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California's pension system lowered a key estimate of future investment returns Wednesday, a move that will drive up pension costs for cities across Sonoma County and further squeeze public services.

The board of the California Public Employees Retirement System voted 9-1 to reduce its investment return rate from 7.75 percent to 7.5 percent.

The decision will mean yet another hit to beleaguered local budgets as CalPERS jacks up pension contributions by public agencies to make up for lower investment returns.

The change will cost the state an estimated $303 million, and untold millions more for the municipalities and other local governments whose workers are covered by CalPERS retirement plans.

"This was a difficult, but important, decision for the board to make," Rob Feckner, board president, said in a statement. "We understand the impact this will have on our employers in meeting contribution requirements."

CalPERS is the nation's largest public pension fund, with $233 billion in assets. It provides retirement benefits to 1.6 million public employees and their families. Teachers and some county employees, including Sonoma County, have separate pension systems.

It was the first time in a decade the fund reduced the key interest assumption, known as the discount rate. The last time it was lowered from 8.25 percent to the current 7.75 percent, where it remained throughout the recession that decimated its investments.

To soften the blow on local governments, the board directed staff to come up with a plan to spread the costs over two years.

Local officials told the board that they already are laboring under falling revenues and tight budgets.

The threat of such increases has been one of the reasons Santa Rosa has pressed for long-term pension solutions, said City Manager Kathy Millison.

"I've been warning about this since I arrived," said Millison, whose city faces a $112 million unfunded liability. "We knew they were coming. We just didn't know how much."

Others argued that the board wasn't going far enough.

John Bartel, Santa Rosa's pension actuary, said he thought it would have been wiser for the board to reduce its assumption to 7.25 percent as recommended by its actuary.

"Even though that would have been painful, it would position the plans to be better funded down the road," Bartel said.

The board's move represents a continued pattern of refusing to face up to ballooning pension costs, said Joe Nation, a former state assemblyman representing Marin and Sonoma counties and current professor of public policy at Stanford University.

"I think it's a step in the right direction, I just think it's too small a step," Nation said.

The direction to spread the increases out over two years struck Nation as "absolutely the wrong move."

"Everything is about delay, defer and pushing costs in the future," Nation said. "You know and I know and everyone knows that when you do that you pay more in the long run."

He likened spreading out the increase to choosing not to make the minimum payment on a credit card, leaving the unpaid balance to accrue at a higher interest rate.

One upside for local governments is that the rate won't take effect until July 2013, giving officials time to brace for the impact.

The board rejected a similar proposal last year, citing concern about impacts on local governments, but promised to revisit it this year.

According to CalPERS, the change will mean an increase of 1 to 2 percent of the payroll for regular employees, and 2 to 3 percent for public safety employees, who receive more generous benefits.

For Santa Rosa, based on 2010 payroll figures, that would mean a $1.3 million to $1.7 million budget hit. This year the city's total pension costs were $26.4 million.

"That will set us back a bit, which means we'll just have to make deeper cuts," Millison said.

She noted, however, that the city has struck several agreements with its employee groups aimed at reining in pension costs, including establishing lower benefits for new workers and having employees pick up a greater share of the costs.

"It's an incremental process. We're not done yet," she said.

City officials around Sonoma County had varying views of how significant the impact would be.

Petaluma Finance Director Bill Mushallo estimates Petaluma's total increase at about $736,000 beginning in the 2013-14 fiscal year.

"It's a pretty significant hit, especially to the general fund, where we've got tax revenues that are down," Mushallo said. "It is a big deal."

Sonoma City Manager Linda Kelly said the increase that could range from $80,000 to $130,000 would probably be offset by a variety of efforts the city has made to reduce its pension obligations, including outsourcing fire and emergency service to the Valley of the Moon Fire District.

Windsor finance chief Jim McAdler wasn't terribly concerned. He estimated the town will have to contribute $138,000 more annually toward pensions as a result of the revised formula.

"CalPERS has been thinking of changing the rate for some time," he said. "It's something we've been expecting. It shouldn't be too much of a hit, fortunately."

City officials in Healdsburg and Rohnert Park declined to estimate the impacts. But a 2 percent figure applied to their payrolls would suggest a $275,000 increase for Rohnert Park and $190,000 increase for Healdsburg.

The change does not directly affect Sonoma County's pension system, which is a separate entity that could choose to follow CalPERS' lead.

Last year the county fund lowered its assumption rate from 8 percent -- in existence since 2003 -- to 7.75 percent. Unlike CalPERS, county employees share in the cost of changes to investment assumptions.

Starting in July, the change will require an additional yearly contribution of $7.1 million, $5.8 million of which will come from taxpayers and $1.3 million from employees.

Gary Bei, the county pension fund administrator, said the fund's rate would be up for review this year.

Staff Writers Derek Moore, Clark Mason, Jeremy Hay and Lori A. Carter contributed to this report.

You can reach Staff Writer Kevin McCallum at 521-5207 or kevin.mccallum @pressdemocrat.com.

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