During the last year’s budget hearings, Los Angeles City Council Members Paul Krekorian, the Chair of the Budget and Finance Committee, and Paul Koretz, the Chair of the Personnel Committee, were pushing to increase the investment rate assumption for the City’s two underfunded pension plans to 8%, up from the current level of 7.5%.
This would have the dual effect of lowering the then $8 billion unfunded pension liability and decreasing the City’s Annual Required Contribution by an estimated $200 million. This additional cash would allow the City Council to fund the new budget busting labor contract for the City’s 20,000 civilian workers, begin the repair of our lunar crated streets, or pay for new initiatives or pet projects.
Both Krekorian and Koretz felt that this increase was reasonable since the five year average return was over 13% for both the Los Angeles City Employees’ Retirement System (“LACERS”) and the Los Angeles Fire & Police Pension Plans (“FPP”). In addition, the rate of return for the fiscal year ending June 30, 2014 was a bonkers 18%.
Unfortunately, the following year’s rate of return for the two plans averaged 3.3%, resulting in a $400 million increase in the unfunded pension liability.
But rather than increasing the investment rate assumption, many well respected investors believe that the investment rate assumption should be lowered to 6.5% (or lower). This would include the legendary Warren Buffett (photo above) of Berkshire Hathaway whose investment returns over the last 40 years are double those of the Standard & Poor’s 500.
For comparison, corporate pension plans rely on a 4% investment rate assumption according to a recent article by Melody Petersen in our Los Angeles Times.
The Times also disclosed that the $300 billion California Public Employees’ Retirement System (otherwise known as CalPERS) is reducing its investment rate assumption to 6.5% from 7.5% over the next 20 years, granted more slowly than the more aggressive schedule advocated by Governor Jerry Brown.
If the investment rate assumption for City’s two pension plans was 6.5%, the unfunded pension liability at June 30, 2015 would increase to $13.5 billion, up from $8 billion, while the funded ratio would decrease to 71% from 80%.
(On a relatively positive note, LACERS and FPP have been funding their Other Post-Employment Benefits (read medical) since the late 1980’s. The County and the State have not funded any of these obligations, resulting in unfunded liabilities of $27 billion and $71 billion, respectively).
The lower rate would also increase the Annual Required Contribution by an estimated 33% to $1.45 billion, a $350 million increase from the current level of $1.1 billion. The increased contribution would chew up 27% of the General Fund, up from the current level of 20%. This compares to 10% in 2005 when Antonio Villaraigosa became our mayor.
The City’s pension plans have generated considerable controversy over the last decade as they have devoured an ever increasing share of the budget, crowding out other pressing needs such as increased public safety; the repair of our streets, sidewalks, and parks; and affordable housing and homelessness. And even with the new tiers that were established for recently hired sworn and civilian workers, the pension plans will continue to consume a disproportionate chunk of the City’s budget as they rely on the overly optimistic rate of return of 7.5%.
One of the key recommendations of the LA 2020 Commission was to “establish a Commission on Retirement Security to review the City’s retirement obligations in order to promote an accurate understanding of the facts.” But this call for action has not seen the light of day as City Council President Herb Wesson, an original sponsor of the LA 2020 Commission and a smiling participant in the press conferences, has buried it deep in the bowels of City Hall.
Governor Brown, CalPERS, and the $188 billion California State Teachers Retirement System have taken meaningful steps to address the State’s underfunded pension plans and the ever increasing contributions required by state and local governments. Now is time for the City of Los Angeles to come clean about the facts surrounding its severely underfunded pension plans and develop “concrete recommendations to achieve equilibrium on retirement costs by 2020.”
Cross-posted at City Watch.