Archive for July, 2010

SB400 pension boost: uncanny forecast unheeded

July 27, 2010

As CalPERS publicly said a decade ago that a major pension increase, now targeted for rollbacks, could be paid for with investment earnings rather than higher state costs, its actuaries made a startlingly accurate forecast of the impact if earnings fell short.

The actuaries said the annual state payment to CalPERS, $159 million in 1999, could soar to $3.954 billion in fiscal 2010-11 — a long-range forecast that scored a near bull’s-eye on the $3.888 billion state payment for the fiscal year that began this month.

Legislators were told in a 17-page CalPERS brochure that the pension increase, SB 400 in 1999, would not increase state costs. And as critics have pointed out, the brochure did not mention the state would have to pay if investments faltered.

But the agenda for a meeting of the CalPERS benefits committee meeting on June 15, 1999, shows that the board was informed of the risk. One of the members asking for more information was the office of then-state Treasurer Phil Angelides.

The board was given “hypothetical scenarios” of what would happen under three different investment returns during a 10-year period that ended, as it happens, with the current fiscal year.

If investments hit the earnings target assumed by CalPERS, an annual average of 8.25 percent (since lowered to 7.75 percent and now under review), the state payment this fiscal year would be $679 million.

But if earnings during the decade averaged 4.4 percent, a repeat of the decade from 1966 to 1975, the state payment would be $3.954 billion. If earnings averaged 12.1 percent, a repeat of 1947 to 1956, the payment would be zero.

A scenario based on a recent decade when earnings averaged about half of the CalPERS target was a grim reminder of the unpredictable business cycle, with its ups and downs.

As it turned out, a scenario based on a 4.4 percent average return was not “down” enough. CalPERS earnings during the last decade averaged 3.1 percent, according to a Wilshire consultants report in March.

The big swings in the forecast of state costs, from zero in boom times to nearly $4 billion if the economy slowed, shows how dependent public pensions have become on unpredictable investment earnings.

The transformation of the pension funds began with a little-known ballot measure, Proposition 21 in 1984, that shifted investments away from bonds. A cap limiting stocks to 25 percent of the portfolio was lifted, allowing the riskier pursuit of higher yields.

Another chart in the agenda given the committee in 1999 shows how employer-employee contributions, not investments, once provided most of the revenue for the giant CalPERS state and local government Public Employees Retirement Fund.

But after the passage of Proposition 21 investment earnings surged with a historic bull market. By 1999 earnings had provided 78.6 percent of the revenue in the previous decade, giving CalPERS a surplus and fueling the push for a benefit increase.

A history of strong earnings apparently helped give the CalPERS board confidence that pensions could be increased without driving up state costs. But there also was a fallback position.

While being shown how state costs could balloon if earnings were below the target, the CalPERS board received reassurance about steps that could be taken to avoid a rate shock if earnings fell short.

“Staff believes the proposals (SB 400) are justified, reasonable and economically prudent,” said a staff memo accompanying the scenarios.

“Further, staff believes that in the event, in future years, lower markets do not permit CalPERS to achieve our expected investment target,” said the memo, “we have at our disposal various actuarial funding procedures and methods which would allow us to manage and help mitigate such negative impact.”

The CalPERS board adopted one change in 2005 as Gov. Arnold Schwarzenegger briefly backed a proposal to switch state and local government new hires from pensions to a 401(k)-style individual investment plan, now common in the private sector.

A rate “smoothing” plan spread CalPERS investment gains and losses over 15 years, up from three years, and the “corridor” allowed for valuing assets was expanded from 10 to 20 percent of their market worth.

A second change adopted last year phases in rate increases from losses during the 2008 market crash over three years. It briefly expands the corridor to 40 percent and treats market-crash losses separately, paying them off over 30 years.

Despite the changes, the $3.9 billion contribution CalPERS imposed on the state this year is a $600 million increase from last year. The 18 percent increase in pension costs comes as the deficit-ridden state faces another round of deep cuts to most programs.

Now the current governor, Schwarzenegger, and the two leading candidates to replace him, Democrat Jerry Brown and Republican Meg Whitman, are all calling for state worker pension cuts to reduce costs.

Schwarzenegger wants to roll back pensions for new hires to the pre-SB400 level and has tentative deals with a half dozen unions. Whitman proposes switching new state hires, except police and firefighters, to 401(k)-style plans and extending retirement ages.

Brown unveiled an eight-point plan last week that would renegotiate pension formulas for new hires and extend retirement ages, increase employee contributions. and have the governor’s finance director monitor the basic CalPERS activities.

In 1999 another part of the governor’s office took a hard look at the pension increases sponsored by CalPERS in SB 400. The position of former Gov. Gray Davis was outlined in an update to state managers on bargaining with unions.

The personnel administration director, Marty Morgenstern, said in the memo that the administration believed the “record high” CalPERS investment earnings might not continue and that state contributions could “soar” if the economy weakened.

“If future returns are more like those earned between 1966 and 1975, the state could end up contributing over $3.9 billion a year to maintain the new benefit level, according to CalPERS actuaries,” said the Morgenstern memo.

In 2003 Morgenstern told a Sacramento Bee columnist, Daniel Weintraub, that he had been able to trim the cost of the CalPERS proposal in labor negotiations by tweaking retirement formulas and shifting some costs to workers.

Morgenstern said he reminded Davis of what happened in 1979 when Jerry Brown was governor, Davis was Brown’s chief of staff, and Morgenstern was the personnel director.

“Brown had refused to negotiate a pay raise for state employees, only to see the Legislature send one to his desk,” Weintraub wrote. “Brown vetoed it and the Legislature overrode his veto. Then he vetoed the money out of the budget and they overrode that, too.”

Reporter Ed Mendel covered the Capitol in Sacramento for nearly three decades, most recently for the San Diego Union-Tribune. More stories are at http://calpensions.com/ Posted 27 Jul 10


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