City is under investigation by the Federal Bureau of Investigations and the Securities Exchange Commission for reporting irregularities associated with a previous bond issue, and is prohibited from borrowing money. Yet, even if the City could issue bonds, it would not result in a savings for the taxpayer. In order to refinance the ballpark debt, the City would need to borrow enough money to deposit an amount equal to the principal and future interest payments with a trustee, who could then make the principal and interest payments to the bond holder. (This action is referred to as a defeasance.) That new loan would amount to more than the original $169 million debt, and would depend on the interest rate that the City could secure in today's market. Even if the City could borrow money, given the fiscal uncertainties created by the underfunded pension plan and its downgrade in all three credit rating agencies, it is likely that the City would not improve on its current interest rate. It is no wonder that the City has not accomplished the "refinancing" that Mayor Murphy had declared would happen in 2003.

A Better Way The County of San Diego and the City of San Diego work within the same economic climate, with the same set of constraints. They share the same strong diversified local economy for revenue, the same frustrations caused by mismanagement of the State fiscal affairs, and similar governing structures without a strong elected executive. Yet the County of San Diego , under the leadership of the Board of Supervisors, has accomplished a strong financial position.

The most telling example of how strong leadership can impact a jurisdiction's finances can be seen in the contrast between the County and City's approaches to their pension fund obligations. More than $1 billion has been contributed to the County Retirement System over the last 10 years to reduce unfunded liabilities. $550 million was paid to the fund in October 2002 after a bond sale on the New York Stock Exchange, where San Diego became the first county to be listed on the exchange. In fact, the County annually contributes the required Normal Contribution, more than $200 million in 2003, and makes the full contribution the first week in July, so the earnings on the money can be maximized for the entire year. In Fiscal Year 2002-2003, the County of San Diego reduced its unfunded liability by approximately 50 percent, reduced its cost by $23 million, and by maximizing the earnings through sound investment practices, earned $80 million on the proceeds to further reduce its future liability. Similarly, the Board of Supervisors approved funding in 2004 to bring the unfunded accrued actuarial liability above 80 percent, while the City's pension is funded at 67 percent.

Although the San Diego Union-Tribune has expressed the view that issuing bonds to cover the City's obligation is "more deficit financing," the reality is that the pension system accumulated debt is already "deficit financing" and is carrying an eight percent interest cost which could be refinanced to lower the interest cost to approximately 6 percent. With proper professional supervision of pension system investments, the proceeds of the bonds could grow to help extinguish the accumulated debt of the pension system. According to the recently published San Diego County Employee Retirement Association (SDCERA) Quarterly Report, the County's retirement fund experienced a 22+ percent growth in investments last year. By issuing the bonds in October, 2002, and funding a greater portion of the pension obligation, the Board of Supervisors was able to take advantage of the stock market turn-around to maximize investment gains. Had the City dealt with its obligation when the San Diego County Board of Supervisors did, the cost to the taxpayers for funding the retirement obligation would be considerably less.

The County's management of its pension fund mirrors similar practices throughout its governing structure. Due to sound management practices, the San Diego County Board of Supervisors has overseen appropriately funded reserves totaling $600 million. As one example of the Board's dedication to establishing fiscal independence, the Board created a reserve of nearly $400 million by securitizing its share of the proceeds from the tobacco settlement agreement.

The San Diego County Board of Supervisors has been able to set and keep a goal to eradicate deferred maintenance on County facilities. For instance, in the late 1990s, County General Services answered a maintenance needs assessment that identified a $32 million need with a program to spend $11 million a year for three years. For carrying out this plan of action, and for dedicating $11 million annually for ongoing maintenance needs, the San Diego County Board of Supervisors received a 2001 Regional Watchdog Award from the San Diego County Taxpayers Association. In contrast, in early 2002, a Mayor's blue ribbon panel warned that the City needed more than $300 million for repairs to city streets, buildings, sidewalks, fire houses and other City assets. However, that need was not addressed, and the 2004 budget again acknowledges an unmet deferred maintenance need. The San Diego County Taxpayers Association has estimated that for every $5 not spent today on deferred maintenance, the City will need to come up with $25 tomorrow. (Letter from Executive Director Geoff Patnoe to City Manager Michael Uberuaga, May 29, 2002 )

As part of a structural reform effort carried out by the San Diego County Board of Supervisors since the mid-1990s, the County's general management system has been a mechanism to enforce financial discipline on County administrators. The result is that the County has achieved an "A" rating from the Maxwell School of Government, Syracuse University and Governing Magazine rated San Diego one of America 's best managed Counties. When Moody's Investors Service rated the County's 2004 Pension Bond issue, it stated, "The stable outlook is primarily based upon Moody's belief that the County's sound management practices will enable it to sustain its relatively strong financial position while meeting the challenges that it is expected to face over the next two years...The County's financial management continues to be strong, evidenced by conservative budgeting and careful use of reserves to manage the transition to lower ongoing expenditure levels...The County is competently addressing its current and upcoming challenges." (Moody's Investor Service Report, "Moody's Assigns Aa3 Rating to San Diego County's Pension Bonds and Affirms Outstanding Ratings," June 11, 2004)

Conclusion The next mayor of San Diego must possess the fortitude and will to challenge management to improve performance. It is not enough to simply place blame on the stock market or the State government. Where others have failed, the mayor of our City cannot. We cannot afford to continue to ignore our legal, ethical and moral obligations. The future of our City depends on the ability of the next administration to fix the current fiscal crisis. The time for decisive leadership is now.

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