Irvine, Calif. Plans to Prepay Its Pension Bill
The well-to-do city in Southern California will pay off 30 years worth of liabilities in a decade.
Talk about swimming against the tide: While most states and localities continue to chalk up unfunded pension liabilities, Irvine, Calif., is planning to pay off the money it will owe -- 30 years worth of liabilities -- in 10 years time, starting now.
This comes as the credit rating firm Moody’s recalculates the way it measures pension liabilities, causing states and localities to recognize higher liabilities than they thought they had. It also comes as the Center for State & Local Government Excellence reports that last year the funded status of public plans declined from 75 percent to 73 percent. Assuming a robust stock market, the center forecast that going forward the funded ratio will creep above 80 percent.
Why is Irvine pushing toward full funding? Where is the money coming from? And what kind of financial case does the city make for taking such a step? I talked to Sean Joyce, Irvine’s city manager, and Gary Burton, the city’s director of administrative services, to find the answers. Below is an edited and condensed version our conversation.
Let's start with why you’re doing this.
The idea was to put our reserve [Asset Management Plan (AMP)] money to work. We are no different than anybody else in the sense that we were earning less than 1 percent in our AMP investment portfolio -- yet our pension liability has a 7.5 percent interest rate tagged to it. This was a way to utilize our reserves. We put together a plan that, over the course of 10 years, we would [use money in the reserve fund] to make a contribution to our unfunded liability -- that is, pay it down -- by $5 million a year.
With that plan in place, in 2024 we will have an $11 million unfunded liability. If we stayed on the path we were on, we would have had $84 million. There is an opportunity to realize significant savings by prepaying the employers’ annual retirement amount.
How will it work?
At the same time as we take money out of the reserves, we will replenish those reserves. On an annual basis, after we pay the $5 million [from reserves], our rates for our pension payments are going to go down. If we are able to capture the savings generated and put that back in our reserves, coupled with a $1 million payment at year end from budget variances [also known as year-end balances], we will end up with a 98 percent funded pension plan in year 2024, and our reserves will be back where we started shortly after that.
In long run, [we should have] great budget savings [because] we didn’t try to do it all in one year. We spread it out so it is something we can achieve. We can start or stop the program anytime we want.
Does this imperil your Asset Management Plan?
The city’s special fund has a cash balance of about $61 million. The purpose is to provide a long-term funding source for rehabilitation of city infrastructure while preserving the fund’s principal balance; to provide financial reserves to natural disasters and other emergencies; to provide a source for internal loans and liquidity; and to serve as collateral for city debt issues. The new fiscal year allocation for rehabilitation funding is $574,000 [even with the proposed plan, two-thirds of this interest-earned amount would remain available annually for rehabilitation funding].
We were using this fund as an endowment for infrastructure but it is only generating $450,000 a year so it is not doing the job. We’re putting that money to work more effectively and trying to replace [some of the withdrawals] on an annual basis. We don’t deplete it. It will be around $42 million at its low point but it will be paid up back to $61 million when we’re done.
Your pension plan is through CalPERS. How does this plan work with your plans to pay your liabilities down?
CalPERS does the actuarial analysis and determines what the unfunded liability is. In Irvine, that amount is $91.1 million. Among other things, unfunded liabilities rest within CalPERS and the city is charged 7.5 percent annually for the pension liability.
Our liability is amortized by CalPERS to go 30 years. By paying it off over 10 years, we will have savings of $33 million. That includes significant budget savings because we reduce our debt to nearly nothing.
Why did you propose to fund 98 percent of the liability rather than 100 percent?
CalPERS requires annual pension payments, even if you are 100 percent funded. This means that overfunding would result in reserves that are only available to CalPERS, not to the city.
Right now, interest rates are very low and, as you note, your reserve funds are earning only 1 percent. But what if interest rates start to climb or other assumptions change? Will the plan still make sense?
We have to analyze the program every year to determine whether we’re on track or not. If we are off track, we will have to make adjustments. We had pension reform by the state, effective January 2013. We took into account assumption changes associated with that reform in our model to figure out how quickly we could pay this off.
Would public employers in other states be able to replicate your plan or is it specific to California and CalPERS?
We’ve dug into it here and Irvine has been our total focus. In theory, it should work elsewhere. Almost all localities have unfunded liabilities so part of the payment rate is to pay off that debt.
The old argument is that states and localities are passing liabilities on to the next generation -- we’re dealing with that head on.