Ryan McDonald

Council wary of future shortfall as it approves annual budget

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by Ryan McDonald

The Hermosa Beach City Council unanimously adopted the municipal budget for the 2018-19 fiscal year Tuesday night, providing for a year Hermosa will end in the black, but also revealing long-term challenges posed by rising pension obligations for city employees.

The budget includes a five-year forecast with five budget scenarios, several of which show the city running a deficit within four years. Staff presented options under which revenue would continue to exceed expenditures, but they depended on the construction of yet-to-be-approved developments, including the Strand & Pier project, or, more controversially, money from new or increased taxes and fees.

Last week, at the conclusion of a budget study session, Councilmember Justin Massey said the city was operating on a “shoestring budget.” He said council members were sensitive to the ways new fees could impact residents and businesses and promised that any changes would follow outreach and evaluation. But he noted that the city had several looming big-ticket infrastructure needs, including a revitalized civic center. Finding money for these while dealing with the ongoing pension obligations, he said, meant the city had to look at ways to grow revenue.

“This requires adult conversations about what we can afford, what we want to afford, and what we’re willing to reach into our pockets for,” he said.

Finance Director Viki Copeland said that city staff had anticipated a “tight” budget year because expenses grew at least one percent faster than revenue. Some of these were one-time costs, like the millions set aside for a renovated city yard, which officials said will make public works more efficient. But others represented a new reality, like the roughly $1 million increase in the amount the city spends on fire services.

The City Council voted last year to contract with the Los Angeles County Fire Department, and the county officially took over from the former Hermosa department at the close of last year. City staff has said that maintaining the existing department would have required additional firefighters and facilities upgrades that would have been at least as expensive as the fee increase the switch to the county required.

But although the city no longer maintains its own department, it is still on the hook for a share of the pensions held by the firefighters it once employed. These costs and retirement obligations for other employees in the California Public Employees Retirement System, or CALPERS, proved the most challenging expenditure issue for the council.

Employee compensation represents the bulk of the budget in almost every city, and in Hermosa, some of the pressure on the bottom line is coming from increases in the salaries on which employee pensions are based. According to a presentation from John Bartel, an actuarial consultant hired by the city, the segment of compensation subject to CALPERS for “miscellaneous” employees — essentially, all city workers except sworn public safety officers — jumped from an average of $35,400 in 1993 to $65,000 in 2016. According to the Bureau of Labor Statistics’ Consumer Price Index, this is about 10 percent higher than inflation during the period. Bartel’s data indicate that the city’s police officer salaries beat inflation by about 20 percent during that stretch, while firefighter wages rose almost 36 percent faster than inflation.

But according to Bartel’s data, demographics are a more significant factor than wage increases. In 1993, the city had 37 police officers. By 2016, that number had fallen to 36, but the number of retirees skyrocketed to from 43 to 92. Miscellaneous employees and the fire department experienced similarly flipped ratios of active-to-retired employees.

Bartel, whom Copeland called “the most highly used and best actuary in California,” said that an aging population with pension-drawing retirees outnumbering active employees is challenging cities across California. And budget drafting has been made more complicated recently by the fact that the CALPERS board’s decision to downgrade the “discount rate,” or the expected return on the investments the pension fund makes. The rate may continue to drop, Bartel said, as the fund adopts a more conservative investment strategy, with lower risks but lower projected returns.

Contribution rates for employees are set by contract, so cities will likely be on the hook for a larger share in coming years, part of the explanation for Hermosa’s forecasted budget difficulties. But Hermosa, Bartel said, was better prepared for the issue than most. Tuesday’s budget, for example, continues to put aside money into an interest-drawing trust fund that staff said will help “smooth” future spikes in contributions.

Pointing to a chart indicating an eventual peak in the share of employee compensation dedicated to retirement liabilities, Bartel said that the main thing was for cities to be prepared for what was coming.

“I encourage all of my clients to think: Where are you going to get the money to pay for the top of the mountain?” he said.

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