SAN FRANCISCO - San Francisco and its employee unions have agreed to share the cost of rapidly growing retiree health care obligations beginning in 2009 in order to protect the city's credit ratings and long-term financial health.

"This is a massive problem that we need to begin to address," said Supervisor Sean Elsbernd, who negotiated the deal on behalf of the city. "If we don't address this, 20 years or 30 years from now, this would have a crushing impact on basic city services."

Rating agency analysts and local officials said San Francisco's liability for so-called other post-employment benefits, or OPEBs, is among the highest in the nation at $4.2 billion. That's because the city offers fully paid retiree health insurance to workers after just five years of service. The cost amounts $5,645 for each of San Francisco's 744,000 residents.

A proposed charter amendment would halt the growth of the unfunded liability by requiring new employees to work longer to qualify for benefits and to contribute to a new retiree health care trust fund. In exchange for health care concessions, both new and current city workers would receive more generous pensions.

The city was forced to acknowledge its OPEB liability because a Government Accounting Standards Board rule change requires governments to recognize the obligations as they accrue, not years later when they are paid. San Francisco - which is a combined city and county government - would continue to pay that accrued liability on a pay-as-you-go basis. That bill rose to $135 million in fiscal 2008 from $17 million in 2001.

"San Francisco's OPEB liability is certainly one of the bigger numbers" local governments have reported, said Ian Carroll, a director at Standard & Poor's. "Funding future liabilities as they accrue would probably be a much better situation for the city's credit."

The city's $1.2 billion of outstanding general obligation debt is rated AA by Standard & Poor's, AA-minus by Fitch Ratings, and Aa3 by Moody's Investors Service.

Elsbernd's plan - which is co-sponsored by Mayor Gavin Newsom - would require a change in the city charter. The Board of Supervisors unanimously approved the charter amendment Feb. 26. The plan will go before voters June 3.

The agreement with non-public safety workers took four months to negotiate and includes a web of new benefits and obligations for both San Francisco and its workers. It would create a two-tiered benefit plan in which new workers receive less generous retirement health benefits than older workers.

"There are tough choices that need to be made," Carroll said. "Sometimes that means making retirement health care benefits less generous for future employees, just due to the realities of the costs."

The agreement would force new employees to contribute 2% of their earnings to a trust fund, starting on Jan. 10, 2009. The city would contribute another 1% to the fund. The trust fund would pay half of retiree health insurance premiums after 10 years of employment, 75% after 15 years, and 100% after 20 years. The city would still be responsible for any shortfalls.

While current workers would not contribute to the trust fund and would keep all promised benefits, all employees' wages would be frozen for a year and a half, beginning July 1, 2009. That would save San Francisco about $35 million in the first year, and the savings would be compounded over time, according to a study by the city controller's office.

In return, the city agreed to increase pension benefits for workers who work past age 60. Unlike its retiree health liabilities, its pension fund is fully funded.

Under the new formula, a non-public safety employee could retire with a pension equal to their years of service multiplied by 2.3% of their highest pay if they wait until age 62; at present, the top formula is 2% at age 60.

They would also get larger cost of living adjustments as retirees.

"No one believes the city can continue to provide retiree health carewith no employee contribution and five short years to qualify without endangering the city's general fund," said Tim Paulson, executive director of the San Francisco Labor Council and one of the union negotiators. "This was an opportunity for workers to increase their pension benefits while solving the health care liability problem."

All told, the average worker's pension income would be 21% larger after 10 years of retirement, according to the Coalition for Pension Reform, a union group. Keeping the pension fund fully funded would cost the city an average of $84 million a year over the next 20 years.

"Should the proposed charter amendment be approved by the voters, in my opinion, the city will have both significant added costs in the near and medium term for the cost of employee pension benefits and significant savings in the near term under its labor contracts and in the long term for the cost of retiree health benefits," city Controller Ed Harrington wrote in a report to the Board of Supervisors.

The city negotiator, Supervisor Elsbernd, said San Francisco needs to improve its pension offerings to compete for workers with other local governments, most of which offer more generous pensions.

The agreement is not a panacea for the city's retiree cost problems, Elsbernd admitted. Officials would have to find the money for the new pension benefits in a budget that's already being strained a slowing economy, and it must figure out how it's going to afford its accrued OPEB obligations. The controller's office predicted that the cost paying the accrued liabilities will rise to between $250 million and $300 million annually.

Elsbernd said he wouldn't support an OPEB bond issue to fund those costs.

"This is not something that is going to save the city money next year," he said. "This is step one in addressing this problem, not the final step."

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