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How City Salaries And Pensions Have Become

Unsustainable in Palo Alto.

Pensions have become a constant concern for most city governments from one end of California to the
other. Because of the complexity of the system, and the general lack of knowledge of how the CalPERS
pension system works, many elected officials and most of the population have little idea why pensions
are becoming an albatross around too many government agencies’ budgets.

CalPERS (California Public Employee Pension System) claims that the average pension payout is currently
about $35,000/year. While this is true today, CalPERS has not been very open in offering information
about the future payouts for CalPERS members, particularly those who currently being hired with initial
salaries of $100,000, or more.

This short paper will provide insights that each CalPERS member agency and CalPERS itself should be
providing the public about the costs associated with employees today, and in the future, and why the
constant need for new revenues are forcing cities to seek new taxes to feed the “black hole” of CalPERS.

Pension Plans

The first thing to point out is that there are two pension plans: One for Public Safety employees (Fire and
Police) called “Safety” and the other for all other employees, called “Miscellaneous”. Within these two
plan types, there now two kinds of CalPERS members: “Classic” and PEPRA (Pension Employees Pension
Reform Act). How the salaries and pensions of “Classic” and PEPRA members differ will be explained

Classic Employees

CalPERS members (employees) hired before 01/01/2013 means that retirees’ pensions are directly linked
to their exit salaries and are uncapped—growing yearly no matter how long they live. To demonstrate
what this means, the graph below documents the 30-year salary and 30-year pension payouts for a
Miscellaneous employee and a Safety employee hired in 2012.
30-Year Salary and 30-Year Pension of Palo Alto Employees Hired in 2012








Regula r Employee Police/Fire Empl oyee

The graphs above show the growth of each employee’s salaries and pensions, over a total sixty-year
period. Table.1 summarizes the total amounts of these two compensation periods. Given the long
timeframes involved in this model—the model’s total compensation could easily be understated, or
overstated. The “Average Yearly Salary” numbers are derived from the 60-year totals, which typically is
not done by governments when discussing compensation with employees and the public.

Lifetime Compensation for “Classic” Employees

Regular e
30-Year $5,000,26 $5,932,83
Salary 8 4
30-Year $8,074,48 $11,842,0
Pension 9 57
60-Year $13,074,7 $17,774,8
Total 57 90
on $217,912 $296,248

Table.2 below lists the salaries of “Classic” regular (Miscellaneous and Safety) employees, hired on the
first day of 2012, who work for 30 years on the job. After retirement, the data lists how much each
former employee will receive in pension payouts for the first thirty years of his/her retirement. For
readability, the table is presented in five-year increments:

Compensaton In 5-Year Incrs.

Year Regular Safety
2012 $100,000 $100,000
2017 $115,927 $121,665
2022 $134,392 $148,024
2027 $155,797 $180,094
2032 $180,611 $219,112
2037 $209,378 $266,584
2042 $242,726 $324,340
2047 $215,442 $315,968
- -
2052 $237,866 $348,854
2057 $262,623 $385,163
- -
2062 $289,957 $425,252
2067 $320,136 $469,512
2072 $353,456 $518,379

PEPRA Employees

Pension obligations became so pressing on all CalPERS member agencies that the Legislature was forced
to take note. 2012 saw a significant change in State law that effectively capped pensions, although not
totally. This law, known as the Public Employee Pension Reform Act (PEPRA) set a cap for the amount
that an employee’s exit salary could be calculated at a limit determined by the State (the California
Actuarial Advisory Panel). This amount is increased from time-to-time to reflect changes in the
Consumer Price Indices for All Urban Consumers (CPI-U) U.S. City Average. The initial cap of $136,440
has been increased by a yearly average of 1.3% since 2013. The PEPRA cap will increase every year
unless economic conditions prove that an increase is unnecessary. Projections for this cap show it will
grow to $165,383 by 2028 and $188,728 by 2038. Of course, the PEPRA yearly “bump” could be larger,
so this cap could be slightly larger in that event. This PEPRA limit will grow in perpetuity, unless the
PEPRA law is rescinded, or modified.
PEPRA imposes two primary effects on pensions: a reduction in pension payouts to employees and a
reduction in pension costs for employers.

1) Pension caps means that government employees will be paid less in their retirement. This
means that pensions will no longer be directly linked to exit salaries, depending on the size of
the exit salary. For employees whose pension payouts are less than they yearly cap, they will not
be affected. Given that pension payouts for some retirees can easily generate twice what these
former employees were paid on the job, and in many cases result in payouts in the millions of
dollars, it is not difficult to see why the Legislature saw a compelling reason to pass the PEPRA

2) For government employers, CalPERS “contributions” are based on CalPERS long-term assessment
of its ability to generate the money to pay the pensions of all government retirees and their
surviving spouses. With pensions capped, then the amount of money that CalPERS will have to
generate yearly to pay the pension claims is smaller. Since the total CalPERS outlay is smaller,
then the difference between CalPERS total revenues and its outlays will be smaller, the
difference that the member agencies will have to provide CalPERS will be smaller. This obviously
means that the dollars dedicated to “benefits” for pensions will be smaller in the future. Given
the alarming increase in the CalPERS demands for more money, these increases have come at
the expense of the proper function of local government in many cases—with contributions
increasing to 20% or more of many municipality’s general fund.

Over time, the number of “Classic” employees will retire, and eventually (twenty-five years or more) all
employees will be classified as PEPRA--with only one tier of pension classification left.

The following graph projects the 30-year salary and 30-year pension payouts for PEPRA employees:

30-Year Salary and 30-Year Pension

of Palo Alto Employee Under PEPRA Hired In 2013

13 16 19 22 25 28 31 34 37 40 43 46 49 52 55 58 61 64 67 70 73
20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20

Regul a r Empl oyee Fi re/Pol i ce Empl oyee

Table.3 below lists the salaries of PEPRA regular (Miscellaneous and Safety) employees, hired on the first
day of 2012, who work for 30 years on the job. After retirement, the data lists how much each former
employee will receive in pension payouts for the first thirty years of their retirement. For readability, the
table is constructed in five-year increments:

Lifetime Compensation for PEPRA Employees

Regular e
Salary 5,000,268 5,932,834
Pension 7,413,615 7,425,093
$12,413,8 $13,357,9
Total 83 26
Compensa $206,898. $222,632.
ton 05 10

Notice that pension payouts are no longer linked directly to exit salaries, and the payouts are
significantly smaller over time. Both Miscellaneous and Safety retirees receive the same payout once
their payouts exceed the PEPRA cap.

Compensaton In 5-Year Incrs.

Year Regular Safety
2012 $100,000 $100,000
2017 $115,927 $121,665
- -
2022 $134,392 $148,024
- -
2027 $155,797 $180,094
- -
2032 $180,611 $219,112
2037 $209,378 $266,584
2042 $242,726 $324,340
2047 $214,760 $214,760
2052 $229,091 $229,091
2057 $244,379 $244,379
2062 $260,686 $260,686
2067 $278,082 $278,082
2072 $296,639 $296,639

Some Pension Concepts Beyond The Basics

The CalPERS system is incredibly complicated. So much so that few outside the system have much of an
idea how the inside works. There are a number of concepts with which Cities must deal, relative to the
financial in-workings of the system. The following are a few of these concepts taken from material
developed by others:

CalPERS is an entity established by the state to manage retirement funds for member agencies (total of
over 3,000 employers and 1.85 million members).

Defined Benefit Pension Plan. This type of plan provides public employee retirees with a guaranteed
lifetime monthly income, based on a predetermined statutory formula. This approach contrasts with
defined contribution plans, although some employers offer a combination of the two kinds of plans—a
concept known as a hybrid plan. There are a series of considerations that have been identified for local
agencies to use in determining what kind of system makes sense for the local agency, and essential
design elements for defined benefit pension plans.

Actuarial Valuaton. This is a procedure actuaries use to help pension funds establish the amount a plan
needs to collect in order to meet the fund’s current and future payment obligations. One technique used
is to estimate the current (present) value of the future benefits a pension plan should expect to pay.
Once this number is calculated, then the contribution amounts necessary to cover those benefit costs
can be computed. Unfunded costs are costs not currently covered by plan assets.5

Actuarial Valuaton Report. This report is an assessment of whether, given 1) current and projected
levels of employee and employer contributions and 2) current and projected investment earnings, the
pension fund will have enough money to pay amounts promised to pension beneficiaries. These reports
are usually prepared annually in order to determine whether employer contribution rates need to be
adjusted. The report uses past performance of plan assets to project contributions necessary to fund
current estimated liabilities. A general goal is to fund the amounts necessary to pay employees’
estimated pension costs while the employees are working and earning pension benefits.

Base Salary. This is the fixed rate of compensation that an employee receives from an employer for a
specified job. Base salary does not include employee benefits, bonuses or any other form of special
compensation that may be part of an employee’s pensionable wages. Related concepts: benefit
formulas, one-year final compensation, employer/employee contributions, and pensionable wages.

Fully Funded. This is status is achieved when a pension fund has sufficient assets to meet its
commitments to participants (the financial target is more technically known as accrued actuarial
liability). Note that a “fully funded” plan does not mean that employer/employee contributions should
be zero. Related concepts: funded ratio, funding policy, normal cost, underfunded and unfunded liability

Normal Cost. The employer’s annual “normal cost” represents the present value of benefits that pension
system members earn during the valuation year. This term is sometimes also referred to as “current
normal cost.” Related concepts: actuary, assumed rate of return, employer/employee contribution,
funding policy, and present value of future benefits.

Pensionable Wages. For purposes of retirement, this is an employee’s base salary plus any special
compensation allowed to be counted as part of an employee’s overall compensation for purposes of
calculating pension benefits under a pension system’s benefit formula. Special compensation may
include any payments for special skills as well as such items such as bonus pay, incentive pay, longevity
pay, and value of employer paid member contributions. Related concepts: base salary, benefit formulas,
one-year final compensation and employer/employee contributions.
Present Value. The key task for defined benefit pension plan administrators and their actuaries is to
determine how much the pension trust fund needs to have on hand in order to meet current and future
pension benefit obligations. The concept of “present value” is useful in calculating how much in
employer/employee contributions a pension fund needs to receive and invest now in order to meet its
projected obligations. The present value of a future payment is what money is worth now in relation to
what someone thinks it will be worth in the future based on expected earnings. For example, if one
expects to make a 10 percent return on an investment, $1,000 is the present value of the $1,100 one
expects to have a year from now. Related concepts: actuary, assumed rate of return, employer/employee
contribution, funding policy, investment policy, present value of future benefits, and unfunded liability.

Present Value of Projected Benefits (PVB). This is a calculation in which future pension benefit
payments (actuarial accrued liability) are expressed in today’s dollars using assumed rates of return. This
discounted value calculation of all future expected benefit payments is based on various actuarial
assumptions. This concept is relevant to a pension system’s effort to determine such things as a plan’s
funded ratio and whether employer/employee contributions need to be increased in order to satisfy the
agency’s funding policy. Related concept: actuary, expected future benefits.

Unfunded Liability. This exists when the value of benefits estimated to be payable to plan members as a
result of their service exceeds the projected value of plan assets available to pay those benefits. This
phenomenon is sometimes referred to as “unfunded actuarial accrued liability” (sometimes referred to
by the acronym UAAL). This amount changes over time as a result of changes in benefits, pay levels, rates
of return on investments, changes in other actuarial assumptions, and changes in the demographics of
the employee base. Public entities typically reduce an unfunded pension liability over time as part of
their annual employer contribution. Under standards set by the Governmental Accounting Standards
Board (GASB), unfunded liabilities should be addressed over a period of not more than 30 years in order
to provide reasonable assurance of the payment of future benefits.105 Related concepts: actuary
(actuarial assumptions), fully funded, funded ratio, funding policy, normal cost, pension obligation
bonds, present value of projected benefits, and under-funded

Unfunded Actuarial Accrued Liability (UAAL). The UAAL is an actuarial term that refers to the difference
between the actuarial values of assets (AVA) and the actuarial accrued liabilities (AAL) of a plan.
Essentially, the UAAL is the amount of retirement that is owed to an employee in future years that
exceed current assets and their projected growth. HMEPS has experienced an UAAL for the past 12
years. Public pensions UAAL have historically ranged from 50% in the mid-70s, 20% in the mid 90s to 0%
in 2000.

Obligaton value is based on CalPERS assumptions of each employee’s:

1. Years of service
2. Ending salary
3. Projected retirement age
4. Extended lifespan
5. Formula(s) of benefit

CalPERS generates its funding for obligations from:

- Employee contributions
– Employer contributions
- Investment earnings

Unfunded Accrued Liability (UAL). Each year they estimate the value of the retirement obligation versus
projected revenue. The difference is called unfunded accrued liability (UAL). UAL must be funded by
agencies and is spread out over 20-30 years.

City’s Annual Payment is comprised of 2 components:

-Normal cost (% of salary)

-Payment of portion of UAL

CalPERS Shared Responsibility: Every dollar paid to CalPERS retirees comes from the sources:

62%--Investment Earnings
25%--CalPERS Employees
13%--CalPERS Members

The CalPERS minimum required employer contribution includes the sum of two components:

1. Normal Cost (NC) Rate, which represents the annual cost of service accrual for the upcoming
fiscal year, for active employees. Normal cost is shown as a percentage of payroll and paid as
part of the payroll reporting process.
2. Annual payment on the Unfunded Accrued Liability (UAL) is the amortized dollar amount
needed to fund past service credit earned (or accrued) for members who are currently receiving
benefits, active members, and for members entitled to deferred benefits, as of the valuation
date. The UAL is billed monthly.
Rising Pension Costs in California and Natonally

This issue of pensions has been ignored for decades. Elected public officials have caved in to labor union
demands for higher salaries, and linked pensions without ever asking themselves: “how much is this
going to cost my agency, and who is going to pay the bill?”

For the last five years, or so, far-sighted individuals, and small groups, have begun to “do the math” and
realize that the bill is quickly coming due, and that it will be very expensive for our children, and our
grandchildren. The following provides a few key costs--

From the Dan Walters articles below:

The squeeze is destined to get even tighter. For instance, cities that are now paying 50 cents
into CalPERS for every dollar of police officers’ salaries are projecting that it could go to 75 or
80 cents within a few years.
Two national actuarial associations established a joint task force to study the thorny discount
rate issue, but a dispute erupted over publishing the research project’s conclusions that public
pension earnings assumptions are too high and should be sharply reduced. Were its
recommendations to be followed, the nation’s unfunded pension liability would quadruple
from $1.5 trillion to $6 trillion.
Rising Pension Costs Here in Palo Alto
Palo Alto City Government produces some information about its long-range financial situation, which
includes details from the CalPERS account valuation. The data below was taken from the 09/18/2018
Staff Report (CMR 9604), which recaps key information about Palo Alto’s CalPERS pension account:

Palo Alto Unfunded Liabilities—

As noted above, the CalPERS unfunded liability (frequently referred to as simply “the UAL”) is effectively
a debt that Palo Alto acquires in order to pay the difference between CalPERS projection of the cost of
paying all of the retirees drawing against Palo Alto’s account, and the assets CalPERS is currently
managing. This number is not only that can be easily demonstrated, since it requires all of the data and
finance methodology of CalPERS to generate.

CalPERS Projected Unfunded Accrued Liability for the City of Palo Alto (UAL)

As of As of As of As of
30 June, 2014 30 June, 2015 30 June, 2016 30 June, 2017
Miscellaneous $191,411,633 $219,668,121 $261,680,231 $260,720,776
Miscellaneous Funded
Status 71.30% 68.50% 64.20% 66.30%
Safety $103,333,634 $118,764,933 $143,025,193 $164,190,990
Safety Funded Status 71.90% 68.60% 63.60% 63.50%
Total $294,745,267 $338,433,054 $404,705,424 $424,911,766

Notice that the “funded status” for both of the City’s pension plans is in the mid-low sixty-percent range.
The difference between this percentage and one-hundred percent represents the measure of
underfunding that the City Council has permitted for these funds.

Notice that since 2014 (a council election year) the UAL (debt) has increased by more than $130M.

Projected Increase of UAL based on 2014-2017 Increase

The average yearly increase in Table.5 from 2014 until 2018 is about 13%. Using this yearly increase, the
following table projects the growth of the UAL over the next few years:

UAL Projected Growth (2018-2024)

2018 2019 2020 2021 2022 2023 2024

$480,712, $543,841, $615,261, $696,060, $787,469, $890,883, $1,007,877,
866 988 477 057 428 039 337

Projecting UAL increases would be better done by CalPERS, but without their actually providing the City
this sort of projection, this simple estimate is being offered so that voters and taxpayers can understand
what the Council is allowing to happen without elevating the issue to the public for education and
discussion about possible solutions.

Palo Alto Increased CalPERS Contributions

The snippets from Dan Walter’s articles above document that many California Cities are seeing their
yearly CalPERS contributions increase. The same thing is happening here in Palo Alto, but not will much
public notice by the City Council.

CalPERS Past and Projected Employer Contributon Rates

FY 2018 FY 2019 FY 2020 FY 2021 FY 2022 FY 2023 FY 2024 FY 2025

Miscellaneous 28.90% 30.20% 35.60% 38.20% 40.00% 41.40% 41.90% 42.50%
Safety 45.40% 55.60% 59.40% 64.10% 68.00% 71.10% 72.70% 73.70%

(Blended UAL and Normal Costs)


Notice that the Employer Contribution Rates (what the City must pay) will have jumped by about thirty
percent for Safety personnel, and about fifteen percent for the Miscellaneous (regular) employees. This
contribution is a percentage of each employee’s base salary (overtime not included). Given that labor
costs now exceed over $100M yearly, these pension contribution increases will necessarily become
significant impediments to providing local services unless the City begins to create new revenue from
new taxes, fines and fees.

Pensions Guaranteed To Current Employees

Each employer in the CalPERS system is ultimately responsible for the pensions promised to employees
when pensions are legally a part of the employment package. Using the compensation data made
available from the City of Palo Alto, the total pensions offered, and guaranteed by the City of Palo Alto
comes to over $6B over the next forty years, or so. Unless some catastrophe were to occur to California,
CalPERS will ultimate be responsible for most of the pension payouts made to retirees. However, Palo
Alto is the ultimate guarantee for the money necessary to pay its retirees, and others who are making
claims against Palo Alto’s CalPERS account.


Short papers like this one can not begin to provide adequate explanation of the CalPERS pension system,
or the long-term pension obligations facing Palo Alto and other government agencies. The best papers
such as this can do is identify specific revenue and expenditure streams and project them into the future
using published financial variables like the CPI.

Even though there has been some discussion about pensions at the Palo Alto City Council level, there
seems to have no awareness between the linkage of salaries and pensions. Salary increases are awarded
without much in the way of comprehensive review of local salaries. If any of the Council is aware of
these linkages, there does not seem to be much in the way of leadership to require the Finance
Department to produce the kinds of data demonstrating these linkages. This paper, and the underlying
research into City finances was pursued by a Palo Alto resident in order to investigate these linkages and
the possible costs to the City over the next three to four decades.
Using the publicly available compensation data for the City of Palo Alto, total pension guarantees of
current employees are exceed $6B over next forty years. The data above points out that as new
employees are hired, the pension obligations will increase over time.

This paper will not investigate solutions to this pension problem which is now threatening to “sink” every
government agency that has been roped into providing “defined benefit” lifetime pensions. The
underlying problems involve State and Federal Constitutions that deal with the sanctity of contracts—
which courts have ruled pensions to be.

One key piece of data that does not readily appear in most Palo Alto City documentation is the debt per
resident that the City’s current pension obligation imposes on the residents. Some debt, such as bonds,
generally are paid down by the property owners. The City’s use of Certificates of Participation shift this
burden to residents, property owners, and visitors—as the City has targeted for ever-higher
“contributions” needed to operate the City.

The City has not done a very good job elevating these long-term obligations into the public domain. One
Stanford researcher has calculated that this debt, when allocated to the individual resident, and
household. The researcher suggests that the market pension debt/individual is about $16,000 and the
market pension debt per household at about $40,000. This is debt that should be on the City’s “books”,
but ultimately will need to be paid, somehow, but the residents in order to pay for these multi-million
dollar pensions.

It’s difficult not to see that as “intergenerational theft”. Few sitting on the Palo Alto Council will likely
accept this as the result of their decisions about increasing salaries that are linked to pensions. PEPRA
will reduce some of this “theft”, but not anytime soon, and not by that much.

The reality of the Council’s decision to spend as much as they have on salaries and benefits, will
doubtless see new taxes every election cycle.


Tables.1-4 provide a cost estimation for hiring future Palo Alto employees, based on an initial salary of
$100,000, or more. Given the modest increase in the Consumer Price Index (CPI), City of Palo Alto
employees hired in 2012 will be paid between $225,000 and $350,000 (Miscellaneous and Safety,
respectively) when they retire in 2042. After thirty years of increasing pension payouts, these former
employees will be receiving over $350,000 and $500,000 yearly (Miscellaneous and Safety, respectively).
PEPRA employees will see the same salaries during this timeframe but will see smaller pensions.

The question becomes, given the Palo Alto City Council’s commitment to increasing the salaries of Palo
Alto employees as frequently as they seem to do, where will the money come from to pay these ever-
increasing salaries and benefits.

The City Council has, from time-to-time, tried to raise taxes on businesses and residents here in Palo
Alto. Some years back, they tried to impose a business tax on Palo Alto businesses, unsuccessfully. In
2014, the Council was able to increase the Transient Occupancy Tax (TOT) on visitors to the City, again
successfully. This year (2018), the Council is again trying to tax non-residents for money to be used to
pay these salaries and pensions—even though they have gone to the voters with ballot language
claiming that all of the new money raised will be spent on “infrastructure”—while not locking any of that
money into infrastructure accounts in the ballot language. If passed, this, and future Councils will be
able to spend this money anyway they want—which the graphs above predict would be on salaries and
pensions for current City employees and former employees.

Isn’t it time that our City Council does a really comprehensive study of our long-time finances and
infrastructure needs rather than trying to convince Palo Altans that people who don’t live here should
pay the bill by raising the Transient Occupancy Tax every 3-4 years?

This paper was prepared by Wayne Martin, a long-time resident of Palo Alto.

Data Sources
This paper is based the examination of millions of records of employee compensation data
for schools and cities, as well as pension data for CalPERS and CalSTRS, obtained from Data used in this paper comes primarily from the City of Palo Alto.

Model Assumptons

Continued economic growth, limited population increase.

Only 30 years of service time considered—to maximize pension payouts.
Only 30 Years of Retirement considered in this set of projections
Spousal survival benefits not considered in this calculation.
Initial Salaries for Safety (Fire and Police) and Miscellaneous employees is $100,000.
Yearly salary increases average 3% over years of employment for
Miscellaneous (Regular) Employees.
Yearly salary increases average 4% over years of employment for Safety (Regular) Employees.
CalPERS COLA (Cost of Living Adjustment) averages 2% Yearly.
PEPRA cap increase limited to 2% yearly.
PEPRA Constraints Started On 01/01/2013 and not rescinded by the Legislature in the future.


PEPRA Compensation Limit for 2018 (Code Section 7522.10):

A Local Official’s Guide To Pension Terminology:

Unfunded Actuarial Liability—What Does It Really Mean?

Understanding Public Pension Plan’s Unfunded Liability:

Understanding CalPERS:

2018 UAL:

Public Agency Required Employer Contributions:

Public Agency Required Contributions (2018-2019):

CalPERS Reduces Amortization Period with Impacts to Employer Contribution Rates:

Sales tax on your local ballot? California’s pension crisis may have nominated it:

Pension Tracker/Palo Alto: