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(In paragraph 7 from bottom corrects to $7.8 billion instead of $7.8 million and clarifies next paragraph on wages)
* Termination letter sent to biggest U.S. pension fund
* Other cities look for ways to rein in pension debt
By Tim Reid
LOS ANGELES, April 17 (Reuters) - The tiny California city of Canyon Lake has served notice on the state's pension fund that it wants to quit the plan, at a time when cities across the state and the United States are looking at ways to rein in soaring retirement costs.
Canyon Lake in southern California is a city of 11,000 people. But its decision to quit the powerful Calpers - America's largest public pension fund with $256 billion of assets under management - could presage much larger problems for the system as it battles with Wall Street bondholders in the bankruptcy cases of California's San Bernardino and Stockton.
Canyon Lake, which says it is ready to pay a termination fee, sent a letter on April 4 to the California Public Employees' Retirement System (Calpers) stating that it wants to end its relationship with the pension fund.
A major factor in its decision was a likely move by Calpers to raise its employer contribution rate by 50 percent in coming years - a decision the fund's board approved on Wednesday .
Calpers confirmed that it had received Canyon Lake's "required signed resolution of intention to terminate" adding other cities and counties have ended their contracts with the fund in the past. No other city or county in California is known to be taking the step to currently quit the plan.
"The problem here is the uncertainty for Calpers, and that is how many cities might opt out," said Michael Sweet, a bankruptcy attorney with Fox Rothschild in San Francisco.
"That is the unknown. The issue here for Calpers is if Canyon Lake becomes a trend."
Pacific Grove, a California coastal city of 15,000, informed Calpers earlier this year that it wants to explore ways to renegotiate its obligations to the fund. Other California cities are taking legal and financial advice about their obligations to Calpers.
Canyon Lake said it has looked at Calpers's website, which states that its unfunded liability to the fund is $661,000.
Richard Rowe, Canyon Lake's interim city manager, said the city decided it would be cheaper to borrow money to pay off Calpers rather than continue to pay the fund.
The city only has two full-time employees. Payments to Calpers for the pair will cost the city about $35,000 in the next fiscal year beginning July 1, Rowe said. If the city quit Calpers and turned those jobs into part-time positions with much lower benefit structures, the city would save about $88,000 annually in pension and health costs, Rowe said.
Servicing a 10-year loan to quit Calpers will cost the city about $77,000 annually, Rowe said - but it would be one line item in the city's budget that should not change.
Out of a total city budget of $3.6 million, $2.6 million is spent on police and fire costs. That is contracted out to Riverside County and the city has no control over those Calpers costs.
The city wanted to quit Calpers because it looked like payments to the fund would continue to increase, and Rowe said it was frustrating that the city had no control over that.
In the last 10 years, the amount paid to Calpers by California and the cities rose nearly four times to $7.8 billion in fiscal 2012.
According to the city, it paid Calpers 17.9 percent of its employees wages, up from 12.8 percent three years ago. Rowe said they have also asked Calpers for an exact termination fee, amid concerns about a rising unfunded liability figure calculated by the fund.
"Budgeting is extremely difficult," Rowe said. "We have no ability to make long-term forecasts because we don't know how Calpers's long term liabilities are going to be resolved."
Brad Pacheco, a spokesman for Calpers, said the fund had not performed any termination calculations for Canyon Lake.
Pacheco suggested the city's assumption that its termination fee was $661,000 might be premature.
"We suspect that they used the hypothetical number from the recent valuation report in the action with their City Council," he said.
The assets of a city that terminates from Calpers are "are put into a more conservative risk pool." (Reporting by Tim Reid; Editing by Tiziana Barghini and Leslie Gevirtz)