Thursday, June 25, 2015

Oakland, CA and the Public Pension Crisis

When I started out researching the finances of the City of Oakland, I fully expected to end up in a very different place than where this story actually ends. I knew that Oakland was struggling with pension liabilities so I thought by chronicling the effect of growing pensions on the city's finances, I might create a reasonable case study of how public employee pensions are weighing on mid-sized American cities.

If we step back to 2001, the city made contributions to CalPERS, the statewide pension administrator, of $24 million, funding 100% of it annual pension contribution or APC. Its net pension obligation was zero. Pension costs for the city's FPRS closed-end pension plan were funded in 1997 by way of a cash contribution of $22.8 million, and supplemented in that year by the proceeds of a pension obligation bond (POB) of $417 million. As a result, the program was projected to be fully funded through 2011 (although its unfunded pension obligation should be adjusted to include the $417 million of unpaid bonds).  

By 2005, however, an unfunded actuarial accrued liability (UAAL) appeared in FPFS of $268 million and its funded status had dropped to 69%. At the same time, the city's CalPERS account showed a combined UAAL of its public safety and miscellaneous employees plans totaling $370 million. The city's annual contribution to PERS had grown from $24 million in 2001 to $87.5 million by 2005, an increase of 265% in just four years. Over the same period, the city's general fund revenues had only grown by just 34%.

By 2014, the city's pension liabilities would begin to look downright ominous. The UAAL of FPRS had declined to $230 million, representing the closed-end nature of the plan and the smaller retiree population covered by the plan. Nonetheless, its funding status had fallen to 64%. And the city's combined PERS liability for its safety and miscellaneous plans had now grown to a staggering $1.13 billion, or nearly four times the size of its payroll. It's annual PERS costs had risen to $98 million.

Now, I know what you're thinking. What about the debt service on all the POBs that the city had issued to fund its UAAL. The city issued $417 million of POBs in 1997 to fund a deposit to FPRS and, in 2012, another $212 million to refund, in part, the 1997 bonds. The debt service on these bonds totalled $50 million in 2014. So this number should effectively be added to the $98 million PERS costs mentioned above, producing adjusted annual pension expense for the city of $148 million in 2014.

So this is about where I thought this story would end. The city's annual pension costs had risen from $66 million in 2001 to $148 million in 2014 (inclusive of debt service on POBs), while its unfunded pension liability had grown from $417 million to $1.7 billion (inclusive of POBs). But here's what I didn't expect to find: how well the city administrators and elected officials would address these costs.

Oakland, like many cities in California and across the country, is still struggling to recover from the 2008 recession. For Oakland, property tax revenues lost following the recession did not recover to their 2008 levels until 2013. Today, six years after the recession, Oakland property tax revenues remain just marginally higher than in 2008. Sales tax and state directed motor vehicle license revenues still haven't climbed back to their pre-recession levels. Revenues, overall, are now only modestly higher than their peak. Nearly all of the revenue gain came on the basis of locally enacted taxes for business licenses, utilities, real estate transfer, transit occupancy, parking and franchise taxes.

So here's the unexpected ending to the story. Clearly, Oakland still faces extraordinary unfunded pension liabilities in the face of limited revenue growth, all of which is pressuring its budget and bond credit ratings. But the city has managed to dramatically reduce the size of its budget to live within its means. In fact, its general fund expenses in 2014 were below those of 2008, allowing the city to record an $8.2 million addition to fund balances. The city accomplished this no small feat with the reductions coming largely from general government, allowing the restoring of funds for pubic safety to pre-recessionary levels.

What the future now holds for Oakland and other US cities is predicated on assumptions for economic growth that cannot be known. At thee same time, pension expense will most surely grow, irrespective of revenue growth, as a function of salary increases, enhanced benefits and demographics. Not a pretty picture, yet thus far, the city has done an extraordinary job of containing the damage.