Opportunity Lost

City Council Overlooks Troubling Financial Indicators in Favor of Relativism and Wishful Thinking

On January 17, City Council was provided a status report update by the City Auditor entitled “Berkeley’s Financial Condition (FY 2012 – FY 2021): Pension Liabilities and Infrastructure Need Attention Audit”.  The objective of the presentation was to report on the implementation status of the Auditor’s recommendations emanating from a May 2022 Audit Report with the same title.

The May 2022 audit report is one of the most concise and revealing analyses of the city’s long-term financial condition. With regard to pension liabilities, the May 2022 audit report documented that the combined growth in pensions and other Post-Employment Benefits (OPEBs) such as health benefits represent one of the most serious “challenges” to Berkeley’s financial well being. The report examines the period between 2012 and 2021 to document long-term financial trends, and the leading indicators are troubling. 

• During this period, city revenues were up by 25%, but combined pension and OPEB liabilities increased by 36%. 

• Particularly alarming was the report of OPEB liability growing by 91% between FY 2012 and FY 2021, from $60.4 million to $115.1 million, adjusted for inflation.

• Combined unfunded pension ($657.9M) and OPEB liabilities ($115.1M) were $773 million in FY 2021.

Equally concerning are recent indicators (since the original audit report in May 2022) suggesting that the gap between revenues and liabilities is expanding further. For example, between 2012-2021, CalPERS investment returns were around 7.7%. Therefore, Berkeley’s liability gap grew despite a decade of robust returns on investments. For the 2021-22 fiscal year, CalPERS reported a -6.1% decline in investments, with negative or diminished returns continuing into the current fiscal year. In other words, we were losing ground even when investment returns were very strong, and now we appear to be losing ground at an accelerated rate.

Pension liabilities are a significant driver of financial health; because, unlike infrastructure needs, they cannot be “deferred.”  As the risk analysis performed by the Government Finance Officers Association pursuant to ballot Measure L (2022) describes, if (1) the gap between revenues and expenditures continues to widen and (2) the cumulative pension liability is substantial ($773.1M) and growing, then the city’s overall credit rating is at risk.

We highlight this dynamic between economic trends and Berkeley’s financial health because it was not clear from the discussion that the City Council appreciated the scope and magnitude of the problem. The mayor did refer to “long-term significant challenges” and he recognized that the city’s “unfunded liabilities will increase.” Councilmember Kesarwani, to her credit, did attempt to unpack the root causes by asking the City Auditor to explain the basis for the State Auditor classifying Berkeley’s pension funding ratio as “high risk”. 

However, these sobering and measured remarks were in contrast to Councilmember Harrison who stated, [time stamp 1:16] “we are in much better shape than many many other cities”... “I am very happy about where we are heading, I am not feeling as dire as where we are at right now.” With regard to fiscal relativism, Berkeley is ranked by the State Auditor in the lowest quartile (25%) of California cities (81st out of 360). On balance, 78% of California cities are considered to be in a better financial condition, so we do not believe fiscal relativism is anything to write home about.

After some confusing remarks about when employees will retire [time stamp 1:26:42], Harrison referred to the $657.9M in pension liability as “so called debt” … that is an “accounting number.” Yes, it is an accounting of the difference between future costs and funds available to cover such costs which can’t be wished away.

One of the critical issues, with regard to the timing of employee retirement, is age. The City pays a retiree medical subsidy that can be used for health insurance premiums of the retiree (single-party) or retiree and spouse/domestic partner (2-party). As noted previously, this OPEB benefit grew 91% in the last decade. It appears the  “great resignation” among city employees, with many taking early retirement, will result in an even greater OPEB liability.

The distinction between pension and other benefits was not even included in the status report or discussion. Another striking observation was that only two council members and the mayor spoke during the discussion which makes us wonder whether our city’s leaders have a complete perspective on the issue.

Later  this year, CalPERS will  release its revised Actuarial Valuation Report. WOM Berkeley anticipates that the consequences of the troubling financial indicators highlighted in our analysis will be revealed in the CalPERS report.  In the meantime, we caution against relativism and wishful thinking.