A recent actuarial study by the firm Bartel and Associates estimates that the city should spend $13.6 million this year on medical expenses for retirees, a number that is 39 percent higher than the estimate in a prior audit. In 2009, the firm Milliman and Associates estimated that the city would have to spend $9.8 million annually to meet its obligation.
The alarming divergence between the two studies has prompted the City Council to wonder how much the city should spend this year to narrow its unfunded medical liability for retirees. The Bartel study pegs the gap at about $134.7 million. Milliman estimated it to be about $105 million. But while council members generally acknowledged at Monday night's discussion that the city would have to increase its annual required contribution, they stopped short of accepting the new conclusions and asked staff and Bartel to further analyze the assumptions behind the latest actuarial report.
John Bartel, whose firm put the new study together, listed a wide range of reasons for the dramatically higher numbers. These include a recent study by California Public Employees' Retirement System (CalPERS) detailing changing employee demographics: increasing retiree lifespans, decreasing retirement age and other factors that added about $8 million to the city's unfunded liability.
Palo Alto's recent wave of retirements, which was prompted in large part by benefit reductions, contributed another $2.7 million to the backlog, according to Bartel's study. The retirees' tendency to choose more expensive medical plans added another $7.7 million.
Council members on Monday, Jan. 30, questioned Bartel's assumptions and, in particular, the firm's methodology, which bases the estimate on a 28-year amortization period that aims to eliminate the unfunded liability. Milliman's estimate used a 30-year period in which annual contributions would not completely pay off the liability, according to a report from Senior Financial Analyst Nancy Nagel.
The Bartel study estimated that the city's unfunded retiree medical liability now stands at $134.7 million, 28 percent higher than the $105 million cited by Milliman.
Council members noted that if the city were to accept the report's conclusion, it would have to take an extra $2.3 million from its General Fund and $1.5 million from its Enterprise Fund in the current fiscal year, which ends on June 30. Vice Mayor Greg Scharff called this "a huge increase" and said the change would cut into other city priorities, including infrastructure.
"You can't absorb an increase like that. ... You won't have money to do anything else," Scharff said.
Councilman Larry Klein also expressed skepticism about the latest numbers and wondered if the Bartel study wasn't too conservative. He also suggested that significantly raising the city's contributions toward retiree medical costs may not be the best use for city funds. The medical contributions, he observed, would be close to 10 percent of the city's General Fund budget.
"That to me is freezing out various expenditures which may in fact be better for the health of our community in the long run," Klein said. "I can make an argument that paying large sums into this may not be healthy for the community long-term financially."
The Bartel study also projects a steeper near-term increase in the medical costs (9 percent per year until 2021) than the Milliman study (6.5 percent until 2018). This projection did not surprise city staff. Lalo Perez, director of the city's Administrative Services Department, said Palo Alto's medical costs have doubled over the past six years and said it's important for the city to have discussions with its employees about the rising pension and health care costs.
In the past two years, the city added a second tier of pension for new employees and adopted new requirements for employees' health care contributions.
"It creates difficult decisions, not just for management but for the council and the community," Perez said. "We do plan to do outreach on this to employees in the general sense, not just in negotiations."
The council voted to direct staff and Bartel to re-examine the assumptions in the new report and to return with more information about payment alternatives. The conversation is scheduled to resume at the Feb. 28 meeting of the council's Finance Committee.