Modesto braces for spike in pension costs

Modesto has done the math to gauge the impact of a recent decision that will require it and thousands of other public sector agencies across California to pay more for employee and retiree pensions.

And the numbers are not pretty. Modesto could be paying as much as $13.5 million more to the California Public Employees’ Retirement System in several years. As a point of reference, the city expects to pay CalPERS $23.3 million in its current budget year.

“These are numbers that the city takes very seriously and will have a significant impact on our budget,” Modesto Deputy City Manager Joe Lopez said.

The public sector agencies will pay more because the CalPERS board voted in December to lower its discount rate from 7.5 percent to 7 percent. The rate is what CalPERS expects to earn on its investments. Lower investment earnings mean larger contributions from the roughly 3,000 agencies that belong to CalPERS. Public employees also contribute to the pension system, and newer employees will see their contributions rise.

CalPERS is lowering its discount rate over three budget years, starting this July for the state and July 2018 for cities and other local agencies. It will take seven years for the full impact to play out. Lopez said public agencies also are paying more because of other changes enacted by CalPERS in recent years, including increasing the life expectancy for retirees and accelerating the time period to fully fund the pension plan.

Cities will feel the brunt of the pension increases in their general fund, which primarily pays for public safety. Modesto estimates that about 70 percent of the increases will be borne by its general fund. Modesto’s current general fund is roughly $118 million.

About 74 percent of Modesto’s general fund is for police and fire services. Public safety also dominates Modesto’s pension costs. Pensions for police officers and firefighters make up $14.7 million of the $23.3 million the city expects to pay CalPERS in its current budget year.

Municipal finance expert Michael Coleman said cities will be faced with difficult decisions, including cutting services, asking for concessions from their labor groups, or perhaps asking constituents to pay more in taxes. “We are going to have some bankruptcies in the next five to 10 years,” he said. “We’ve got some really severe situations coming.”

The increased pension costs come as Modesto has approved pay increases for its police officers, including managers, totaling more than 10 percent over roughly the next 2 1/2 years. City officials have said the increases are needed to provide competitive compensation and attract and keep high-quality officers.

Lopez said Modesto officials soon will start talking publicly about pension costs. He said there will be a discussion at the City Council’s Effective Government Committee meeting Feb. 27 and during the council’s budget workshops this spring.

He said it is too early to say how rising pension costs will affect Modesto. He said the city followed the guidance CalPERS issued to its member agencies to help them calculate broad estimates on the increased pensions costs. Lopez said the city will do more analysis to refine those numbers and their impact on city finances, but he still expects the financial impact will be significant.

Modesto could face even more pension increases. Some CalPERS observers say the pension fund will need further discount rate reductions. CalPERS’ own experts expect the pension fund to earn 6.2 percent on its investments over the next decade. And the pension fund earned 2.4 percent and then 0.6 percent in its last two budget years.

Still, Lopez said Modesto has weathered other financial challenges and will do so again.

“The city was very resilient going through the Great Recession,” he said, “and we are confident Modesto will meet its financial obligations and continue to provide services to the community.”

He added that the issue is larger than Modesto, and that the long-term answer is meaningful pension reform.

“CalPERS continues to look at this from the revenue side,” Lopez said. “At some point, they may need to look at the totality of the pension system, and not just (requiring) additional revenue from its member agencies.”

This story was originally published February 4, 2017 at 3:02 PM with the headline "Modesto braces for spike in pension costs."