A change in the city’s pension plan designed to attract and retain quality employees could wind up costing taxpayers millions, a Star analysis shows.
The city recently reduced the amount employees hired after July 1, 2006, contribute to their own pensions in order to leave them with more take-home pay.
City officials said the plan wouldn’t add a dime to the already overburdened budget. But a Star analysis shows that without a huge surge in the investment markets, it will likely cost taxpayers at least $107 million over 20 years to make up the difference.
After reviewing the Star’s analysis, city officials responded that they believe the taxpayers would only be on the hook for a maximum of $22 million extra.
In 2006 the city significantly increased employee contributions for new hires as a way to combat rising pension-plan costs. It was legally prohibited from raising rates for existing employees. Newer employees were paying about 14 percent into their retirement while older employees were paying a fixed 5 percent rate.
Last March, in a nod to fairness and an effort to keep talented newer employees from leaving, the City Council approved a plan pitched by the City Manager’s Office to cut some non-public-safety employee pension contributions between 5 and 7 percent, depending on the year hired.
The council was told that by extending the projected average job tenure, employees would be paying into the fund from 15 to 20 years, and, shifting around a few other numbers, the adjustment wouldn’t drain any extra money from city coffers.
But even with the longer estimated employee tenure, the Star analysis, based on data from city records and information provided by the city’s actuary, shows gaps in funding will still occur as a result of the change.
In the first three years the pension-funding gap averages $2.5 million. By 2033, that difference grows to about $9 million.
Those gaps need to be filled either by higher returns on investments, higher city/taxpayer contributions or boosting employee contributions back up.
The city’s actuary said it’s presumptuous to conclude taxpayers will pick up those costs.
Dana Woolfrey, of Gabriel, Roeder, Smith & Co., wrote in an email that while the Star’s projections aren’t “unreasonable,” there are variances between the city’s numbers and those the Star used. She described the Star figures, which were taken directly from city financial reports, as more conservative as they relate to employee contributions versus city contributions in future years.
She also said the Star’s projections fail to sufficiently account for savings the city would experience by extending the average time employees would pay into the system by five years.
She wasn’t sure a person could conclude the city would make up the difference.
Michael Hermanson, city pension and benefits manager, said taxpayers will be protected because it is unlikely the city will use a consistent funding level over 20 years, which the Star’s analysis used.
He also said the payroll projections in the Star’s analysis were much higher than what they will likely be in the future.
Hermanson said the city staff fully vetted the change in the plan before bringing it forward and stands by it as a sound fiscal move. “We did prudent management on this,” Hermanson said. “It was a great fix for the plan.”
But Michael Bond, a University of Arizona professor of finance, also reviewed the Star analysis and said it’s on target.
What’s more, he said, basing projections on the 7.75 percent return on investments the city and the Star used “significantly understates the funding issues,” and the 20-year shortfall could actually be in the $150 million to $160 million range.
Human Resources Director Lani Simmons said it wasn’t fair to force new employees to pay for the pension promises the city made to previous workers, nor was it fair for some workers to pay for almost all of their retirement during their working years while others paid only a fraction.
If the plan were left unchanged, Simmons said, newer employees would ultimately fund up to 94 percent of their retirement benefits while workers hired before July 2006 would contribute barely 30 percent.
Furthermore, high pension contributions placed financial hardships on many employees since they were putting 14 percent of every paycheck toward the retirement system.
Simmons and others in the city feared these discrepancies would cause current employees to flee and would hamper efforts to attract talented workers.
The adjustable contribution rate for employees hired after 2006 was supposed to let the city increase rates as needed to cover funding gaps in the pension plan without putting an extra burden on taxpayers. But ultimately that meant new employees were not only contributing to their own pensions but were covering any gaps in yearly funding if the city’s investments tumbled.
But those decisions were made well before the economy plummeted into a deep recession, said Chief Financial Officer Kelly Gottschalk.
As the economy tanked, so too did the city’s pension investment portfolio, which meant employee contributions climbed every year to cover the losses.
“Employees who weren’t even here were having to fund losses in 2008,” Gottschalk said. “They shouldn’t have to pay for that.”
With the changes, employees won’t be responsible for covering the city’s investment losses, Gottschalk said. Instead, their contributions will reflect what they can expect to receive in benefits.