San José has two retirement systems. The Police and Fire Department Retirement System serves sworn public safety employees. The Federated City Employees’ Retirement System serves all other employees.

Note: Employees who participate in the City’s pension plans do not contribute to Social Security and do not earn credit for Social Security benefits while working for the City. The Mayor, City Councilmembers, and non-benefited (i.e. part-time, temporary, contract) employees do not participate in the city’s pension plans.

Source: San José Retirement Services Department. Visit the Additional Resources section for retirement benefit fact sheets.

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2011-2012 Contribution Rates * Percent of Employee's Base Salary
Retirement Plan	City	Employee
Police Plan	56.90%	17.47%
Pension Benefits	49.29%	10.46%
Retiree Healthcare	7.61%	7.01%
Fire Plan	56.32%	15.62%
Pension Benefits	51.05%	10.76%
Retiree Healthcare	5.27%	4.86%
Federated Plan	35.50%	11.20%
Pension Benefits	28.34%	4.68%
Retiree Healthcare	7.16%	6.52%
Source: Office of Employee Relations, January 2011 * View a precise breakdown of contribution rates: Police Department Plan, Fire Department Plan, and Federated (Non-Sworn) Plan

• Cost-Sharing for Pension Benefits:
  The City and employees split the normal cost for pension benefits on an 8 to 3 ratio (for every $8 the City pays, an employee contributes $3). However, the City is responsible for paying off 100% of any "unfunded liabilities" in the pension plans. As a result, taxpayers assume all of the risk for the pension plans' investments.
  
  Unlike some governments, the City of San José has consistently made its annual retirement contribution (ARC) for pension benefits. 

• Cost-Sharing for Retiree Healthcare Benefits:
  For retiree medical benefits, both the normal cost and the cost of any unfunded liabilities are split 50/50. Retiree dental benefits are split between the City and employees on either a 3:1 ratio (for police/fire employees) or an 8:3 ratio (for federated employees).
  
  Both the City and employees are still in the phase-in period for paying the full annual retiree healthcare contribution. Once the phase-in is complete, there will be dramatic increases in retiree healthcare contributions for both the City and employees.

It is important to note that the current contribution rates are based on optimistic assumptions adopted by San Jose’s independent retirement boards, including a 7.5% assumed rate of return. Using a more realistic investment assumption would significantly increase the City’s and employees' annual contribution rates.

Sources: Office of the City Auditor, Report on Pension Sustainability ; Office of Employee Relations, City of San Jose Retirement Benefits FAQs

Unfortunately, the City’s retirement systems are significantly underfunded.

As of June 30, 2011, the City’s two retirement systems had about $3 billion in unfunded liabilities. These unfunded liabilities are the result of retroactive benefit enhancements, changing demographics, and overly optimistic assumptions that haven’t held true (note: these factors are discussed further in: Why Retirement Costs Have Grown So Much).

The plans’ growing unfunded liabilities have been accompanied by a decline in the plans’ funding ratios. In particular, the plans only have a small fraction of the money needed to fund retiree healthcare benefits. This is largely due to the fact that the City and employees have only been partially pre-funding their retiree healthcare benefits. However, both are now in a “phase-in” period for fully-funding their annual healthcare contributions.

These unfunded liabilities represent a huge debt that must be paid off in the future. This not only shifts the costs for today’s employees onto future generations, it also ends up costing more in the long run. And the larger the unfunded liability grows, the greater the risk that the retirement plans will not be able to pay retirees the benefits they have earned and accrued.

Sources: June 30, 2011 Actuarial Valuations for the Police and Fire Retirement Plan & the Federated Employees Retirement Plan (available on the Office of Employee Relations website )

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Providing these generous retirement benefits and paying down the plans’ unfunded liabilities have taken a significant financial toll on the City of San José.

The City's retirement costs have more than tripled over the past decade, growing from $73 million in FY 2001-02 to $245 million in FY 2011-12. Retirement benefits now cost more than 50% of base payroll and consume more than 20% of the City's entire General Fund.

While the City’s FY 2012-13 retirement costs are expected to stay flat (due to recent layoffs and pay cuts), the City’s annual retirement contribution is projected to increase to $320 million in FY 2015-16 and continue rising for many more years after that. In addition, retirement costs could grow much larger than currently projected if the independent retirement boards adopt more realistic actuarial assumptions (for example, the boards currently assume a 7.5% annual return on investments).

Retirement costs are also escalating for city employees. In particular, both the City and employees will see dramatic retirement cost increases once they complete the phase-in period for paying the full annual retiree healthcare contribution.

As a result, these growing retirement costs threaten City's ability to provide basic public services. Read about Mayor Reed's efforts to implement critical Fiscal Reforms

Sources: Retirement System Comprehensive Annual Financial Reports (Police & Fire Plan & Federated ), Office of Employee Relations, FY2011-12 Total City Salary and Benefit Costs , Cheiron's Five Year Projections Dated February 8, 2012 and February 21, 2012 (as outlined in the City of San Jose Future Retirement Costs Study Session Presentation )

There are a number of factors that have contributed to the City’s growing and unsustainable retirement costs. Listed here are three of the factors that have had a particularly large impact on retirement costs.

1. Retirement Benefits Have Been Continually Enhanced

The City Council - and in some cases, outside arbitrators – have enhanced pension benefits numerous times over the past two decades. Among these fiscally irresponsible actions:

• The maximum pension benefit for San José police officers and firefighters was increased multiple times: first to 80%, then to 85%, and finally to 90% of compensation.
• The cost-of-living adjustment (COLA) was changed to a guaranteed 3% annual adjustment.
• The definition of "final compensation" (which is used to calculate pension benefits) was changed from the highest average over a 3 year period to the highest 12 consecutive months, for the Federated Plan.

Even worse, some of the above enhancements were made retroactively. This is what happened when police officers (in 2006) and firefighters (in 2008, via outside arbitration) were awarded a maximum pension benefit equaling 90% of final compensation. These retroactive increases immediately added more than $70 million in unfunded liabilities that the City has been obligated to pay.

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Overall, retirees are receiving significantly larger pension payments today than they did 20 years ago. Even after adjusting for inflation:

• The average annual pension benefit has increased by 75% for Police and Fire retirees.
• The average annual pension benefit has increased by 54% for Federated retirees.

Furthermore, total annual pension benefit payments from the retirement funds have grown seven-fold over the past 20 years (see chart to right).

2. Employees Are Living Longer and Retiring Earlier.

The average life expectancy continues to rise (currently 78 years in the U.S.) and more individuals are opting to retire at an early age. This means that retirees are collecting benefits for a longer period of time. In fact:

• The average retiree in the Police and Fire plan receives a pension benefit for 21 years.
• The average retiree in the Federated plan receives a pension benefit for 18 years.

In addition, the overall number of retirees receiving benefits is now 2½ times greater than 20 years ago.

These changing demographic factors have had a significant impact on the cost of providing the City's retirement benefits. It has also meant that past actuarial assumptions (i.e. those based on a lower life expectancy) haven’t held true, resulting in new unfunded liabilities.

3. Investment Gains Have Not Kept Up with Projections

Any time that retirement fund investments fall short of their projected returns, a new unfunded liability is created. Most recently, investment losses between 2007 and 2009 created a $978.8 million unfunded liability.

However, the retirement funds were experiencing gaps between projections and actual returns long before the current economic downturn. That’s because, over the past 30 years, the retirement systems have assumed an unrealistic rate of return - typically between 8.0% and 8.25% annually - that has outpaced its actual investment earnings (note: the retirement boards have begun to gradually reduce the assumed rate of return).

Paying off these unfunded liabilities drives up retirement costs in future years. And in the case of the pension plans' unfunded liabilities, the burden falls completely on the taxpayers.

Source: City Auditor's Report on Pension Sustainability