Piedmont’s New $16 Million Problem
The City of Piedmont has discovered it faces a $16 million unfunded liability for retiree health benefits which may require contributions of up to $1.6 million per year to fully fund – or 10% of the City’s total operating budget. The City’s March, 2011 Audit Report reflects the City made a $1.8 million contribution in 2010 to begin funding this liability.
The City’s discovery of its unfunded liability resulted from a new law which forced it to hire an outside consultant to determine, for the first time, the true actuarial cost of the medical benefit it has promised to employees when they retire. Previously, Piedmont has shown this benefit as a “pay-as-you-go” expense: a $75,000 budget item for 2009-10, and less for prior years.
In March, 2010, using a conservative 4% future earnings assumption, the consultant reported Piedmont’s unfunded liability to be $16 million, requiring annual contributions of $1.6 million to achieve full funding. Consultant’s Report, p. 4-8.
When presenting the consultant’s news to the City Council, staff offered the option of rejecting the consultant’s recommended 4% earning assumption and using a more aggressive 7% assumption. (Higher earnings assumptions reduce calculated annual contributions.) Staff pointed out that a 7% earnings assumption together with existing City assets could allow future funding contributions of only $480,000, rather than $1.6 million, annually. Since the City currently makes contributions of only $200,ooo-250,000 annually, employee contributions of $230,000-280,000 per year would still be needed to fund at this lower level and require re-negotiation of union contracts. No suggestions were offered for fully funding the higher annual contribution level required if the City used the consultant’s more conservative 4% earnings assumption. Details: Staff Report and City Audit Report, p. 4-8 and 3-15-10 minutes at p. 14 and 6-7-10 staff report at p. 19-20.
After receiving the consultant’s report, the Council took initial steps to address the unfunded liability: it created an Other Post Employee Benefits (OPEB) trust account, funded the new trust with $1.8 million from the City’s PERS Medical Fund, and appointed a subcommittee to oversee the new account. Contributions to the new fund will be invested with Osterweis Capital Management (6-7-10 minutes (page 5-6). Based on past experience using Osterweis, the Council hopes the funds may earn 7% when invested. The Trustees of the newly formed trust are the persons holding the positions of City Administrator and the City Finance Director with the City of Piedmont.
_____________________________________________________________ Editor’s Note: If returns of 7% per year are not achieved, this may force the City to increase its annual contributions in the future years. For the 7 month period from June, 2010 through 1/26/2011, the return on the trust funds invested with Osterweis has been 11%. The Council transferred an additional $200,000 from the PERS Medical Fund to the trust on February 7, 2011.
I find it appalling that this unfunded liability is “new news” to the City. Banking on 7% seems risky; it seems that re-negotiating the contracts will have to be part of the package.
This news makes it all the more important that the city have ironclad, bulletproof protection that it will have no exposure at all on the Blair Park sports field development.
Re: “…the Council hopes the funds may earn 7% when invested.” – Is “hope” a sufficiently prudent strategy for managing this major exposure? “For the 7 month period from June, 2010 through 1/26/2011, the return on the trust funds invested with Osterweis has been 11%.” I suggest that this is near-meaningless, as that short period should be taken in context of a general market recovery from a low starting point, and moreover, 7 months is far from the long-term view we need to adopt here. And finally, “No suggestions were offered for fully funding the higher annual contribution level required if the City used the consultant’s more conservative 4% earnings assumption.” Apparently our city engaged a consultant, then rejected the outcome when it was found to be unpalatable. As citizens we need to demand true stewardship for our city. I do commend the Council for creating the OPEB trust account but I think more study is called for to (a) quantify the liability and (b) develop conservative, not aggressive, strategies to mitigate the risks of lower investment returns.
Using overly optimistic projected rates of return or projected rates of increases in local government revenues is too common in local government. As many of you may recall, the Piedmont School District assumed an annual increase in assessed property values of 6% for 40 years in their financial feasiblity study for Measure E in 2006. The average Piedmont house will need to rise to approximately $4 million, or else their will be a substantial increase in property taxes to repay the bond obligation. Given the flatness to even decline in property values since 2006, the prognosis does not look promising.
7% is interesting considering in 2008 many fixed income “safe” funds lost 30% – 40%. Banking on a consistent 7% is silly. And although in the last century housing prices had consistently gone up, that very fundamental American “Truism” may be just that, of the last century.
I never understood why there was such a push to pass the 3/60 Pension Plan for City Employees plus the very generous medical plan. We could not afford that 7 years ago, we certainly cannot afford that now. Either another ballot measure should be put in place or the City Council must take up the issue of city employees sharing costs. In the Sep 23, 2010 SF Chronicle article about City Manager salaries, Geoff Grote’s was lowest. Sounds good until you examine it from a per capita basis where Mr. Grote’s salary was 32%higher than the next highest city, Albany ($17.58 v $13.23)