For more than 3,500 municipal workers in North County and more than 17,000 people employed by San Diego County, a career in government service ends with an ample reward.

Most are able to retire relatively early in comparison with private-sector workers, and they do so with sizable monthly paychecks based on the number of years worked.

In other words, the pension is the ultimate payoff, and in recent years the deal has gotten even sweeter.

Enhanced pension benefits, granted in response to gains in investment returns in the mid- and late-1990s, coupled with demands from employee unions have resulted in California having the nation's most generous pension programs for government workers.

There's a dark side to the picture, however, for taxpayers.

The benefit boosts and recent dips in retirement plan investment earnings mean governments have to take more money from their budgets to fund their retirement plans rather than using that money for other programs, ranging from routine street repairs to anti-crime initiatives.

Local governments also are carrying a higher amount of overall unfunded pension liabilities, the amount governments owe their pension systems.

What's the deal?

The current pension deal for the county's general government workers, for example, pays them a yearly pension of 3 percent of their annual salary for each year worked with retirement at age 60, or 2 percent of their annual salary for each year worked with retirement at age 50.

City workers have pretty much the same pension benefits.

For public safety workers —— police and firefighters —— the deal is even better.

For county sheriff's deputies, as well as all North County city police officers and firefighters, pensions are based on 3 percent of salary for each year worked with retirement at age 50. Unions have successfully argued that earlier retirement for public safety workers is fair because of the stress and physical demands of those jobs.

Those kinds of retirement packages are hard to find in the private sector, where 401(k) programs have largely replaced traditional pension programs and generally provide much lower benefits.

'Smoothing' the way

If one listens to officials in the Sacramento offices of the California Public Employee Retirement System, the spike in pension system payments is temporary. They say that investment-return improvements and new accounting methods will soon lower the annual contributions cities now face.

The system, known as CalPERS, manages the retirement accounts for 1.4 million state and local government workers, who generally pay 6 percent to 8 percent of their salary for their pensions. It has a portfolio value of $183 billion and carries an unfunded liability of about 17 percent.

A new Employer Rate Stabilization Plan adopted last month by the board that oversees the system is intended to reduce the volatility of pension contributions. The so-called "smoothing" spreads gains and losses over 15 years rather than three years, thereby reducing the big fluctuations resulting from declines in investment returns.

"Smoothing doesn't mean cities don't have to pay what they owe, but it does take away the high swings in required payments that have been seen recently," said Patricia Macht, a retirement system spokeswoman.

The new accounting is scheduled to take effect in 2007, and with expected returns of 7.75 percent on investments, the increases cities are seeing in their pension contributions should be greatly reduced, Macht said.

Macht also said that 75 cents of every $1 paid in pension benefits today comes from the retirement system's investment earnings and only 25 cents from taxpayers.

"The thing that has gotten lost in all the rhetoric about pensions is that the lion's share of payments are made solely from investment gains," she said. "Cities are now working through the down market, and in the next couple of years their situation will improve and rate smoothing should provide stability."

Critics, however, contend the smoothing techniques amount to little more than accounting gimmickry. They contend that if the system has a string of bad years, the new policy will hide that from taxpayers.

On the plus side, a string of good years won't lead to temptations to forgo pension funding when returns are up.

The retirement system's board also is considering establishing its own "rainy day" fund to help keep rates stable in years when returns are down.

Getting more

With tax breaks and other pension plan options, including calculations based on "highest final year" salaries, some city workers end up with annual pensions that actually exceed the yearly salary they earned while working.

Carlsbad's retired city arborist, Fred Burnell, is an example of a retired municipal worker with a pension that exceeded his highest annual salary.

Burnell, who tended the city's trees, told the North County Times in April that he was "amazed" he was able to retire and get an annual pension that actually exceeded his highest annual salary by 12 percent.

That topped out at $70,000, but Burnell took advantage of an option that allowed him to "purchase" extra years, and he got credit under the retirement system for four years spent in the military. Burnell ended up with more than 41 years in his pension benefit calculation even though he actually worked for the city for only 32 years.

Today's obligations

The North County cities of Carlsbad, Encinitas, Escondido, Oceanside, Poway, San Marcos and Vista are paying a combined $40.2 million out of their general fund budgets to fund pensions this fiscal year, according to information provided by city officials.

In the next fiscal year beginning July 1, that figure is projected to rise to $46.2 million. The obligation is expected to rise because of enhanced pension guarantees cities have made and to make up for declines in pension fund investment returns.

The increases are easy to see. In Carlsbad, for example, the city was paying 3.5 percent of its payroll expenses to pensions for police and fire workers in 2002. In 2004, the rate rose to 27.5 percent of the city's payroll costs. For general government workers, the rate went from zero in 2002 to 6.9 percent in 2004.

In Escondido, the city was paying 7.2 percent of its payroll costs to pensions for police and fire workers in 2002, 9.3 percent in 2003 and 21.1 percent in 2004. Its percent of payroll for general government workers went from zero in 2002 and 2003 to 5.5 percent in 2004.

The zero figures are the result of pension fund investments being accounted for two years after they were actually earned under the retirement system's accounting methodology. In other words, 2004 payments to the retirement system are based on what was required after taking into account 2002 investment returns.

Like the cities, the county also is experiencing lower-than-expected returns in its $6.3 billion pension fund for current and retired workers. The county, which operates its own pension system, is paying $248 million from its $2.8 billion budget to its pension programs in this fiscal year and planning the same in the next fiscal year.

Unfunded liabilities

Pension funds traditionally carry a percentage of unfunded liability in order to have cash on hand.

Unfunded liabilities are generally defined as the amount of money it would take to fully fund all retirement obligations.

The county's current unfunded liability is $1.2 billion, a figure reduced from $1.4 billion earlier this year when the county Board of Supervisors authorized selling $400 million in bonds.

The North County cities have a combined unfunded liability of $112.3 million, a debt load overseen by the retirement system and one that assumes what it cost to fully fund all pension obligations.

Standard & Poor's, a company that provides credit ratings and risk evaluations, views unfunded public pension liabilities as long-term liabilities that drive up contribution expenses. That matters, it said in a recent report, because it adds fiscal stress to public agencies that in recent years have had to trim costs wherever possible to keep up with increasing health care and public safety costs.

'Benefit excess'

Despite arguments from city officials and union representatives that pension benefits are not out of line and are necessary for employee recruitment and retention, one pension fund observer says changes must be made.

Steve Austin is managing director of Swenson Advisors and was a member of the city of San Diego's pension reform committee.

Austin says municipal and county pensions are simply too generous and that government officials need to have the courage to stand their ground and reform a system that provides the best pension benefits in the nation.

"The benefit levels are well in excess of the norm," Austin said. "Cities need to start looking to reduce the level of benefits for new employees who should have a smaller plan than what is offered to workers today."

Escondido Mayor Lori Pfeiler defended the pensions her city offers.

"They are generous, but ones we can afford and make sense to the people that are working for us," she said. "The proof is that we have a lot of applicants today from the city of San Diego. When we weren't offering appropriate pensions, we had shortages in firefighters and people in water works.

"And those are skills necessary to run the city," she said.

The mayor also said she expects the pension volatility to subside, something the retirement system's Macht said should come about from another accounting change made last month.

That change requires cities to make payments even when investment returns don't require any. The new accounting practice also calls for smaller payments when the returns are hurting, thereby reducing the kinds of payment balloons now being experienced.

Austin said recent reports about pension fund investments in risky "hedge funds," unregulated investment vehicles that seek big returns, are a troubling new wrinkle in the pension issues confronting California.

"Investments in the high-risk hedge funds will come under a lot of scrutiny in the next few months," Austin said. "Pension plan assets in hedge funds could wind up increasing the underfunding, and plan administrators need to reassess their position with regard to hedge funds."

Two weeks ago, the California First Amendment Coalition filed requests to get information from the California Public Employees Retirement System about how much money it has invested in hedge funds following published reports that those funds had some major losses.

The retirement system's Macht said the agency is analyzing that request and intends to comply with the request for records.

Modest reforms proposed

Pension observers say that unless there is a new round of losses in pension investments or continued spikes in what cities have to spend to pay for their workers' retirements, taxpayers should not expect any immediate changes.

Not surprisingly, the League of California Cities, which represents city governments, says it likes the current pension system. But it did issue recommendations in March that call for rolling back or repealing plans that provide "benefits in excess of levels required to maintain a fair standard of living."

The league specifically calls for the following:

• Police and fire workers: 3 percent of salary for each year worked with retirement at age 55, offset by 50 percent of anticipated Social Security coverage for those workers who also will receive Social Security.

• General government workers: 2 percent of salary for each year worked with retirement at age 55, offset by 50 percent of anticipated Social Security coverage for those workers who also will receive Social Security.

• All "highest final year" pension calculations would be repealed for new workers.

• Establish alternative plans for job classifications not intended to be career public service employment.

• Give cities greater flexibility to determine when a part-time worker should be entitled to public pension benefits. The League says the hourly threshold now in the retirement system is too low.

• Require employees to pay more into the system when employer contributions exceed "normal costs." Employees now contribute 6 percent to 8 percent of their salaries each year toward their pensions.

Contact staff writer Mark Walker at (760) 740-3529 or mlwalker@nctimes.com.