San Diego doesn’t have to accept spiraling public pension costs

San Diego is headed back into a public pension crisis it worked so hard to escape. A court-mandated reopening of its defined benefit pension system has revived the same structural risks that previously led to San Diego’s skyrocketing public pension debt. But San Diego doesn’t have to accept spiraling public pension costs as inevitable. Other cities and states have successfully contained these pension risks by adopting risk-sharing strategies that distribute financial responsibility more equally between public employees and employers, i.e., taxpayers.

The case of San Diego’s public pension costs and reforms

San Diego previously tackled its pension issues through a 2012 voter-approved reform that replaced traditional defined benefit (DB) pensions with 401(k)-style defined contribution (DC) plans for newly hired employees. The reform reduced the long-term risks of underfunded public pensions and provided employees with more control over their retirement benefits. However, labor unions challenged the pension reform, suing the city for failing to adhere to rules requiring negotiations with them before altering any terms of employment (even for future hires). 

In 2021, the courts reversed the reform, mandating the reinstatement of defined benefit pensions and converting the retirement benefits of employees hired under the defined contribution system back into pension promises.  

After years of steady financial recovery, San Diego is now expecting to have a $136 million deficit in 2025 and a $258 million deficit in 2026, with more deficits to come. The San Diego Department of Finance estimates that from 2026 to 2030, city budget deficits could total $1.03 billion. This grim outlook has compelled the city to implement hiring freezes and impose significant departmental budget cuts, even to public safety.

The return of defined benefit pensions comes with risks. Unlike a defined contribution plan, the DB guarantees particular lifetime payments, but the costs depend heavily on assumptions about investment returns, salary growth, and life expectancy. When those assumptions miss the mark, costs explode—a risk often borne entirely by taxpayers. 

San Diego is already feeling the pressure. The city’s pension system is only 76.8% funded, with a $3.1 billion shortfall, meaning it has the funding to pay for 76.8% of the benefits already promised to workers. This financial burden has grown yearly despite the city making the actuarially required pension contributions in full. The numbers speak for themselves: San Diego’s annual pension costs have climbed to $533 million. Without structural changes, the city is trapped in escalating public pension liabilities.

Risk-sharing success stories from state pension systems

Managing the intrinsic risks of guaranteeing defined benefit pensions to public employees has been a persistent challenge for state and local governments. Some public pension systems have found much success by creating a new tier in the public systems that better distributes risk between employees and employers, and has automatic triggers adjusting contributions to prevent underfunding.

The Wisconsin Retirement System, for example, ties retiree cost-of-living adjustments (COLAs) directly to investment performance. When investment returns fall short, retirees see a reduction in benefits, slowing the accumulation of unfunded liabilities. As a result, Wisconsin’s pension system remains consistently funded at 100%.

Arizona’s Public Safety Personnel Retirement System took another approach, instituting a 50/50 cost-sharing structure where both employees and employers contribute equally to any increase in pension costs, including paying down unfunded liabilities. This ensures that rising costs don’t become an unchecked burden on taxpayers. The system also mandates a strict 10-year amortization schedule for new debt, ensuring liabilities don’t linger for decades, accruing costly interest.

Utah’s pension reforms offer another instructive model. In 2011, the state introduced a plan allowing new hires to choose between a 401(k)-style defined contribution plan or a DB/DC (defined benefit/ contribution) hybrid plan. In the latter, employer contributions are capped at 10% of payroll, and any additional costs beyond that must be covered by employees. The result? This approach ensures that new hires aren’t adding to escalating costs for the state. Today, these plans are 95.6% funded—far stronger than most pension plans, with the most recent median funded ratio at 80%.

San Diego should follow these examples and implement risk-sharing policies to tame the risks posed by the reopening of its defined benefit plan. A properly designed retirement system ensures that employees share not only the benefits but also the risks of traditional defined benefit plans. These policies wouldn’t just stabilize pension costs; they would protect essential city services from being cut back to shift taxpayer funding to cover rising pension obligations.

Risk sharing is just one element of designing a sound pension system. The key is ensuring that appropriate contributions are made and sound assumptions are used to determine these contributions. Low-risk and market-aligned investment returns are another essential element.

The forced reopening of San Diego’s defined benefit system will expose taxpayers to rising costs, but risk-sharing reforms could help prevent history from repeating itself. Without pursuing new pension reforms, San Diego is once again gambling with taxpayers’ money—and this time, the odds appear worse than ever. 

The post San Diego doesn’t have to accept spiraling public pension costs appeared first on Reason Foundation.

Source: https://reason.org/commentary/san-diego-doesnt-have-to-accept-spiraling-public-pension-costs/