EDITORIAL: San Jose pension board must get real on rate of return

By San Jose Mercury News, Calif.

Nov. 5--The board in charge of San Jose's police and firefighter pensions today will decide what rate of return on investments to use in its projections. Should it be 8 percent, or 7.5?

It may seem picayune. But this decision will have profound implications for taxpayers, and it will tell them a great deal about the priorities of the board's members. The higher projection will please police officers and firefighters by keeping their individual contributions down. But it will leave taxpayers on the hook for the difference if the actual returns on investment fall short, as they almost certainly will.

To be a good steward of the public interest, the board needs to adopt the lower rate. The difference could mean tens of millions of dollars in additional taxpayer contributions if projections don't materialize.

Every two years the pension board has outside actuaries advise it on an assumed rate of return. This year those actuaries recommended keeping the rate at 8 percent, where it has been for years -- even though performance has been falling short. But the board's own staff actuaries have recommended gradually reducing the rate to a more realistic 7.5 percent.

A higher projected rate of return looks better on paper because it assumes more of the fund's obligations will be met by market gains, requiring lower employee and city contributions initially. At an 8 percent rate of return, worker contributions are estimated to remain

about the same for the next five years.

But if the return does not materialize, taxpayers -- not employees -- make up the difference. There is growing consensus among experts that 8 percent is an unrealistically high estimate that hides the true cost of the pensions.

Next year, for example, San Jose is forking over an additional $45 million to its two pension funds -- close to the cost of libraries and code enforcement combined -- primarily to help make up for the funds' $1 billion in losses. And that's in addition to the $137 million or so taxpayers are expected to contribute to meet current funding obligations.

At a 7.5 percent rate of return, the city's projected annual contributions are significantly larger, but their risk of huge makeup payments later is greatly reduced. Police and firefighters' contributions would rise a little bit, too -- a reasonable expectation, given their very generous pensions.

The current pension board, made up of two City Council members and five representatives of employees and retirees, might be too eager to favor workers in this decision. Mayor Chuck Reed has proposed restructuring the city's two pension boards to include more experts, and this situation illustrates why that's necessary: With competing actuarial assessments to choose from, expertise on the part of board members is crucial.

In the meantime, the current board must show that it's a responsible guardian of the public interest. Setting the rate of return at the more conservative 7.5 percent will help protect against the consequences of future market losses. And it will provide a truer picture of the cost of the city's pension agreements.

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