Pension funding is very complex, so it is often helpful to make comparisons that are not entirely accurate, but help illustrate the point nonetheless. So with that disclaimer in mind, the $5 million prepayment is similar to paying down your mortgage at a faster rate.
While that initial payment obviously increases costs today, you end up saving money by having to pay much less in interest over the remaining payment periods — which are now shortened thanks to the lump sum extra payment, ie your debt will be paid off sooner, and at a lower total cost, than if you simply made the monthly minimum payments.
That’s basically the scenario here. So as the city points out in the document you link to at end of your post, that $5 million dollars paid today knocks nearly $12 million off the amount Sierra Madre owes to CalPERS.
In addition to reducing long-term costs, I think this is smart because it leaves the city better protected should an economic downturn hit. Cities who do not address their existing debts will fare much worse if/when the next market downturn hits, and CalPERS costs explode.
So paying down as much as you can now, when things are good and you can afford to, will make that scenario more manageable.
I think it’s a prudent, fiscally responsible move. Far too many officials care only about keeping costs low under their watch, knowing that if residents get screwed in the next 10-20 years, it will be someone else’s problem. So I’d give Gabe and whoever else is responsible for this policy some much-deserved praise.
One more positive effect: reducing their outstanding debt could also increase the city’s credit rating, which would mean lower interest costs on other loans.
Robert Fellner - Executive Director, Transparent California
San Diego may accelerate paying off pension debt, which could create budget woes (San Diego Union-Tribune link): San Diego may accelerate paying off the city’s pension debt of $2.76 billion to avoid leaving taxpayers with a long-term bill they can’t afford, but the move could spike the city’s annual pension payment and force budget cuts.
Members of San Diego’s pension board say they will weigh their long-term goals against any short-term impacts to the city’s budget when they consider in September new policies for handling increases in the projected pension debt. For more than a decade, the pension system has softened impacts on the city budget of new pension debt by spreading corresponding increases in the city’s pension payment over either 15 years or 30 years.
No one is suggesting the pension system immediately pay off such increases in debt, which are caused by stock market losses, shrinking long-term investment expectations and increased estimates of how long employees will live.
But board members, during a preliminary discussion this month, analyzed scenarios under which the pay-off periods for such new debt would shrink to as little as five years. Under such a scenario, the city’s annual pension payment would increase from about $350 million per year to about $530 million per year over the next five years.
Board members said such a spike would probably be too extreme, but directed the board’s investment committee to present as many as five options for accelerated payoff periods during the September board meeting.
The board, however, may decide to have the new payoff policies only apply to new pension debt the city faces in the future, instead of having them apply retroactively to previous debts for which payoff periods are already spread over 15 or 30 years.
Potential policy changes have been prompted by concerns about a significant down turn in the stock market that many financial analysts are predicting.
Mod: The rest of the Union-Tribune article is available at the link.