San Diego Now that criminal charges have been filed against former and current pension-fund trustees, some San Diegans feel the city has hit bottom. There is nowhere to go but up. Not so. Individuals and institutions in a downspiral only hit bottom when they realize the depth of their problems. And San Diego is still in la-la land.
The magnitude of the city's pension and health-care deficits is significantly understated by the mainstream media. The dung is far deeper than citizens realize.
You read that the pension deficit is $1.37 billion and the health-care deficit is $500 million. Nonsense. Those numbers are based on phony accounting and false assumptions. The pension deficit is at least $2 billion and possibly above $5 billion. Instead of 65 percent funded, the deficit may be about 32 percent funded. The health care liability may well be $1.5 billion.
"Even at a time of disaster fully recognized by the general public, the mayor, and council, managers and union leaders continue to insist the problems are small, the fixes are easy, and that's nothing to worry about," says Diann Shipione, the former pension board member who blew the whistle on the mess. "In fact, the financial problems are infinitely larger than anything we've seen reported so far." The city and pension board "are still using false numbers."
The press has blown chances to report on reality. In April, councilmember Donna Frye's committee on open government invited the city's auditor, Rick Roeder, to testify about the realistic pension deficit. "We started with $1.37 billion," which was then the figure most often bandied about, says Frye. Then the committee asked Roeder what the deficit would be without some of the fairy tales.
For example, there are two main ways to calculate an employer's future pension liabilities. One is the preferred conservative technique, called entry age normal. San Diego used it until 1991, when things got a little tight. So it switched to a looser technique called projected unit credits, which is used by only 11 percent of governments. It understates future liabilities, says Shipione. At the meeting with Frye's committee, Roeder was asked to calculate the pension liability if entry age normal were used.
Also, the city assumes that its portfolio will achieve an 8 percent annual rate of return. Many believe that is unreasonably high. Roeder was asked to calculate the deficit if the expected return were lowered to 7.75 percent (still high, by many people's reckoning). Then, the city doesn't account for payments to be made under a past legal settlement. Roeder was asked to stir that in -- and to use a 15-year amortization period, instead of the overoptimistic 30-year period. When the dubious accounting techniques and assumptions are stripped away, "We are pushing $2 billion on the deficit," says Frye.
But nobody from the press reported on that meeting.
There's more. Beginning in 1980, the city foolishly decided that each year, money that exceeded the expected rate of return on the pension fund -- called "excess earnings" -- would be distributed to retirees in various ways, including health-care coverage. The city-financed Vinson & Elkins report calls this concept "the snake in the garden" of the pension system. Investment portfolios have good years and bad years. Skimming off the so-called excess in good years is not good policy. Those funds are needed for the bad years. San Diego, utilizing that money for purposes that would normally come out of the annual budget, looks upon the surplus earnings as a "budgetary free lunch," says Vinson & Elkins.
The accounting firm KPMG refuses to issue audits for 2003 and 2004, partly because it disagrees with some of the findings by Vinson & Elkins. But it agrees with Vinson & Elkins on the use of excess earnings. On July 22 of last year, Roeder wrote to the retirement board, pointing out that KPMG then believed that the assumed rate of return should be only 4 percent -- half of what it now is -- as long as San Diego disbursed those excess earnings. "KPMG believes that 4 percent is an appropriate 'after the fact' investment return instead of the current 8 percent," wrote Roeder, listing reasons why he disagreed.
In January of this year, Shipione put it to Roeder: What would the deficit fall to if San Diego used 4 percent instead of 8 percent? "He said it would go from $1.3 billion to $5.3 billion," recalls Shipione. The system would then be 32 percent funded, she says. And that could be too rosy.
"The concept of excess earnings went astray," says Jim Gleason, who was on the pension board for 12 years. "The original concept was to equitably distribute excess earnings to participants in the system, but only if the system were 100 percent funded. But this concept has long since been lost." Funds were distributed in years in which there were no excess earnings. City council knows of the snake in the garden but hasn't passed an ordinance to change it, he says.
Attorney Michael Conger, who successfully sued the city and pension board last year over the underfunding, agrees that the pension benefit is "close to $2 billion." Then, he says, "Health care is probably another $1.5 billion, so we are talking about a deficit of $3.5 billion." In calculating the health-care liability, the city and pension system have used wildly unrealistic cost estimates, he says. "If you put in realistic health-care cost figures, they have been rising 15 percent a year for the last several years." The city's assumption is one-third of that.
Shipione says health-care costs have been rising 17 percent a year over a decade. Worse, "We don't know what the true costs are for health care -- who is included, who is excluded," she says. "The number of employees working for the city is not correct -- it's hidden and veiled."
Last week's charges just scratch the surface. Investigators must learn who was really culpable for the 1996 raid on the pension fund to finance the Republican convention, the 2000 vote in which the council and mayor gave themselves more generous benefits, and the 2002 machinations in which the city avoided a balloon payment it couldn't afford by boosting benefits of pension-board members who would in turn vote for continued underfunding.
Both Shipione and Gleason compare San Diego's situation with the pension mess in the private sector. Bankrupt airlines are dumping their pension obligations on the quasi-governmental Pension Benefit Guaranty Corp. Other airlines and large one-time blue-chip companies may well follow suit. There is a huge incentive for blue-chip corporations to go bankrupt. Some may be the same blue chips that used phony accounting in the 1990s -- taking their pension-fund excesses into profits.
The corporate frauds are instructive. "The financial condition of San Diego is built on every one of the irregularities which plagued the private sector in the late 1990s -- Enron and similar companies," says Shipione. She wonders if managers in San Diego government "believed that government entities were easier and more forgiving targets for manipulation and abuse."
"Private enterprise is laying off pension problems on future generations of stockholders," says Gleason. "San Diego is laying them off on future generations of taxpayers."