Cities Must Rein in Unsustainable Employee Costs.

The costs of total compensation for employees have grown substantially in the past decade and now threaten the cities ' fiscal stability. City Response to Finding 1 The City agrees with this finding. As shown below, for the City's sworn employee bargaining units, the San Jose Police Officers' Association ("POA") and the San Jose Fire Fighters Union, from Fiscal Year 2000-2001 to Fiscal Year 2009-2010, the City's average cost per employee for pay and benefits has increased by 77.64%. However, as shown below, during that same time period, the number of full time equivalent positions (FTEs) has only increased by 2.13%. The major factor in the increase in average total cost per FTE was for retirement benefits, which increased by 174.69%. Sworn Salary and Benefits 3 4 2000-2001 2009-2010 % Increase BASE PAYROLL (includes special/premium pays for all $153,485,514 $248,621,465 61.98% employees) RETIREMENT BENEFITS $23,520,821 $64,609,556 174.69% HEALTH/DENTAL BENEFITS $9,692,922 $22,904,476 136.30% OTHER BENEFITS $1,778,656 $5,800,686 226.13% GRAND TOTAL $188,477,913 $341,936,183 81.42% zcatt Average Total Cost Per FTE 05. •• - $161,748 X77.64 • TOTAL FTEs 2070.00 2114.00 2.13% 3 Source - Salary and Fringe Benefit Costs by Union Code & Fund for the 2000-2001 Adopted Budget to the 2009- 2010 Adopted Budget. This does not include worker's compensation costs or overtime costs. The figures above are budgeted costs and include the cost of providing paid time off, such as vacation, holidays, personal/executive leave, and sick leave, to the extent that paid leave is taken during the fiscal year. The actual salary and benefit costs of individual employees vary. HONORABLE MAYOR AND CITY COUNCIL September 21, 2010 Subject: Response to the Civil Grand Jury Report Entitled "Cities Must Rein in Unsustainable Employee Costs" Although the costs for our non-sworn employees did not increase as dramatically as the costs for sworn employees, there has also been a significant increase in costs for non-sworn employees. As shown below, from Fiscal Year 2000-2001 to Fiscal Year 2009-2010, the City's average cost per non-sworn employee for pay and benefits has increased by 52.48%. However, as shown below, during that same time period, the number of FTEs has decreased by 8.76%. Non-Sworn Salary and Benefits 5 6 2000-2001 2009-2010 % Increase BASE PAYROLL (includes special/premium pays for all $262,524,906 $333,716,243 27.12% employees) RETIREMENT BENEFITS $39,533,262 $72,862,473 84.31% IIEALTH/DENTAL BENEFITS $20,624,870 $41,293,502 100.21% OTHER BENEFITS $4,829,656 $7,765,501 60.79% GRAND TOTAL $327,512,694 $455,637,719 39.12% Average Total Cost per FTE $66,264 $101,043 52.48% TOTAL FTEs 4942.51 4509.36 -8.76% Grand Jury Recommendation 1 All of the cities in the County need to implement measures that will control employee costs. As a starting point, each city should determine the percentage of savings required from the total compensation package to reach budget stability, and provide choices of wages and benefits in collective bargaining sessions for the unions to choose to achieve that percentage goal. City Response to Recommendation 1 This recommendation has been implemented. It is important to look at total compensation, as an employee's compensation package is more than just base pay. Total compensation also includes the value of the cost of benefits, including pension and 5 Source - Salary and Fringe Benefit Costs by Union Code & Fund for the 2000-2001 Adopted Budget to the 2009- 2010 Adopted Budget. This does not include worker's compensation costs or overtime costs. The figures above are budgeted costs and include the cost of providing paid time off, such as vacation, holidays, personal/executive leave, and sick leave, to the extent that paid leave is taken during the fiscal year. The actual salary and benefit costs of individual employees vary. HONORABLE MAYOR AND CITY COUNCIL September 21, 2010 Subject: Response to the Civil Grand Jury Report Entitled "Cities Must Rein in Unsustainable Employee Costs" healthcare. This was the City's approach for the 2009-2010 negotiations with the City's bargaining units. In November 2009, the City Council in open session approved a goal of a 5% total compensation reduction for all City employees. Due to changed circumstances with the City's budget in March 2010 and an increase in the City's structural budget deficit, the City Council changed this goal to a 10% total compensation reduction for all City employees. During negotiations with bargaining units, the City provided many options for achieving that goal through reductions to pay and benefits. As of August 2010, the following was achieved through negotiations using this approach: Progress of Achieving 10% Total Compensation Reduction7 Total Compensation Reduction Employee Unit 5% Ongoing 5% One-Time Total FTEs 5% Unit 99/Unit 82 5% 10% 242 5% ALP 5% 10% 43 AEA 5% 5% 10% 202 CAMP 5% 5% 10% 360 5% IBEW 5% 10% 75 AMSP (cid:9) 0 5% 5% 10% 79 OE#3 5% 5% 10% 772 ABMEI8 5% 0% 5% 55 POA 0.67% 3.15% 3.82% 1273 IAFF, Local 2309 NA NA NA 660 MEF1° NA NA NA 1958 CEO" NA NA NA 191

Salary and wage increases do not reflect changes in economic conditions; e.g. even with minimal inflation, yearly COLAs are granted with little bearing on the actual increase in cost of living or market conditions. Source: Salary and Fringe Benefit Costs by Union Code & Fund for the 2010-2011 Adopted Budget. Council approved terms of 5% ongoing total compensation reduction in April 2010. No agreement has been reached with the San Jose Firefighters. MEF has received a 2% general wage increase per their current contract, which extends through FY 10-11. CEO will receive a 2% general wage increase per their current contract, which extends through FY 10-11. (cid:9)(cid:9)(cid:9)(cid:9)(cid:9)(cid:9)(cid:9)(cid:9)(cid:9)(cid:9)(cid:9)(cid:9)(cid:9)(cid:9)(cid:9) HONORABLE MAYOR AND CITY COUNCIL September 21, 2010 Subject: Response to the Civil Grand Jury Report Entitled "Cities Must Rein in Unsustainable Employee Costs" City Response to Finding 2 The City agrees with this finding. In past years, general wage increases given in many years exceeded CPI. The chart below shows the average Citywide FTE cost increases versus CPI over the past ten years.'' This shows that the City's increase in personnel costs have far exceeded the CPI. Average Citywide FTE Costs versus CPI Changes Over Time .- -,:' (cid:9) „ i,.„,.•..c*" (cid:9) , ',..., '..-i' (cid:9) .,, ..• 120,418 $120,000 -.EA: (cid:9) .6. , (cid:9) - (cid:9) '--7,,,,`„-.- -To.-- (cid:9) ,..,, . - , - - -- (cid:9) .,,,,,, ., (cid:9) -,2,-,F .,,,,, .,... -,--- -e (cid:9)a -% ., '(cid:9) e.<.,".-.- -, (cid:9) .—> (cid:9) - (cid:9) . . 4 (cid:9) - - (cid:9) -- g -,-- 4 - k . '; , , " (cid:9) t :, ,. - .: ,- 112 - ,4 (cid:9) - = ' ,1`-. ' -:: (cid:9) '-'1P . (cid:9) -741W ... 7 7- .:v. (cid:9) ,-.-..,, (cid:9)" - tm -1,4 $110,000 v. (cid:9) .4.:-.*--.., -,.. (cid:9) ,t....., 06981 — 7.' • (cid:9) -_,I.A,. $100,000 iv 4 •s ,. W .. e - ' ., * ' . . .2 - ,2, . . I - - . . - , 4- 7 - (cid:9) - , - .. 4 (cid:9) . : .-: ' ^" I ' f (cid:9) -- (cid:9) (cid:9) -..7- : . ' . ,(cid:9) (cid:9) , ,. , ., .. :, - - - : -. 1 - . .s.41 . *, . -, 1 - • :% , .- , -y-,- .. .- 5 -4 . * :- .. -- .- - -. . , - .. , . „ . , . 4 , , , - - - , ,. - - z (cid:9) (cid:9) - . - 0 . (cid:9) , , (cid:9) - - (cid:9) ,• , .. (cid:9) , (cid:9) (cid:9) i(cid:9) „.,. - . (cid:9) ----, (cid:9) , - (cid:9) - 4 -. 1 .- e (cid:9) ., , - (cid:9) , - ... ,,,,,,% e . ^ (cid:9) , •--e- ..,. 3 (cid:9) -*- . . (cid:9) .,.-..- (cid:9),- •,'. (cid:9) -,, • , ,,,,,,,,,.--_•,...„ (cid:9) • - (cid:9) A -. 0 .., . ,-:Piv- .44.-;?,' 72:7}ZUPE-1,-,7“.,! .. (cid:9)- (cid:9) „ . -.. (cid:9) 4. - , . , - . (cid:9) ' " 4- (cid:9) ,„ 4 ; .,,,.... --._ (cid:9) '..C. , -. ,...-, (cid:9) --;.4,,, -* (cid:9) - , (cid:9) $90,000 '' ....;.Fe ,* Y,g,F,, w 1 p ,P o o 4 z . .. , , . %. , . . afs e 0. (cid:9) 7,.---,.00 t • ri" '' . :-.. . g ,".4.* .. - , - (cid:9) ,--T- (cid:9) ,-,,, (cid:9)- (cid:9) — , -'' (cid:9) , - ,,,,.. "fi;'- , .24." (cid:9) .-.- ... ... ...., (cid:9) z., t,,,.. $(cid:9)86,798 (cid:9) $86,9 97 7,(cid:9)9.2.. 8 $80,000 $76511 (cid:9) ,ter (cid:9) .:,c,4S' --, 4,*. (cid:9) ,„ , , . „ .1 . - (cid:9) , , (cid:9) ,.,. (cid:9) ....,L4._..,- . . (cid:9).. 0 , xi-'-',?-71, e' : (cid:9) -,r-04 .w.-ss.;-,,,,,,,. (cid:9) ..,,,.,„,.,,, - , (cid:9) : - , - . - . , 4 - ..,.,.,,,y.. ... .,,.•. (cid:9),-- . $73,581 s74,464 $75,656 $76' 700 . (cid:9) $7 . (cid:9) 7 . (cid:9) 54 . (cid:9) .5 - : (cid:9) (cid:9) '''' '''''' .' -",i,-. , (cid:9) 4(cid:9) z -: .-- , . A . (cid:9) A4 - (cid:9) -, f .. f .. : . . .k - . 7W:'-':r447' t* r - Y ' $70,000 2000-2001 2001-2002 2002-2003 2003-2004 2004-2005 2005-2006 2006-2007 2007-2008 2008-2009 2009-2010 is-- Citywide CPI-U —*—Average Citywide FTE Cost Grand Jury Recommendation 2 Cities should not increase salaries and wages that are not supported by planned revenue increases. Cities should tie COLA increases to clear indicators and retain the ability to adjust or withhold based on current economic data. City Response to Recommendation 2 This recommendation requires further analysis, which will be done for the upcoming negotiations in the next few months. There are a variety of factors that need to be considered when increasing salary and wages, including CPI, market comparisons, and particularly the City's fiscal situation. In addition, there are downsides to negotiating 12 Source: Salary and Fringe Benefit Costs from 2000-2001Adopted Budget to the 2009-2010 Adopted Budget and Bureau of Labor Statistics; San Francisco-Oakland-San Jose CPI-U Index. HONORABLE MAYOR AND CITY COUNCIL September 21, 2010 Subject: Response to the Civil Grand Jury Report Entitled "Cities Must Rein in Unsustainable Employee Costs" formulas in contracts that base salary growth on CPI as the City has no control over the CPI and such a formula could require salary increases that do not reflect the City's fiscal situation.

Step increases are arbitrary and do not adequately represent an employee's added value to a city. Combined with COLAs, new employees' wages increase quickly and are not necessarily reflective of improved knowledge and skills. City Response to Finding 3 The City agrees with this finding. Employees in all but one of the City's non- management bargaining units, are typically eligible for a 5% automatic pay increase just for time spent in the classification until an employee reaches the top step in the position's salary range. When combined with negotiated general wage increases, this could result in an employee receiving a significant pay increase in a year without any consideration given to that employee's performance. For example, in 2010-2011, two City bargaining units had a previously negotiated general wage increase of 2%. Employees represented by those bargaining units who are not at top step, will receive a 7% increase this Fiscal Year, in comparison to approximately 1800 employees who took a 10% total compensation reduction. It should be noted the City's management bargaining units and unrepresented management employees receive merit increases based on performance. However, merit increases are not guaranteed and are given at the discretion of the City Manager or other Council Appointee. Due to the City's fiscal situation, merit increases have not been authorized in the last two years for management employees. Grand Jury Recommendation 3 Cities should negotiate step progressions from the current three and a half years to seven years. Employees should not receive COLA increases while in step progression. City Response to Recommendation 3 This recommendation has not yet been implemented, but may be implemented in the future. However, there needs to be further analysis on whether or not seven years is the appropriate timeframe. The City has proposed in bargaining for the last few years moving to a system where step increases are given based on performance after an employee receives an "above standard" overall rating on the employee's performance appraisal. The City has also proposed moving the difference in the steps from 5% to 2.5%, which would also assist the City in controlling payroll costs. Unfortunately, this has not yet been achieved with any non-management bargaining unit, but will continue to be the subject of future negotiations. HONORABLE MAYOR AND CITY COUNCIL September 21, 2010 Subject: Response to the Civil Grand Jury Report Entitled "Cities Must Rein in Unsustainable Employee Costs"

Medical insurance costs for active employees are growing year after year at rates that exceed most cities' revenue growth, while the employee contribution to medical care is minimal. City Response to Findings 4 The City agrees with this finding. The following chart shows the increases in medical plan costs for the City versus the increases in active employee costs: Kaiser Family Premiums (Monthly) $1,084.68 $998.26 $975.32 $1,000.00 $750.00 $500.00 $$4 28.70 $413.28 (cid:9) a $250.00 $99.94 (cid:9) $108.12 (cid:9) $110.54 (cid:9) $120.52 $50.00 $25.00 (cid:9) $25.00 (cid:9) $25.00 (cid:9) $25.00 (cid:9) $25.00 (cid:9) $25.00 $0.00 2000 (cid:9) 2001 (cid:9) 2002 (cid:9) 2003 (cid:9) 2004 (cid:9) 2005 (cid:9) 2006 (cid:9) 2007 (cid:9) 2008 (cid:9) 2009 (cid:9) 2010 —a—City Premium (Monthly) —dr-Employee Premium (Monthly)] As shown above, for six of the last 11 years, the maximum employee contribution for the Kaiser HMO plan was capped at $25.00 per month and the annual increases in medical costs were completely paid for by the City. However, in the last five years employee contributions towards healthcare have increased to approximately 10% of the cost of Kaiser HMO plan premiums. Grand Jury Recommendation 4 Cities should negotiate that employees assume some of these increased costs for their medical benefits. To contain medical costs cities should consider the following: A. Split monthly premiums between the city and the employee and increase the employee's share, if already cost splitting, and remove any employee caps. HONORABLE MAYOR AND CITY COUNCIL September 21, 2010 Subject: Response to the Civil Grand Jury Report Entitled "Cities Must Rein in Unsustainable Employee Costs" B. Establish reasonable co-pays for doctors' visits, prescription drugs, and in-patient and out-patient hospital care. C. Prohibit an employee from being covered by both city-provided medical benefits and as a dependent of another city employee. D. Request cash-in-lieu payments E. Introduce a new lower premium, high-deductible medical plan. City Response to Recommendation 4a This recommendation has been implemented for many of the City's employees. Since 2005, the City has been negotiating with the bargaining units changes to cost sharing and removing caps that had been in place. As a result, most employees have a 90% City/10% Employee cost sharing split with no cap. Employees represented by the San Jose Fire Fighters union continue to have a $150 cap on monthly employee contributions. In 2010 and 2011, there will be approximately 1500 City employees who have moved or will move to an 85% City/15% Employee cost sharing split. The shift to the 85% City/15% Employee cost sharing split will be a subject of the upcoming negotiations with the bargaining units that still have the 90% City/10% Employee cost sharing split. City Response to Recommendation 4b This recommendation has been implemented for many of the City's employees. During the last few years, co-pays have also been increased through negotiations with the City's bargaining units. Previously, the City of San Jose had one of the last remaining Kaiser $0 co-pay plans, which was one of the factors of the City's rising healthcare costs. As of 2009, all employees moved to a $10 co-pay plan and in 2010 and 2011, approximately 1500 City employees will move to a $25 co-pay plan. The shift to a $25 co-pay plan will be a subject of the upcoming negotiations with the bargaining units that still have a $10 co-pay plan. City Response to Recommendation 4c This recommendation has been implemented for some of the City's employees. In 2010, the City began negotiations to prohibit an employee from being covered by both City- provided medical benefits and as a dependent of another City employee. This prohibition now applies to approximately 1500 City employees and the prohibition will again be the subject of upcoming negotiations with the other bargaining units that are not subject to this prohibition. City Response to Recommendation 4d This recommendation has been implemented for some of the City's employees. In 2010, the City also began negotiations to reduce the amount of the cash-in-lieu payments. Previously, the cash-in-lieu payment was tied to medical plan premiums, so as the medical plan premium costs rose for the City, so did the cash-in-lieu payment. In 2010, the City achieved a reduction to the cash-in-lieu payment, as well as a cap on the cash-in- HONORABLE MAYOR AND CITY COUNCIL September 21, 2010 Subject: Response to the Civil Grand Jury Report Entitled "Cities Must Rein in Unsustainable Employee Costs" lieu payment for approximately 1500 City employees. The reduction and cap on the cash-in-lieu payment will again be the subject of upcoming negotiations with the other bargaining units that are not subject to this reduction. City Response to Recommendation 4e This recommendation requires further analysis. The Human Resources Department has been evaluating and will continue to evaluate introducing a new lower premium, high- deductible medical plan, which will be done for the upcoming negotiations in the next few months.

Pension formula changes instituted in the past decade, stock market losses, the aging "baby boomer" work force, and the growing unfunded pension and OPEB liability all contribute to making retiree pension and health care costs the most problematic and unsustainable expense the cities are facing. The city contribution to pension plans and OPEBs far exceeds the employee contribution. City Response to Finding 5 The City agrees with this finding. Below are charts showing the historical City contribution rates, as well as the employee contributions rates. 1314 13 Some bargaining units are contributing more to offset the City's Contribution as part of the 10% Total Compensation Reduction. Source: Retirement Services Department HONORABLE MAYOR AND CITY COUNCIL September 21, 2010 Subject: Response to the Civil Grand Jury Report Entitled "Cities Must Rein in Unsustainable Employee Costs" Federated City Employees' Retirement System Contribution Rates 35.00% 29.59% 30.00% 24.0 % 25.00% 23.56% 21.98% 20.00% 17.40% 17.12% 16.52% 16.09% - 15.20% 15.00% 9.35% 10.30% 10.00% ___. 8.93 % 7.58% 6.06% 531% 4.76% 4.96% 5.08% (cid:9) _ 5.00% - 0.00% 1/11/98 (cid:9) 6/25/00 (cid:9) 8/19/01 (cid:9) 6/23/02 (cid:9) 7iO4/04 (cid:9) 7/02/06 (cid:9) 6/29/08 (cid:9) 6/28/09 6/2710 ICI Total City O Total Employee I Contribution Rate Contribution Rate Police & Fire Department Retirement Plan (Fire Contribution Rates) 50.00% 44.16% 45.00% 40.00% 35.00% 28.31% 30.00% 24.5959% (cid:9) 25.04% (cid:9) 25.22% (cid:9) 25.61% 25.00% - - 20.00% 15.70% - 14.22% ____ 13.70% 15.00% _ 12AO% 939% 10.25% 11.16% 11.16% - 11.2 6% - 11.26 % 10.00% ---- 5.00°/a 0.00% (cid:9) (cid:9) (cid:9) (cid:9) (cid:9) (cid:9) (cid:9) 6/25/00 6/23/02 7/04/04 7/03/05 7/02/06 7/01/07 6/29/08 6/27/10 °Total City (cid:9) 0 Total Employee Contribution Rate Contribution Rate (cid:9)(cid:9) HONORABLE MAYOR AND CITY COUNCIL September 21, 2010 Subject: Response to the Civil Grand Jury Report Entitled "Cities Must Rein in Unsustainable Employee Costs" Police & Fire Department Retirement Plan (Police Contribution Rates) 50.00% 44.58% 45.00% .,- ;.).1 40.00% -,-- — (cid:9) ‘,; , -, (cid:9) .... (cid:9) .... — *----,o, 35.00% ' (cid:9) - (cid:9) ..., . (cid:9) . (cid:9) .. (cid:9):,,5->" (cid:9) ,..,... (cid:9) -4 ' (cid:9) ,7;,---,---. (cid:9) - - (cid:9) ; (cid:9) -.-, (cid:9) cb.1, 28.51% (cid:9) 28.90% 30.00% ...... (cid:9) --.4 . (cid:9) 0 . 4,...-. (cid:9) r 26.89% 24.5904 (cid:9) 25.04% (cid:9) ,,,,„...-.. (cid:9). r: ' (cid:9) (cid:9) ....."...,,- (cid:9) '-. (cid:9) .... 258. 0Vo (cid:9) 25.00% ?,. 20.00% 15.70% ,A. 14.22% (cid:9) 12.96% 15.00% 9.79 _ % 10.25% 11.16% 11.16% 11.26% 11.67% s 11.67% 1196% 10.00% ; 5.00% ... ,... _ 0.00% 6/25/00 (cid:9) 6/23/02 (cid:9) 7/4/04 (cid:9) 7/03/05 (cid:9) 7/02/06 (cid:9) 12/17/06 (cid:9) 7/01/07 (cid:9) 6/29/08 (cid:9) 6/28/09 (cid:9) 6/27/10 (cid:9) IR Total City 0 Total Employee Contribution Rate (cid:9) Contribution Rate As demonstrated in the charts above, there was a significant increase in contributions from Fiscal Year 2009-2010 to Fiscal Year 2010-2011. This rate increase equates to approximately S25 million in additional costs for retirement, which is the equivalent of approximately 140 public safety positions. Given recent actuarial reports, the City expects contribution rates to rise dramatically in the upcoming years. Below are projected contribution rates as a percentage of payroll for both pension and retiree healthcare are expected to be in the next 5 years. 15 15 Does not include Pre-Payment Discount and assumes IAFF, Local 230 will agree to phase in contribution of the employee's share to full pre-fund retiree healthcare. , 74.89% (cid:9) -0--4 (cid:9) . (cid:9) .1..442f: k...-4 _ ,,.. (cid:9) 69.89 s- s, • . , 4 --• , (cid:9) - (cid:9) '.- (cid:9) 4' ''' ' (cid:9) .. , - ,V (cid:9) —t N.(cid:9) ...34.... (cid:9) A, (cid:9) - ..- (cid:9) (cid:9) , . (cid:9) .., ... — .,„. -.-.:?--.„.;..-..-t-,--- ".*.-- (cid:9) (cid:9) 52.39° (cid:9) ..y., (cid:9) ..4W ..-- , , .,. 44 . 5g (cid:9) z. .. , -,--)i, '51,2 42.71% 45.14% 38.42% , HONORABLE MAYOR AND CITY COUNCIL September 21, 2010 Subject: Response to the Civil Grand Jury Report Entitled "Cities Must Rein in Unsustainable Employee Costs" Retirement Contribution Rates (Percentage of Payroll) 80.00% 70.00% 60.00% 50.00% 40.00% 34.29% 29.59% 30.00% —..--. 20.00% 10.00% - 0.00% (cid:9) (cid:9) (cid:9) (cid:9) 2010-2011 2011-2012 2012-2013 2013-2014 2014-2015 q Federated q Police & Fire i Grand Jury Recommendation 5a Cities should: I. Renegotiate and make provisions for increasing the employees ' contribution for current pension plans 2. Renegotiate to stop paying the employees' contribution amount to pension plans 3. Renegotiate to implement a contribution amount for employees to OPEB; this contribution should provide for a reasonable split of costs between a city and the employee for retiree medical and dental benefits. City Response to Recommendation 5a-1 This recommendation has been implemented for some of the City's employees. As noted above, as part of the agreements with some bargaining units for the total compensation reduction, some bargaining units agreed to make additional retirement contributions, thereby offsetting the City's contribution obligation. In addition, the City's focus in 2010-2011 will be retirement reform and there are a variety of things occurring in order to negotiate these changes. The City has developed a stakeholder process to begin at the end of September 2010, in order for stakeholders to have input on the goals for retirement reform. In addition, the stakeholder process will provide an opportunity for education on why retirement reform is necessary. HONORABLE MAYOR AND CITY COUNCIL September 21, 2010 Subject: Response to the Civil Grand Jury Report Entitled "Cities Must Rein in Unsustainable Employee Costs" City Response to Recommendation 5a-2 This recommendation will not be implemented because it is not warranted because it is not applicable to the City. Unlike certain PERS agencies which pay a portion of the employees' contribution amount to pension plans, the City is not in PERS and does not pick up any of the employee's portion. City Response to Recommendation 5a-3 This recommendation has been implemented. For the City, eligible employees can receive a lifetime benefit for retiree health and dental. The cost sharing for retiree medical benefits is already 50% City/50% Employee. However, the amount contributed was only a portion of what needed to be contributed in order to fully pre-fund the benefit. In 2009, the City and all of the bargaining units, except for the San Jose Fire Fighters, began ramping up to fully pre-funding the Annual Required Contribution (ARC) for retiree medical benefits. Grand Jury Recommendation 5b Cities should thoroughly investigate reverting to prior pension formulas that were less costly. City Response to Recommendation 5b This recommendation requires further analysis. The City's focus in 2010-2011 will be retirement reform and there are a variety of things occurring prior to beginning negotiating these changes, including a ballot measure in November to allow the City Council to adopt an ordinance to exclude future City officers and employees from any existing retirement plans or benefits and to establish retirement plans for future employees that do not provide for the current minimum requirements in the City Charter. The City has developed a stakeholder process to begin at the end of September 2010, in order for stakeholders to have input on the goals for retirement reform. In addition, the stakeholder process will provide an opportunity for education on why retirement reform is necessary. Grand Jury Recommendation 5c To provide a meaningful, long-term solution, the cities should negotiate agreements to: I. Institute a two-tier system for pension and retiree health care for new hires. 2. Increase the retirement age from 50 or 55 to 60 or 65. 3. Calculate pensions on the last three to five years of salary. 4. Replace current post-employment health care plans with health savings plans. HONORABLE MAYOR AND CITY COUNCIL September 21, 2010 Subject: Response to the Civil Grand Jury Report Entitled "Cities Must Rein in Unsustainable Employee Costs" City Response to Recommendations 5c-1 This recommendation requires further analysis. The City's focus in 2010-2011 will be retirement reform and there are a variety of things occurring in order to negotiate these changes. The City has developed a stakeholder process to begin at the end of September 2010, in order for stakeholders to have input on the goals for retirement reform. In addition, the stakeholder process will provide an opportunity for education on why retirement reform is necessary. City Response to Recommendations 5c-2 and 5c-3 These recommendations require further analysis. The City's focus in 2010-2011 will be retirement reform and there are a variety of things occurring in order to negotiate these changes, including a ballot measure in November 2010 to allow the City Council to adopt an ordinance to exclude future City officers and employees from any existing retirement plans or benefits and to establish retirement plans for future employees that do not provide for the current minimum requirements in the City Charter to eliminate the minimum benefits section of the City Charter. The City has also developed a stakeholder process to begin at the end of September 2010, in order for stakeholders to have input on the goals for retirement reform. In addition, the stakeholder process will provide an opportunity for education on why retirement reform is necessary. It is not specified in the recommendation as to whether or not these changes are recommended for current employees or new hires. There are legal issues, however, related to the City's ability to make modifications to retirement benefits for retirees and current employees. As part of retirement reform, the City will be discussing with the bargaining units changes to retirement benefits. This will include potential changes to pension formulas for new hires, as well as increasing retirement age, the calculation of the pension benefit and options regarding retiree healthcare benefits. City Response to Recommendations 5c-4 This recommendation requires further analysis in order to determine the cost benefit of instituting a health savings plan. This will be evaluated during the upcoming retirement reform process and discussions.

Public sector employees are granted a generous number of holidays, personal days, vacation days and sick leave annually. Rules and limits on accrual vary by city and union, but vacation days and sick leave can be accumulated and converted to cash or calculated into the pension benefit within those limits. HONORABLE MAYOR AND CITY COUNCIL September 21, 2010 Subject: Response to the Civil Grand Jury Report Entitled "Cities Must Rein in Unsustainable Employee Costs" City Response to Finding 6 The City agrees with this finding. Previously, City employees were able to accrue an unlimited amount of vacation that would be paid out upon leaving City employment. The City has since negotiated a vacation accrual cap, which limits the amount of vacation an employee can accrue to two times an employee's annual accrual rate. It should be noted that accumulated vacation and sick leave are not part of the calculation of determining an employee's pension benefit. There has been significant focus on the City's sick leave payout benefits. In comparison to other public sector agencies, the City's sick leave payout formulas are very generous. In the case of employees represented by the POA and the San Jose Fire Fighters union, those employees are eligible to receive a payout of 100% of their sick leave hours, with no limit. In Fiscal Year 2009-2010, the City spent $14 million on sick leave payout alone. Sick Leave Payouts (Fiscal Year 2007-2008 to 2009-2010) (cid:9) FY 07-08 FY 08-09 (cid:9) FY 09-10 High (cid:9) Total (cid:9) High (cid:9) Total (cid:9) High (cid:9) Total $227,351 (cid:9) $6.96 Million $251,870 1$11.73 Million $256,969 1$14.61 Million Grand Jury Recommendation 6a Cities should renegotiate with the bargaining units to 1) reduce vacation time; 2) reduce the number of holidays and/or personal days; 3) cap sick leave and eliminate the practice of converting accumulated sick leave to cash or adding into their years of service for inclusion in their retirement benefit. City Response to Recommendation 6a This recommendation requires further analysis. The City has already made changes to vacation in order to limit the City's liability when it comes to vacation payout. The City will also be evaluating reductions in all leave benefits as a cost containment measure and in order to limit time away from work so as to maintain City services. In regards to sick leave payout, this has been a topic of negotiations this year and in past years, but unfortunately changes have only been achieved with one bargaining unit. The sick leave payout benefit will again be a topic of negotiations in 2011. HONORABLE MAYOR AND CITY COUNCIL September 21, 2010 Subject: Response to the Civil Grand Jury Report Entitled "Cities Must Rein in Unsustainable Employee Costs" Grand Jury Recommendation 6b Cities should negotiate to substitute paid days off for unpaid days instead of imposing furloughs. For example, reduce paid holidays to major holidays only, consistent with the private industry; and convert minor holidays to unpaid. Therefore, the public is not impacted by fewer services cause by furloughs, and the city saves the employee cost. City Response to Recommendation 6b This recommendation requires further analysis. The City has utilized voluntary furloughs for many years as a cost savings measure and has also had a limited use of mandatory furloughs. The City is mindful that furloughs are also a service level reduction and could in some cases, increase the City's costs or liabilities. When furloughs have been instituted recently, the City has been cautious to ensure that the retirement system is kept whole through retirement contributions still being made on the unpaid time since employees can earn a full year of pension credit. This ensured that an unfunded liability was not created through the use of furloughs. The concept of substituting paid days off for unpaid days was evaluated during the 2009- 2010 negotiations and would have been considered had furloughs been more a focus of the discussions. Through the City's evaluation of this concept, various issues were raised, including the impact it would have to exempt employees. This recommendation would need to be evaluated further.

Cities traditionally determine their compensation packages by surveying the wages and benefits of other public sector employees in the same geographic area. There is a major resistance to comparing themselves or mirroring trends with the private sector. This has allowed wages and benefits to become artificially high and out of sync with market trends. City Response to Finding 7 The City disagrees partially with this finding. Trends in employee compensation in the private sector are important to consider when determining City employee pay and benefits. However, determining the value of some benefits that vary drastically from those found in the private sector can make comparisons difficult. Where such comparisons are possible, they should be considered, along with several other factors, when deciding what the appropriate compensation package for City employees. Grand Jury Recommendation 7a Cities should research competitive hiring practices and alter the approach to determine fair wages and benefits for each city by using public and private sector data. HONORABLE MAYOR AND CITY COUNCIL September 21, 2010 Subject: Response to the Civil Grand Jury Report Entitled "Cities Must Rein in Unsustainable Employee Costs" City Response to Recommendation 7a This recommendation requires further analysis. The City has in some cases compared specific classifications to the private sector. This would not be able to be done in all circumstances as some job duties/classifications do not exist in the private sector. Grand Jury Recommendation 7b Cities should renegotiate salaries and wages using valid market comparisons and not only the current wage index. Cities should utilize more market-oriented compensation practices so that salaries can adjust as competition for labor changes. Cities should reduce entry-level compensation for positions for which there are many qualified applicants. City Response to Recommendation 7b This recommendation has not been implemented, but may be implemented in the future. Reducing entry-level compensation for positions for which there are many qualified applicants was also a recommendation that came out of the City Manager's Structural Deficit Task Force. This will be subject to negotiations with the bargaining units.

All cities perform certain core functions to run smoothly and provide services to their residents. To reduce employee costs and streamline operations, the cities are in various stages of contracting services to private industry or partnering with other cities, special districts or the County to deliver services. City Response to Finding 8 The City agrees with this finding. With the City's current budget situation, all options should be evaluated in order to continue providing services. This includes evaluating contracting services to private industries and partnering with other cities, special districts or the County to deliver services. Grand Jury Recommendation 8a Cities should explore outsourcing some functions and services to private industry. Cities should discuss the prospect with cities that are successfully doing this to determine best practices and areas for success. Cities should develop contracts with measurable objectives, performance goals, and timelines. City Response to Recommendation 8a This recommendation has been implemented and will continue to be pursued. For Fiscal Year 2010-2011, as part of resolving the City's $118.5 million deficit, the City Council made the difficult decision to contract out various services in order to continue providing HONORABLE MAYOR AND CITY COUNCIL September 21, 2010 Subject: Response to the Civil Grand Jury Report Entitled "Cities Must Rein in Unsustainable Employee Costs" those services at a lower and more sustainable cost. These options will continue to be evaluated this year for Fiscal Year 2011-2012. Grand Jury Recommendation 8b Cities should create partnerships with other cities, special districts and/or the County for services, such as payroll, human resources, animal control, police and fire. Cities should investigate sharing the cost of new information technology systems. City Response to Recommendation 8b This recommendation has been implemented. The City of San Jose is currently participating in a City/County Workgroup to evaluate the sharing of municipal services.

Cities can gain operational efficiencies and effectiveness with lower employee costs by making sure they are staffed with the correct numbers of people in the appropriate job classification in all departments and work groups. City Response to Finding 9 The City agrees with this finding. Again, with the City's fiscal situation and facing a $118.5 million deficit for Fiscal Year 2010-2011, it was important that all avenues be considered, including operational efficiencies. Grand Jury Recommendation 9 Cities should analyze the functions performed by all job classifications and make adjustments in the work force. Consolidate functions within the same group or a similar group. Reassign appropriate work to lower paid job classifications. Eliminate unnecessary functions. City Response to Recommendation 9 This recommendation has been implemented. The City has always strived to be an efficient and an effectively staffed organization. Changes to staffing receive careful review and consideration, and are included in the budget process. Further, as vacancies in staffing arise, careful consideration of the vacant position is completed before refilling the position and any changes to the job classification are pursued. In July of 2010, almost 800 filled and vacant positions were eliminated resulting in approximately 200 layoffs. Reductions occurred in all departments and at all levels of the organization. This significant organizational staffing reduction has necessitated the consolidation of duties, elimination of unnecessary work, and regular pursuit of efficiencies in an effort to maintain quality services to the public. Layoffs and substantive job changes are subject to impact bargaining pursuant to collective bargaining laws. HONORABLE MAYOR AND CITY COUNCIL September 21, 2010 Subject: Response to the Civil Grand Jury Report Entitled "Cities Must Rein in Unsustainable Employee Costs"

The San Jose City Auditor identified 88 positions currently being performed by public safety employees that can be performed by civilian employees at lower costs. The safety employees could be moved to positions that require their expertise and training. The auditor estimated this could be accomplished in less than 90 days and save approximately $5 million annually. City Response to Findings 10 The City agrees with this finding and the City Council approved the City Auditor's report that contained this recommendation. The amount of savings generated would be determined by the number of sworn positions being eliminated and replaced with civilian positions. If the City maintains the same number of sworn positions while creating additional civilian positions, this would result in additional cost to the City. Civilianization is subject to labor negotiations with affected bargaining units, please see response to Recommendation 10 below. Grand Jury Recommendation 10 San Jose should negotiate this suggested transfer with the San Jose Police Officers' Association and set realistic timeframes to move these safety positions to civilian positions. City Response to Recommendation 10 This recommendation has not yet been implemented, but will be implemented in the future. The City of San Jose and the San Jose Police Officers' Association (POA) currently have an agreement that extends through June 30, 2011. The City will commence negotiations with the POA in January 2011 and will discuss the issue of civilianization of certain positions.

In many cities, the contract negotiation process is completed by placing the negotiated collective bargaining agreements on the consent calendar for approval, which is acted on quickly at the start of council meetings by a single motion and vote of the council. City Response to Finding 11 The City agrees with this finding. Grand Jury Recommendation 11 Cities should consider holding well-publicized public hearings about the cities ' goals of negotiations before negotiations begin, and again at the end of negotiations to report to citizens clearly what changes have been made in contracts. HONORABLE MAYOR AND CITY COUNCIL September 21, 2010 Subject: Response to the Civil Grand Jury Report Entitled "Cities Must Rein in Unsustainable Employee Costs" City Response to Recommendation 11 This recommendation has been implemented. As part of the City's Sunshine Reform Measures to enhance open government, the City adopted reforms specific to these

Current contracts were negotiated in good faith by representatives of the cities and the bargaining units; they were approved by the city councils. Promises made to employees were made by elected officials, past and present. Responsibility for formulating and approving solutions to restore the cities ' financial stability resides squarely with our elected officials. The economic downturn has placed additional pressure on the situation. City Response to Finding 12 The City agrees with this finding. Grand Jury Recommendation 12a City council members and mayors should become better informed about the fiscal realities in their cities, long-term costs and commitments, and be cognizant of potential issues in labor agreements. City Response to Recommendation 12a This recommendation has been implemented. City Administration informs the City Council of the fiscal situations, long-term costs and commitments and other issues in labor agreements through open and closed session, stakeholder process and other educational task forces. As mentioned above, City Administration brings forward in open session to the City Council, prior to the negotiations beginning an Annual Summary of Labor Negotiations. This provides information to the City Council and members of the public regarding labor issues. As part of the annual budget process, the Administration submits a Preliminary One-Year General Fund Forecast to the City Council in November, a Five-Year General Fund Forecast in February, and the annual Proposed Budget document in May and discusses HONORABLE MAYOR AND CITY COUNCIL September 21, 2010 Subject: Response to the Civil Grand Jury Report Entitled "Cities Must Rein in Unsustainable Employee Costs" budgetary issues with the City Council at special meetings in November, February, May, and June. As part of monitoring budgeted revenues and expenditures, every two months, the Administration submits a financial status report to the Public Safety Finance & Strategic Support Committee outlining the year-to-date performance of the General Fund and selected special funds as well as informing the City Council about economic trends impacting the City's budgetary situation. Finally, in accordance with the City Charter, in October, the Administration presents to the City Council the Annual Report which summarizes the fiscal performance of the General Fund and selected special and capital funds of the previous fiscal year. Grand Jury Recommendation 12b City councils and mayors should direct city administrators to (re)negotiate collective bargaining agreements that reverse the escalation of employee costs through concessions, cost sharing, and a second tier for new employees. City Response to Recommendation 12b This recommendation has been implemented in part. This was the direction to City Administration for 2009-2010 negotiations. For 2009-2010, the City negotiators were directed to achieve a 10% total compensation reduction. This was achieved with many of the City's bargaining units through pay decreases, health plan changes and additional retirement contributions. A second tier for retirement benefits for new hires will be a subject of negotiations in 2011. Grand Jury Recommendation 12c City councils and mayors should meet with the bargaining units to clearly outline the cities' financial health and show how employee costs are impacting the budget. City Response to Recommendation 12c This recommendation has been implemented. The City Manager is responsible for negotiations with the bargaining units and has delegated this authority to the Office of Employee Relations. During negotiations and through the budget process, the bargaining units are informed of the City's financial situation and the impact of employee costs. Bargaining units are provided with the budget documents containing this information. Although the Mayor and City Council cannot negotiate directly with the bargaining units, there are many learning opportunities for the bargaining units regarding the budget, including budget study sessions. In addition, the City Manager holds regular meetings with the bargaining units and some of those meeting are dedicated solely to budget updates. In addition, the City has an unprecedented amount of information available to the public on its Labor Relations Website, (cid:9) or.asp, HONORABLE MAYOR AND CITY COUNCIL September 21, 2010 Subject: Response to the Civil Grand Jury Report Entitled "Cities Must Rein in Unsustainable Employee Costs" including total compensation information, negotiations updates, correspondence between the City and the bargaining units and proposals exchanged during negotiations. Grand Jury Recommendation 12d City councils and mayors should inform citizens of their plans for controlling unsustainable employee costs and remove politics from the equation. City Response to Recommendation 12d This recommendation has been implemented. For the 2009-2010 negotiations, the City negotiators were directed to achieve a 10% total compensation reduction for Fiscal Year 2010-2011. This was achieved with many of the City's bargaining units through pay decreases, health plan changes and additional retirement contributions. This occurred in open session and gave the public an opportunity for input into the process. In addition, the City has an unprecedented amount of information available to the public on its Labor Relations Website, including total compensation information, negotiations updates, correspondence between the City and the bargaining units and proposals exchanged during negotiations. In January, as part of the budget development, the Mayor's Office in conjunction with the Administration holds a Neighborhood Association/Youth Commission Budget Priority Setting session to set the context for the budget for the upcoming fiscal year. During the budget process, the Mayor's Office and respective City Council District offices hold budget meetings in each of the ten City Council Districts. Then, after the release of the City Manager's Proposed Budget document, there are multiple public hearings in May and June to allow members of the public to provide input into the budget process and

Binding arbitration is not open to the public and results in an adversarial process between the city and employee groups. Binding arbitration limits the ability of city leaders to craft solutions that work for the city's budget. The process has resulted in wage and benefit decisions that have been great than the growth in basic revenue sources. City Response to Finding 13 The City agrees with this finding. HONORABLE MAYOR AND CITY COUNCIL September 21, 2010 Subject: Response to the Civil Grand Jury Report Entitled "Cities Must Rein in Unsustainable Employee Costs" Grand Jury Recommendation 13a San Jose City Council should make binding arbitration open to the public. City Response to Recommendation 13a Binding arbitration under City Charter Section 1111 has not historically been open to the public. Through the City's arbitration panel representative, the City requested that the 2006-2007 interest arbitration with the San Jose Firefighters, IAFF, Local 230 be open to the public. The Union's arbitration panel representative opposed the City's request and requested that the proceedings be closed to the public. The Chair of the Board of Arbitrators, having the final deciding vote, also opposed having the proceedings open to the public and did not grant the City's request. Therefore, the arbitration proceedings were closed. Binding arbitration provides for a third party, often times not even a resident of the City of San Jose, to make financial decisions that can have serious impacts on the City's fiscal situation. On August 3, 2010, the City Council approved putting a measure on the ballot for the November 2010 election to amend City Charter Section 1111 relating to interest arbitration. This ballot measure includes a provision that would require arbitration hearings to be open to the public and documents submitted designated public records, unless provided otherwise by law. Grand Jury Recommendation 13b San Jose City Council should prepare a ballot measure asking voters to repeal Section 1111 of the City Charter that addresses binding arbitration. City Response to Recommendations 13b On August 3, 2010, the City Council approved putting a measure on the ballot for the November 2010 election to amend Charter Section 1111. The measure changes the arbitration procedures for Police and Fire arbitrations and changes the factors considered by the Board of Arbitrators in making an award. In particular, the primary factors to be considered by the Board are the City's financial condition and its ability to pay for compensation (defined to include wages and benefits) from ongoing revenues without reducing services. PUBLIC OUTREACH/INTEREST By the very nature of the Grand Jury's report and its release, public outreach requirements have been met. Additionally, upon approval of this memorandum by Council, the City Attorney will submit the memorandum to the presiding judge of the Superior Court, as required under Penal Code Section 933(c). HONORABLE MAYOR AND CITY COUNCIL September 21, 2010 Subject: Response to the Civil Grand Jury Report Entitled "Cities Must Rein in Unsustainable Employee Costs" COORDINATION This memorandum was coordinated with the Human Resources Department, the City Manager's Budget Office and the City Attorney's Office. CEQA Not a project, File No.PP10-069 (b) Personnel Related Decisions. Debra Figone City Manager For additional information on this report, contact Alex Garza, Director of Employee Relations, at 535-8150. Attachment: 2009-2010 Santa Clara County Civil Grand Jury Report: Cities Must Rein in , Unsustainable Employee Costs CITY OF gill% SAN JOSE CAPITAL OF SILICON VALLEY Office of the City Auditor Report to the City Council City of San Jose PENSION SUSTAINABILITY: RISING PENSION COSTS THREATEN THE CITY'S ABILITY TO MAINTAIN SERVICE LEVELS - ALTERNATIVES FOR A SUSTAINABLE FUTURE Report 1 0-1 0 September 2010 01% ('Fry 01: SAN JOSE ( All I Al OF SILICON VALLEY Office of the City Auditor Report to the City Council City of San Jose PENSION SUSTAINABILITY: RISING PENSION COSTS THREATEN THE CITY'S ABILITY TO MAINTAIN SERVICE LEVELS ALTERNATIVES FOR A SUSTAINABLE FUTURE CITY OF SAN JOSE Office of the City Auditor CAPITAL OF SILICON VALLEY Sharon W. Erickson, City Auditor September 29, 2010 Honorable Mayor and Members of the City Council 200 East Santa Clara Street San Jose, CA 95113 Pension Sustainability: Rising Pension Costs Threaten the City's Ability to Maintain Service Levels — Alternatives for a Sustainable Future The City of San Jose provides two defined benefit retirement plans for City employees: the Police and Fire Department Retirement Plan (Police and Fire) for sworn employees, and the Federated City Employees' Retirement System (Federated) for all other benefited City employees. In addition, the City offers a voluntary 457 deferred compensation plan for employees to supplement their savings. City employees do not participate in the Federal Social Security program. The purpose of this audit was to assess the long-term sustainability of the City's pension benefits and the potential impact of increases in pension costs on City operations, and provide background on pension reform alternatives being pursued by other retirement systems. This audit focuses on pension benefits. Chapter I of the report provides background information about the City's pension benefits. The City also faces considerable challenges with regard its obligations for retiree healthcare. Pension benefit increases had dramatic impacts on costs even before recent market losses. Chapter 2 describes how, over time, the City's two retirement plans have changed significantly. New and enhanced benefits have been added since voters approved minimum benefit levels in 1965. Over the past 20 years, total annual pension benefits paid out of the retirement funds have grown seven fold. The City's annual contributions into the retirement funds to pay for pension benefits doubled from FY 1998-99 to FY 2009-10 and pension contribution rates as a percentage of payroll have grown sharply. As of June 30, 2009, the City's estimated liability for pension benefits totaled $5.4 billion. As a result of losses suffered during the 2007-09 economic downturn, the market value of assets as of June 30, 2009 totaled just $3.4 billion and the City had an estimated unfunded pension liability of $2 billion based on the market value of assets. Because of the actuarial method of smoothing gains and losses over time, recent market gains and losses have not been fully recognized for actuarial purposes (e.g. the actuarial value of assets as of June 30, 2009 was $4.3 billion) nor reflected in the actuarially determined 200 E. Santa Clara Street, San Jose, CA 95113 Telephone: (408) 535-1250 (cid:9) Fax: (408) 292-6071 Website: www.sanjoseca.gov/auditor/ contribution rates to date. In spite of recent strong investment returns (the market value of assets total $3.8 billion as of June 30, 2010), previous losses are expected to push contribution rates higher as they are recognized in the coming years. Furthermore, the declining ratios of employees to retirees and beneficiaries creates a risk of higher contribution rates. As of June 30, 2009, the City also had a $1.4 billion unfunded liability for its other post employment benefits (OPEB) based on the market value of assets. Rising pension costs threaten the City's ability to maintain service levels. Chapter 3 addresses the question of sustainability. Personnel costs account for about two-thirds of General Fund expenditures and an increasing portion is attributable to retirement contributions. By FY 2014-15, annual pension and other post-employment benefit (OPEB) contributions are projected to reach 25 percent of total General Fund expenditures, up from 17 percent in FY 2010-11 and 6 percent in fiscal year 2000-01. Recent budget deficits required cuts to services, layoffs, and concessions from employee bargaining groups. Projected future deficits, in part due to rising pension costs, will require similar considerations. The City's unfunded pension liability has grown dramatically in recent years. As of June 30, 2009, the City's unfunded pension liability was $2 billion on a market value basis. Chapter 4 describes the reasons for the rise in the unfunded liability. One reason, of course, was investment losses totaling about $978.8 million which were incurred from 2007-2009. In spite of recent investment gains of $512 million, those losses will continue to affect the City's unfunded liability over the next few years because of the actuarial method of recognizing or smoothing gains and losses. Another reason for the growth in the unfunded liability was the granting of retroactive benefit enhancements. Because San Jose residents are ultimately responsible for pension costs and retroactive benefit enhancements can create unfunded liabilities, we recommend the City Council explore prohibiting (I) pension benefit enhancements without voter approval and (2) retroactive pension benefit enhancements that create unfunded liabilities. Another significant reason for the rise in the unfunded liability is that the assumptions used by the plans' actuaries to calculate pension liabilities and contribution rates did not hold true. This resulted in about $750 million being added to the unfunded liability between June 30, 2007 and June 30, 2009. Actuarial assumptions represent expectations about future events such as investment returns, member mortality and retirement rates, and salary increases, among others. Actuaries use those assumptions to calculate pension liabilities and contribution rates. To ensure the reasonableness of the methods and assumptions used in the plans' actuarial valuations, we recommend the City Council amend the Municipal Code to require an actuarial audit of such valuations every five years if the actuary conducting the valuation has not changed in that time. Individual components of the City's pension plans have different impacts on overall costs. Chapter 5 provides information about the major cost drivers of the City's pension costs. Two major drivers of those costs are the age at which members are eligible to receive benefits (50 for Police and Fire and 55 for Federated) and the plans' guaranteed annual 3 percent cost-of-living adjustment (COLA). Other provisions also have varying impacts on overall cost. There are alternatives for a sustainable future. The City has limited legal maneuverability in how it could change its pension plans for current employees. Nonetheless, it is important that the City move aggressively to rein in pension costs that threaten the stability of the General Fund and the services it provides to the residents of San Jose. It is important to start somewhere, and it is important to start now. Chapter 6 briefly outlines some alternatives and our recommendation that the City Council pursue at least one or a combination of pension cost-containment strategies, including: (I) additional cost sharing by employees, (2) eliminating or at least prohibiting transfers in and distribution of ii supplemental benefits when the plans are underfunded, (3) prospective changes in the plans for existing employees, (4) a second tier pension for new hires, and/or (5) joining CaIPERS. The City will continue to face considerable financial risks from rising pension costs for years to come. There is a risk that even if the City implements the recommendations in this audit, pension costs may still be unsustainable. Because of the risks of rising pension costs to the City's financial and budgetary future, in Chapter 7 we recommend that the Retirement Services Department (I) provide an annual report to the City Council that includes updates on the financial status of the plans, forecasts of pension costs, and sensitivity analyses showing best and worst case scenarios, and (2) provide an annual summary report to plan members that includes summary financial and actuarial data in an easily accessible format. I will present this report at the October 21, 2010 meeting of the Public Safety, Finance, and Strategic Support Committee. We are releasing this report well advance of the Committee meeting so that the report can also help inform the work of the General Fund Structural Deficit Elimination Plan Stakeholder Group. The Administration has reviewed the information in this report and their response is shown on the yellow pages. Respectfully submitted, Sharon W. Erickson City Auditor finaltr SE:bh Audit Team: Steve Hendrickson Joe Rois Diana Chavez Jazmin LeBlanc CC: Debra Figone Russell Crosby Deanna Santana Scott Johnson Richard Doyle Jennifer Maguire Mollie Dent Kim Walesh Alex Gurza Danielle Kenealey Aracely Rodriguez Michael Moehle Ed Shikada Mark Danaj Table of Contents Cover Letter (cid:9) i Glossarry (cid:9) iv Chapter I (cid:9) Introduction (cid:9) I Background (cid:9) I Audit Objective, Scope, and Methodology (cid:9) 8 Chapter 2 Pension Benefit Increases Had Dramatic Impacts on Costs Even Before Recent Market Losses (cid:9) I I New and Enhanced Benefits Have Been Granted Since the Voters Approved Benefit Minimum Levels in 1965 (cid:9) 12 Pension Benefit Payments to Retirees and Beneficiaries Have Grown Seven Fold Over the Past Twenty Years (cid:9) 16 The City's Annual Contributions Into the Retirement Funds More Than Doubled Over the Past Decade (cid:9) 18 The City's Contribution Rates Have Risen Sharply in Recent Years and Are Projected to Rise Even Further in the Near Future (cid:9) 19 The Retirement Plans' Unfunded Liabilities Play a Major Role in Rising Contribution Rates (cid:9) 21 The Declining Ratio of Employees to Retirees and Beneficiaries Creates a Risk of Even Higher Future Contribution Rates (cid:9) 24 At Current Contribution Rates, Estimates Show the Amount Owed in Pension Liabilities Will Continue to Grow at a Much Faster Rate Than Available Plan Assets 25 Chapter 3 Rising Pension Costs Threaten the City's Ability to Maintain Service Levels (cid:9) 27 Fiscal Sustainability Should Be a Consideration For Any Decision on Whether the City Has Overcommitted on Pension Promises (cid:9) 27 About One Quarter of All General Fund Expenditure are Expected to Go Toward Retirement and OPEB Contributions by FY 2014-15 (cid:9) 28 The City Has Seen Recent Budget Deficits and Projects More in the Future — Pension Costs Are a Major Factor (cid:9) 30 Chapter 4 The City's Unfunded Pension Liability Has Grown Dramatically in Recent Years (cid:9) 33 As of June 30, 2009, the City Had a $2 Billion Unfunded Pension Liability (cid:9) 34 Retirement Plans Have Experienced Large Market Losses in Recent Years, Increasing the Unfunded Pension Liability (cid:9) 35 Retroactive Benefit Enhancements Have Also Increased the Unfunded Pension Liability (cid:9) 36 Recommended Best Practice: Actuarial Audits (cid:9) 43 Chapter 5 Individual Components of the City's Pension Plans Have Different Impacts on Overall Costs (cid:9) 45 Retirement Age and the Guaranteed 3 Percent COLA Are Major Cost Drivers of the City's Pension Plans (cid:9) 45 Other Cost Elements (cid:9) 50 Chapter 6 Alternatives for a Sustainable Future (cid:9) 51 Maneuverability to Change Plans for Current Employees is Limited Under Current Law (cid:9) 51 The City May be Able to Reduce Costs Through Negotiations with Employee Bargaining Groups (cid:9) 52 The City Should Explore a Second Tier for New Employees (cid:9) 55 There is a High Cost to Self-Administer a Pension Plan (cid:9) 58 Pension Obligation Bonds (cid:9) 59 Moving Towards Sustainability (cid:9) 60 Additional Actuarial Review of Changes Before Approval Should Ensure Complete Understanding of Their Long-Term Impacts (cid:9) 61 Chapter 7 The City Will Continue to Face Considerable Financial Risks From Rising Pension Costs for Years to Come (cid:9) 63 The City Council Should Receive Annual Updates on the Retirement Plan's Performance, Impact of Reforms, and Forecasted Pension Costs (cid:9) 63 The City Can Improve its Communication with Plan Members Regarding the Plans' Performance and Financial Health (cid:9) 64 Conclusion (cid:9) 67 Administration Response (cid:9) 69 Table of Exhibits Exhibit 1: Current Base Pension Formulas for the City's Retirement Plans (cid:9) 2 Exhibit 2: Retirement and Other Post-Employment Benefit Payments for Combined Plans, FY 1990-91 through FY 2009-10 (cid:9) 3 Exhibit 3: Annual Pension Payments to Police and Fire Retirees and Beneficiaries as of June 30, 2009 (cid:9) 4 Exhibit 4: Annual Pension Payments to Federated Retirees and Beneficiaries as of June 30, 2009 (cid:9) 5 Exhibit 5: City and Employee Contribution Rates for FY 2010-11 (cid:9) 6 Exhibit 6: Example of a City Employee Paystub (cid:9) 7 Exhibit 7: Impact of Pension Benefit Formula Changes on a Sample of Police and Fire Retirees (cid:9) 15 Exhibit 8: Impact of Pension Benefit Formula Changes on a Sample of Federated Retirees (cid:9) 16 Exhibit 9: Growth in Pension Benefit Payments and Total Retirees and Beneficiaries, FY 1990-91 Through FY 2009-10 (cid:9) 17 Exhibit 10: Growth in the Average Annual Pension Benefit Paid Adjusted for Inflation (2009 dollars) (cid:9) 18 Exhibit 1 1: Annual Contributions for Pension Benefits More Than Doubled Between FY 1998-99 Through FY 2009-10 (cid:9) 19 Exhibit 12: The City's Retirement Contribution Rates as a Percent of Payroll, FY 1990-91 Through FY 2010-11 (cid:9) 20 Exhibit 13: The City's Retirement Contribution Rates for Pension and Retiree Health Benefits, FY 1980-81 Through FY 2014-15 (projected) (cid:9) 21 Exhibit 14: Market and Actuarial Values of Plan Assets Compared to Pension Liabilities, FY 1998-99 Through FY 2008-09 (cid:9) 22 Exhibit 15: Pension Funded Ratios, June 30, 2009 (cid:9) 23 Exhibit 16: Retirement Plans' Funded Ratios based on Actuarial Value of Assets, FY 1981-82 Through FY 2008-09 (cid:9) 24 Exhibit 17: Decline in the Ratio of Employees to Retirees and Beneficiaries, FY 1980-81 Through FY 2009-10 (cid:9) 25 Exhibit 18: Pension Benefit Payments Have Exceeded Contributions Since 2001 (cid:9) 26 Exhibit 19: Retirement and OPEB Contributions Compared to All Other General Fund Expenditures, FYs 2000-01, 2010-11, and 2014-15 (projected) (cid:9) 29 Exhibit 20: The City's Share of Current and Future Estimated Contribution Rates as a Percent of Payroll (cid:9) 30 Exhibit 21: Retirement Plans' Funded Status (Unfunded Actuarial Accrued Liability), FYI 990-91 Through FY 2008-09 (cid:9) 34 Exhibit 22: Retirement Plans' Investment Gains and Losses, FY 1996-97 Through FY 2009-10 (cid:9) 36 Exhibit 23: Example of How Retroactive Benefit Enhancements Would Affect a Fire Employee Retiring in 2010 After 30 Years of Service (cid:9) 37 Exhibit 24: Police and Fire Retirement Plan Assumed and Actual Net Investment Returns, FY 1980-81 Through FY 2009-10 (cid:9) 40 Exhibit 25: Federated City Employees' Retirement System Assumed and Actual Net Investment Returns, FY 1980-81 Through FY 2009-10 (cid:9) 40 Exhibit 26: Components of the Growth in the Actuarial Unfunded Liability from June 30, 2007 to June 30, 2009 ($millions) (cid:9) 42 Exhibit 27: Estimated Percentage of Current Plan Costs Attributable to Charter Minimums and Other Selected Provisions (cid:9) 46 Exhibit 28: Estimated Costs Attributable to Various Benefit Levels — Police and Fire (cid:9) 47 Exhibit 29: Estimated Costs Attributable to Various Benefit Levels — Federated (cid:9) 47 Exhibit 30: Potential Lifetime Savings Using Highest Three-Year Average as Final Compensation (cid:9) 49 Exhibit 31: Selected Increased Cost Sharing Agreements, Other Governments and Bargaining Groups (cid:9) 53 Exhibit 32: Advantages and Disadvantages of Alternate Plan Designs (cid:9) 57 Glossary (Glossary items italicized in text of audit) Actuarial Assumptions: Assumptions representing expectations about future events (e.g. expected investment returns on plan assets, member retirement and mortality rates, future salary increases, or inflation) which are used by actuaries to calculate pension liabilities and contribution rates. Unfunded liabilities (see below) can grow when actuarial assumptions do not hold true. Actuarial Valuation: Technical reports conducted by actuaries that measure retirement plans' assets and liabilities to determine funding progress. They also measure current costs and contribution requirements to determine how much employers and employees should contribute to maintain appropriate benefit funding progress. Actuary. Professionals who analyze the financial consequences of risk by using mathematics, statistics, and financial theory to study uncertain future events, particularly those of concern to insurance and pension programs. Pension actuaries analyze probabilities related to the demographics of the members in a pension plan (e.g., the likelihood of retirement, disability, and death) and economic factors that may affect the value of benefits or the value of assets held in a pension plan's trust (e.g., investment return rate, inflation rate, rate of salary increases). Actuarial Accrued Liability (or Pension Liability): The value today of all past normal costs (see below). Retired employees are no longer accruing benefits, so their actuarial accrued liability is the entire value of their benefit. The liability represents the value of benefits promised to employees and retirees for services already provided. This concept applies to both the pension liability and retiree health care liabilities. Annual Required Contribution (ARC): The amount of money that actuaries calculate the employer needs to contribute to the retirement plan during the current year for benefits to be fully funded over time. Experience Gains/Losses: Gains or losses that arise from the difference between actuarial assumptions about the future and actual outcomes in an organization's pension plan. Market Gains/Losses: Gains or losses that arise from an increase or decrease in the market value of a plan's assets, including stock, real property, and investments. Normal Cost: The portion of the total present value of benefits that actuaries allocate to each year of service. It can be thought of as the annual premium that the employer must contribute to fund the benefit. It is part of the ARC (see above). Smoothing of Gains/Losses: Actuarial method of spreading, or smoothing, market gains and losses over a period of time (five years for both the Police and Fire and Federated plans). The purpose of smoothing is to minimize short-term, year-to-year contribution rate fluctuations which may result from market swings. The smoothed asset value is also known as the actuarial value of assets. Unfunded Liability: This is the unfunded pension obligation for prior service costs, measured as the difference between the accrued liability and plan assets. When using the actuarial value of plan assets, it is also referred to as the Unfunded Actuarial Accrued Liability. iv Chapter I (cid:9) Introduction In accordance with the City Auditor's 2010-1 I Work Plan, we have completed an audit of the sustainability of the City's pension systems. We conducted this performance audit in accordance with generally accepted government auditing standards. Those standards require that we plan and perform the audit to obtain sufficient, appropriate evidence to provide a reasonable basis for our findings and conclusions based on our audit objectives. We believe that the evidence obtained provides a reasonable basis for our findings and conclusions based on our audit objectives. We limited our work to those areas specified in the Audit Objective, Scope, and Methodology section of this report. The City Auditor's Office thanks the Retirement Services Department, the Board members of the Federated City Employees' Retirement System and the Police and Fire Department Retirement Plan, and the Office of Employee Relations for giving their time, information, insight, and cooperation during the audit process. Background The City of San Jose (City) provides two retirement plans for City employees: the Police and Fire Department Retirement Plan (Police and Fire) for sworn employees and the Federated City Employees' Retirement System (Federated) for all other benefited City employees. City employees do not participate in the federal Social Security program. This means that most City employees do not contribute to Social Security or earn quarters towards Social Security benefits while employed by the City of San Jose. Furthermore, any Social Security benefits they receive as a result of their employment elsewhere may be reduced based on the level of benefit they receive from the City's retirement plans. City employees hired after March 31, 1986 pay mandatory Medicare withholdings. Other Plans Members of the City Council and the Mayor are not members of the City's retirement plans. The City Council and the Mayor are given the option to participate in the California Public Employees Retirement System (CaIPERS) or the City's Part-time, Temporary, Contract (PTC) 457 Deferred Compensation Plan. Councilmembers make retirement contributions into CaIPERS or the PTC plan through bi-weekly payroll deductions, and the City makes it contributions on a bi-weekly basis. A few Redevelopment Agency (RDA) staff who are benefited City employees are members of the Federated Retirement System. RDA staff who are not employed by the City participate in a defined contribution 40I (a) plan to which the RDA contributes 9 percent of base salary and employees contribute 3 percent of base salary. In addition, the RDA and its employees pay into the Social Security program. Pension Sustainability In accordance with federal regulations, the City also provides a retirement plan (the PTC 457 Deferred Compensation Plan) to its part-time, temporary, and contract employees who do not qualify to be members of the Police and Fire or Federated plans. Participants are required to contribute 3.75 percent of gross earnings which is matched by the City. This plan is in-lieu of Social Security, of which the City is not a participant, as noted previously. In addition, the City offers a voluntary 457 Deferred Compensation Plan for employees to supplement their retirement savings. As of September 30, 2009, 72 percent of City employees participated in the 457 plan. Pension Formulas and Benefits Both Police and Fire and Federated Plans are defined benefit plans, meaning that the City provides a stable benefit based on a retirees' years of service with the City and their final compensation.' This is in contrast to a defined contribution plan such as a 401(k) Plan, whereby retirement benefits are solely determined by the amount of assets that are available in the funds which had been accumulated over time by employer and employee contributions and investment earnings. The City Charter (Charter) spells out the minimum pension benefits the City provides for employees. The Charter allows the City Council, at its discretion, to grant greater or additional benefits. Sworn employees may also be awarded additional benefits through binding arbitration.' Exhibit I shows the current base pension formulas for the two plans. Exhibit I: Current Base Pension Formulas for the City's Retirement Plans Police and Fire (cid:9) Federated 1 (cid:9) Eligibility Age 50 with 25 years of service, 55 with (cid:9) Age 55 with 5 years of service 20 years or any age with 30 years (cid:9) or any age with 30 years 4 Benefit Formula Police members (cid:9) 2.5% of final compensation for 2.5% of final compensation for each of (cid:9) each year of service the first 20 years of service, plus 4% per year of service in excess of 20 years of service Fire members 2.5% of final compensation for each of the first 20 years of service; 3% per year of service if 20 or more years of service Maximum 90% of final compensation (cid:9) 75% of final compensation allowable benefit Source: San Jose Municipal Code Final compensation is determined as the average base pay of an employee's highest 12 consecutive month period with the City. In general, this does not include overtime or special pay. The binding interest arbitration process occurs when the City and the police or fire unions are unable to reach an agreement on a successor memorandum of agreement (MOA) during labor contract negotiations and after the impasse resolution procedures have been completed. Chapter I In addition to the base pension formulas, other pension benefits include disability and survivor benefits, annual cost-of-living adjustments (COLAs), and supplemental benefits through the plans' Supplemental Retiree Benefit Reserves (SRBR). Besides those pension benefits, the City provides other post-employment benefits (OPEB) such as retiree medical and dental coverage for retirees who meet the minimum service requirements. Exhibit 2 shows the growth in pension and post-employment benefit payments for both the Police and Fire and Federated Retirement Plans since 1991. Exhibit 2: Retirement and Other Post-Employment Benefit Payments for Combined Plans, FY 1990-91 through FY 2009-10 $250 $200 $50 $0 ‘1, Post-Employment Health Insurance Premiums Pension Benefit Payments Source: Comprehensive Annual Financial Reports, Police and Fire Department Retirement Plan and Federated City Employees' Retirement System, Fiscal Years 1990-91 through 2008-09, Draft Fire Department Retirement Plan and Federated City Employees' Retirement System Financial Statements Fiscal Year 2009-10 This audit focuses on pension benefits. The City also faces considerable challenges in funding its OPEB benefits. For more information on the City's significant OPEB obligations (including retiree medical and dental coverage) see http://www.sanjoseca.goviretireehealthcare/. 3 • (cid:9) (cid:9) (cid:9)(cid:9) Pension Sustainability Pension Payments As of June 30, 2009, there were 1,661 retirees and other beneficiaries in the Police and Fire plan and 2,997 for the Federated plan.3 The median retirement age for Police and Fire retirees was 54 years of age and the median length of time they had been receiving retirement benefits was 12 years. The median retirement age for Federated retirees was 56 and they had been receiving retirement benefits on average for 9 years. As of June 30, 2009 the average annual pension benefit paid to retirees and beneficiaries was about $68,000 and $34,500 for Police and Fire and Federated, respectively.4 Exhibits 3 and 4 provide a stratification of the annual pension benefits paid to retirees and beneficiaries for each plan. As seen in Exhibit 3, there were 327 Police and Fire retirees and beneficiaries (about one-fifth of the total) receiving annual pension benefit payments over $96,000. Of these, 90 percent retired after 2000.5 Exhibit 3: Annual Pension Payments to Police and Fire Retirees and Beneficiaries as of June 30, 2009 32T Average Annual Payment $68,028 ICI 129 126 73 97(cid:9) 86 105 79 93 (cid:9) 100 97 97 85 18 8 (cid:9) 1=1 LI - ( Y N (cid:9) (N c ) i o e (cid:9) CO ( , Y 1 v (cid:9) t. (cid:9) (cid:9) Y ''n/ ro - (cid:9) (cid:9)(cid:9) - r 0 y k ) t\ (cid:9) c,(cid:9) (cid:9) - Y r \ n )S N (cid:9) Y V ' (4 f - c l t Y ' c 1 - Y o - (cid:9) (cid:9) (cid:9) L V i) 0 - (cid:9) ) 1 (cid:9) (cid:9) e (cid:9) n 0 0 \ \ 4 (cid:9) Y - (cid:9) 0 0 (cid:9) (cid:9) \ i Y 0 N N (cid:9) (cid:9) (cid:9) (cid:9) Y N ( ., N N C (cid:9) (cid:9) O (cid:9) (cid:9) N CO 1 Z (cid:9) (cid:9) (cid:9) C ' O I R - (cid:9) Y (cid:9) (cid:9) 0 ,.C Y ‘ \ ) 0 ; \ . (cid:9) O, (cid:9) (cid:9) d Y 6 1 c \ . 9 . t ,0 . • 69- (cid:9) 69. (cid:9) 64 (cid:9) 69. (cid:9) 69. (cid:9) 69. (cid:9) 69. (cid:9) 69- (cid:9) 64(cid:9) 69- (cid:9) 69- (cid:9) 69. (cid:9) Note: Does not include OPEB costs. Figures include 201 survivors of active or retired employees, and may include multiple payees per retiree. Source: Police and Fire Department Retirement Plan Comprehensive Annual Financial Report for the year ended June 30, 2009 Source: City of San Jose Comprehensive Annual Financial Report (CAFR) for Fiscal Year Ended June 30, 2009. Copies of the City's and Retirement plans' CAFRs for the fiscal year ended June 30, 2009 are online at http://www.sanjoseca.gov/auditor/External.asp. CAFRs for the retirement systems can also be found online at http://www.sjretirement.com/. Actuarial Valuations, Police and Fire Department Retirement Plan and Federated City Employees' Retirement System, June 30, 2009. In 2000, the Police and Fire maximum pension benefit was raised from 80 to 85 percent. It subsequently was raised to 90 percent in later years. These and other benefit enhancements are discussed more fully in Chapter 2. 4 (cid:9)(cid:9)(cid:9)(cid:9) Chapter I Exhibit 4: Annual Pension Payments to Federated Retirees and Beneficiaries as of June 30, 2009 397 Average Annual (cid:9) 330 335 Payment $34,537 289 284 257 233 177 182 148 141 (cid:9) 143 81 r,4 (cid:9) co (cid:9) N "zt- .^ c .1 ) (cid:9) (cid:9) (cid:9) r , n o (cid:9) (cid:9) v ,- - ,, , (cid:9) (cid:9) .c v c ,, - o (cid:9) (cid:9) . - , Y c, (cid:9) ,c) (cid:9) tn 69, CO ,v,,- (cid:9) (cid:9) 'N o I (cid:9) (cid:9) - , -0) (cid:9)(cid:9) v(N.I (cid:9) 2 (cid:9) . . 0 0 0 64- 64(cid:9) 64(cid:9) 64(cid:9) 64(cid:9) 64(cid:9) 6,9.- (cid:9) (cid:9) 64(cid:9) 64 O Note: Does not include OPEB costs. Figures include 419 survivors of active or retired employees, and may include multiple payees per retiree. Source: Federated City Employees' Retirement System Comprehensive Annual Financial Report for the year ended June 30, 2009 Funding of Pensions for the Police and Fire and Federated Plans Police and Fire and Federated pensions are paid out of retirement funds administered by the Retirement Services Department. Both plans are designed to prefund pension benefits, meaning annual contributions made over the course of an employee's career (by both the City and the employee) along with investment earnings are expected to pay all of the employee's future pension benefits. It is generally assumed that over time, the majority of retirement plan assets will be generated from investment earnings. Even with the large market losses of recent years, investment earnings accounted for more than half of the additions to the retirement funds over the decade ending June 30, 2009. Contributions The City Charter provides that contributions for retirement benefits allocated to an employee's current year of service are required to be shared by the City with the employee in a ratio that is at least 8:3 ratio (i.e. the City must pay at least eight dollars for every three dollars the employee contributes).6 This cost is called the normal cost of pension benefits. On the November 2010 ballot there is a measure to amend the City Charter that would, among other things, allow the City Council to provide a retirement plan or plans to new employees that are not subject to the Charter's minimum requirements, including the 8:3 contribution ratio. Pension Sustainability In addition, payment of prior service costs may be necessary because market losses or other circumstances may cause the plans to become underfunded. Under the San Jose Municipal Code (Municipal Code), 100 percent of the payments to make up for any underfunding have been the responsibility of the City.7 Contribution rates are set by the two Retirement Boards based on recommendations by outside actuaries. Actuaries are contracted by both plans to prepare actuarial valuations, the purposes of which are to provide information on the value of the plans' assets and liabilities and to set contribution rates to fully fund plan liabilities. Funding for OPEB costs is outlined in the San Jose Municipal Code. The Federated retiree health plan is funded by employer and employee contributions on a 1:1 ratio for medical benefits and an 8:3 ratio for dental benefits. The Police and Fire retiree health plan is funded by employer and employee contributions in a 1:1 ratio for medical benefits and 3: I ratio for dental benefits. Contribution rates are set as a percentage of payroll. Exhibit 5 shows the base City and employee contribution rates for FY 2010-11. Exhibit 5: City and Employee Contribution Rates for FY 2010-1 I Fire Pension Fire OPEB Police Pension Police OPEB Federated Pension Federated OPEB 0% (cid:9) 10% (cid:9) 20% (cid:9) 30% (cid:9) 40% (cid:9) 50% (cid:9) 60% City (cid:9) Employee Note: These rates do not reflect adjustments to the contribution rates as a result of recent negotiations whereby some employee bargaining units agreed to pick up a portion of the City's annual payment to offset the City's contribution rate. Source: Actuarial Valuations, Police and Fire Department Retirement Plan and Federated City Employees' Retirement System, une 30, 2009 As a result of negotiations with bargaining units and Municipal Code amendments related to the City Council's adoption of the FY 2010-11 Budget, some employee bargaining units will pay a portion of their prior service costs to offset the City's costs. This does not reduce the unfunded liability as there will be no additional contributions made (as discussed more fully later). Chapter 1 More information on projected contribution rates is shown in Exhibit 20. Payroll Deductions Exhibit 6 shows an example of a Federated employee's paycheck and highlights the retirement contribution deductions and how they are broken out between pension costs and retirement health costs. Retirement contributions to the retirement system are mandatory and are deducted biweekly on a pre-tax basis from employee pay. This particular paycheck is from a pay period prior to FY 2010-1 I and does not reflect current contribution rates. Exhibit 6: Example of a City Employee Paystub Hours and Earnings Taxes Current YTD Description (cid:9) Hours (cid:9) Earnings Hours (cid:9) Earnings Description (cid:9) Current YTD Regular (cid:9) 80 (cid:9) 3,000.00 80 (cid:9) 3,000.00 Fed Withholding (cid:9) 300.00 300.00 Fed Med/EE (cid:9) 43.50 43.50 Total Gross Pay (cid:9) 80 (cid:9) $ 3,000.00 ' 80 (cid:9) $ (cid:9) 3,000.00 Total (cid:9) $ 343.50 $ 343.50 Before Tax Deductions After Tax Deductions Employer Paid Benefits Description (cid:9) Current (cid:9) YTD Description (cid:9) Current YTD Blue Shield Health (cid:9) 45.91 (cid:9) 45.91 Unemployment Insurance (cid:9) 0.27 0.27 CSJ Vision Plan (cid:9) 6.34 (cid:9)I 6.34 Blue Shield Health (cid:9) 200.52 200.52 Retirement Contribution (cid:9) 227.40 (cid:9) 227.40 DeltaCare/HMO (cid:9) 25.05 25.05 Benefits Administration Fee (cid:9) 4.76 4.76 Em lo ee Assistance Program (cid:9) 2.91 2.91 Retirement Contribution (cid:9) 659.40 659.40 Total (cid:9) $ 279.65 (cid:9) $ (cid:9) 279.65 Total (cid:9) $ 892.91 892.91 Net Pay (cid:9) $(cid:9) 2,376.85 Employee Portion (7.58%) 4.26% Pension Cost 3.32% Retiree Healthcare Cost City Portion (21.98%) 18.16% Pension Cost 3.82% Retiree Healthcare Cost 29.56% Total Retirement Contributions Source: Auditor analysis of a random employee pay stub from PeopleSoft Retirement Plan Responsibilities Retirement Boards Per the San Jose Municipal Code, the Police and Fire and Federated plans are managed, administered, and controlled by their respective Boards of Administration (Boards). Currently, each seven-member Board is composed of a combination of plan members, retirees, Councilmembers, and Civil Service Commission members. The Police and Fire Board also includes a member of the City Administration and the Federated Board includes a public member. Board members are appointed to four-year terms by the City Council. Pension Sustainability On August I0, 201 0 t,h e City Council adopted an ordinance to establish a new plan for- Retirement Board Governance that will replace the City Councilmembers and the Civil Service Commission and City Administration members with public members who meet certain experience requirements. The Police and Fire Board was also expanded to nine members by including one additional retiree and one additional public member. The Boards hold sole fiduciary responsibility over the assets of the plans, including the responsibility of investment of moneys and the administration of the plans. To ensure that the plans remain actuarially sound, the Boards: • Contract for actuarial investigations and valuations of the plans • Review and adopt the actuarial assumptions used in the valuations (e.g. member mortality, service, and other tables and the assumed rate of return on plan assets) • Establish contribution rates for the City and employees It should be noted that the City Administration representative and the retirees and plan members on the Police and Fire and Federated boards are members of the respective plans which they are charged with managing and administering. Retirement Services Department The Retirement Services Department's core service is to Administer Retirement Plans. Key services include supervising the investment of plan assets; administering retirement benefits; and analyzing, developing and recommending policy for the Boards. The Department's operating budget for FY 2010-1 I is $4.4 million with 33.5 authorized full- time equivalent staff. Retirement Services employees are members of the Federated City Employees' Retirement System. City Manager's Office of Employee Relations The Office of Employee Relations (OER) is responsible for negotiating on behalf of the City with representatives of the eleven bargaining units representing City employees regarding wages, hours, and other terms and conditions of employment, including retirement benefits. OER employees are members of the Federated City Employees' Retirement System. Audit Objective, Scope, and Methodology The objectives of our audit were to assess the long-term sustainability of the City's pension benefits and the potential impact of increases in pension costs on City operations, and provide background on pension reform alternatives. Chapter 1 To achieve our audit objectives we performed the following: I. To obtain a history of the City's retirement plans we obtained and reviewed the following documents for each plan: • Actuarial valuation reports, (cid:9) experience studies, annual reports, and/or comprehensive annual financial reports for the years 198 I through 2009 • Memoranda from Retirement Services staff, outside actuaries, and investment professionals to the Retirement Boards about actuarial assumptions and methods, investments, and other relevant subjects • City Council and staff memoranda related to pension costs and budget considerations • Retirement Board minutes surrounding discussions of actuarial assumptions and methods We also reviewed the City's 2000-01 through 2009-10 Operating Budgets, draft Police & Fire and Federated Retirement Plan Financial Statements for 2009-10, the City Manager's 2011-15 Five-Year Economic Forecast and Revenue Projections, the City Charter, the Municipal Code, Memoranda of Agreement with employee bargaining groups, and relevant pension laws and regulations. In addition, we interviewed staff from the Retirement Services Department, the City Manager's Budget Office, the Office of Employee Relations, and members of both the Federated and Police and Fire Retirement Boards. 2. To evaluate the actuarial assumptions and methods used by the two plans, we reviewed the City's retirement plans' current and historical actuarial assumptions and methodologies. We also reviewed Actuarial Standards of Practice and other documents to obtain an understanding of the actuary's role in preparing valuations and recommendations on plan assumptions and contribution rates. 3. To review other public retirement systems and alternative pension reform options, we evaluated actuarial valuation reports, comprehensive annual financial reports, and other information related to other public retirement plans. such as the California Public Employees' Retirement System (CaIPERS), federal employee retirement plans, plans for other California local governments, and plans outside of California. We also reviewed Developing a Policy for Retirement Plan Design Options (1999, 2007), Essential Design Elements of Defined Benefit Retirement Plans (2008), and Sustainable Funding Practices of Defined Benefit Pension Plans (1994, 2005, 2008 and 2009) published by the Government Finance Officers Association. At our request, to determine the major cost drivers of the City's retirement plans, Retirement Services staff assessed the costs of various components of the City's pension plans as a proportion of the overall system costs. Pension Sustainability 4. To assess the accuracy and reliability of pension data, we examined a sample of retirees from the Federated and Police and Fire Retirement Systems and reconciled retiree pension information to actuarial data files, the PensionGold pension administration system, and, where applicable, PeopleSoft.8 In addition, to obtain an understanding of the overall current pension environment we reviewed various reports and documents related to public and private pension systems and other pension-related literature. Further, we reviewed the Governmental Accounting Standards Board (GASB) Proposed Changes to Accounting Rules Under Statements 25, 27, 43 and 45, titled Postemployment Benefit Accounting and Financial Reporting. We should note that as City employees, the Auditor's Office staff are members of the Federated City Employees' Retirement System.9 Previous Audit of Pensionable Earnings and Time Reporting During FY 2009-10 we conducted an Audit of Pensionable Earnings and Time Reporting, which identified payroll and retirement errors resulting in higher pension to retirees, unclear and duplicative time reporting codes, and retirees benefiting from the City's definitions of highest year and earnable income. The report included 15