LONG BEACH — A new pension reform requires CalPERS to report the risk of investment earnings shortfalls when raising employer rates, but there is a problem.
The CalPERS chief actuary, Alan Milligan, says he lacks the staff needed to make multiple calculations for each of the 2,200 plans in the giant system.
The reform is a response to criticism that CalPERS estimates of future investment earnings are too optimistic.
Big returns were erroneously expected to pay for a major pension increase a decade ago, say the critics, and long-term pension debt facing taxpayers is understated.
Requiring CalPERS to report how employer costs and debt could balloon, if earnings fall short, is part of a pension reform obtained by Gov. Arnold Schwarzenegger in a new state budget, finally enacted this month after a record 100-day deadlock.
The reform also gives state workers hired after Jan. 15 lower pensions, rolling back a major increase enacted in 1999 by a CalPERS-sponsored bill, SB 400. The pensions will be based on a three-year salary average, curbing the “spiking” or boosting of benefits by manipulating final-year pay.
Milligan told the CalPERS board last week that the reporting reform applies to all 2,200 plans, not just state workers. The board met in the Hotel Maya in Long Beach, one of two “off-site” meetings held away from Sacramento headquarters each year.
The 1.6 million persons covered by the California Public Employees Retirement System are in three groups of roughly similar size: state workers, non-teaching school employees, and 1,568 local governments.
“So that’s going to be logistically a problem,” Milligan said. “I don’t have the staff to do that work. We are going to have to work on this to try to figure out how we deal with this particular provision.”
Milligan, with a staff of 40 actuaries, said options include requesting additional funding from the state. He said as the bill was presented, some legislators understood the workload problem and seemed willing to consider corrections after the budget passed.
“Hopefully, that would be attended to in a way that actually makes sense,” he said.
The “transparency” provision requires CalPERS, when setting the annual rate paid by employers, to include a forecast of how much higher the rates would be if investment earnings fell short.
CalPERS currently assumes investments will earn an average of 7.75 percent in the decades ahead. The additional calculation required by the reform is a forecast based on 6 percent or 1 percent below the assumed earnings, whichever is lowest.
Schwarzenegger and others have criticized CalPERS for telling legislators that the SB 400 pension increase in 1999 would be paid for by investment earnings, leaving state costs little changed for a decade.
“There were people that pulled wool over their eyes,” Schwarzenegger said after the budget passed. “They never really knew all the facts and the risks that were involved, Now this will be eliminated, this problem. We will have full transparency moving forward.”
A 17-page CalPERS brochure told legislators that enactment of the SB 400 benefit increase would keep the state contribution below the fiscal 1998-99 level, $766 million, for “at least the next decade.”
The legislative analyses of SB 400 said the same thing. What legislators were not told is that CalPERS actuaries had made a startlingly accurate forecast of how state costs would soar if earnings fell short.
The shortfall forecast of actuaries in 1999 nearly nailed the state payment to CalPERS this fiscal year, about $3.9 billion. The state also is paying $1.4 billion for retiree health care and $1.2 billion to the California State Teachers Retirement System.
As a result, 7.5 percent of the state general fund is being spent on retirement costs, $6.5 billion of the $86.5 billion budget. For the first time, Schwarzenegger said, the state budget spends more on retirement costs than on higher education.
CalPERS has already begun to respond to the criticism of overly optimistic earnings forecasts. A new “investment return sensitivity analysis” announced in August will give employers five short-term scenarios with their annual valuation report.
In addition to the usual forecast, two scenarios will show what happens to the employer’s cost if the earnings are a little or a lot below the target of 7.75 percent. Two more scenarios will show what happens if earnings are above the target.
CalPERS board meeting at Long Beach
Another “transparency” reform in the new state budget requires an additional CalPERS report that would show a much larger long-term debt.
Critics contend that overly optimistic earning estimates conceal massive public pension debt, guaranteed by taxpayers without a vote of the people. Some economists argue that a risk-free debt should only be offset with risk-free government bonds.
So instead of using the assumed earnings rate, 7.75 percent, to offset or “discount” the cost of paying for obligations to current workers and retirees in the decades ahead, the new report will use the 10-year U.S. Treasury bond rate, currently 2.5 percent.
The issue of how to properly report long-term public pension debt moved into the spotlight in April. Stanford graduate students used a 4.1 percent risk-free government bond rate to calculate the debt of the three state pension funds.
The Stanford students said CalPERS, CalSTRS and UC Retirement have a combined shortfall of $500 billion, nearly 10 times greater than the $55 billion unfunded liability reported by the three retirement systems.
The pension funds argue that using the assumed earnings rate is a time-tested actuarial method. It’s said to be appropriate for retirement systems sponsored by governments, which unlike corporate pension sponsors cannot go out of business.
CalPERS average earnings hit the target over the last two decades, but fell short during the last decade. Now CalPERS is considering lowering its assumed earnings rate, perhaps by about half of one percent as a panel of experts suggested earlier this year.
But even a relatively small drop in the assumed earnings would trigger an increase in contributions from employers, who already face rising pension costs to cover investment losses in the historic stock market crash two years ago.
Meanwhile, the use of a risk-free discount rate may be gaining traction. A report by Alicia Munnell and others at the Center for Retirement Research at Boston College said a risk-free discount rate should be used for public pension liabilities.
An editorial accompanying a report on state pension funds in the Oct. 16 issue of The Economist magazine said a change in accounting rules is needed to make taxpayers aware of the pension promises they have underwritten.
“Following rules set down (rather shamefully) by the Governmental Accounting Standards Board, the individual states discount their pension liability by the assumed rate of return on the assets, in most cases around 8 percent,” said The Economist.
GASB held a hearing in San Francisco earlier this month on proposed rule changes that include a “blended” discount rate — assumed earnings for liability covered by assets, and a risk-free rate for any remainder.
Reporter Ed Mendel covered the Capitol in Sacramento for nearly three decades, most recently for the San Diego Union-Tribune. More stories are at https://calpensions.com/ Posted 25 Oct 10
Calpensions 
October 25, 2010 at 1:39 pm
All California Pensions should be self funded, by the employees that get the benefits when they retire. If all employees make their contribution, and are conservative in their fund investments, they can fund themselves. Since the people of California back the the Pension plans, the people who invest take unecessary chances with their funds, and have lost billions of dollars.There is no responsilbity for their actions. We the people need to make state wide changes to the pension of government employees, before we go broke and are paying for their retirement through public funds. Let’s make state wide changes NOW, the state representives need to take responsiblity and make the changes that will put us on the right track, otherwise we will be cutting California services.
October 25, 2010 at 5:08 pm
WORSE THAN BERNIE MADOFF – COLORADO’S 2010 PENSION THEFT.
What do the Colorado Legislature and Bernie Madoff have in common? Both stole retirement benefits that were earned over many decades.
We have 80-year old widows in Colorado, who worked hard for the State for thirty years, who trusted the State and made their pension contributions like clockwork for decades, only to see their contracted retirement incomes stolen by the State. This money was taken out of their pockets because the State failed to make pension contributions as recommended by their own actuaries, to the tune of $2.7 billion in the last seven years. If the state had responsibly followed the recommendations of its actuaries, the PERA trust funds would now be more than 90 percent funded. The Colorado pension shortfall is primarily a result of legislative action over the last decade, Bill Owens, et al, in 2000 cut contributions and allowed the purchase of cheap service credit, and now the Legislature wants retirees to bear the cost of legislative ineptitude. In testimony to the Legislature even the proponents of the reform bill acknowledged this historic under-funding of the pension. PERA claims that the pension fund was unsustainable without their actions, because the funded ratio of the pension stands at 68 percent. However, the funded ratio of the pension was in the low 50 percent range in the 1970s, and the pension still exists. If a funded ratio of 68 percent this year is unsustainable, how has the pension been sustained since the 1970s when the funded ratio was in the 50s? Not much of a rationale for breaking retiree contracts.
If you find yourself short on funds, you rearrange your spending priorities, or raise additional revenue, YOU DON’T BREAK CONTRACTS! Why would the Colorado Legislature choose to break pension contracts before breaking other contracts, such as construction contracts? How can a state that is in default, that breaks contracts, maintain its credit rating?
The fact that what Colorado did to public sector employees in this year’s pension reform bill (SB1) cannot be done to private sector employee pensions under I.R.C. Section 411(d)(6), says quite a lot about the moral underpinnings of SB1. This federal “anti-cutback rule” for private sector DB plans permits changes to the plans only if the changes operate on a prospective basis.
Colorado PERA’s actions make it clear that the time has come for the inclusion of public defined benefit plans under all Internal Revenue Code Qualified Plan requirements. It is now obvious that allowing the states to regulate public defined benefit plans does not afford equal protection to state and local government employees.
PERA has put it in writing in pension plan materials over the years, that the COLA “is guaranteed”. Members purchasing service credit gave PERA thousands of dollars based on these materials. Money that they could have left in their 401Ks. PERA officials now claim that the members cannot rely on their pension plan documents regarding their defined benefits. However, Goldman Sachs recently paid a half billion dollar settlement to the SEC based on promises made in plan documents. Apparently, some judges believe that plan documents can set forth contractual terms. In any event, the contractual pension language is set forth clearly in Colorado law.
Colorado’s retiree COLA (and those of 36 other states) are “automatic COLAs” as opposed to “ad hoc COLAs” (which exist in about a dozen states and can be periodically altered.) Colorado’s COLA of 3.5 percent is guaranteed in Colorado law in an identical fashion to the base retirement benefit itself. So, the PERA retiree’s claims are based on both statutory language and plan documents. This 3.5 percent COLA won’t look so hot in the coming years if inflation spikes.
The Colorado pension reform bill’s (SB1) proponents should accept that states cannot legislate away a debt for work that was completed in the past. What the state is attempting is a claw back of deferred pay. The bill’s sponsors should accept that states cannot avoid their contractual obligations simply because they prefer to spend resources on alternative public services or obligations.
Some pension reform advocates argue that public sector pensions should be held to the same standards as private sector pensions. My response to that is “I agree wholeheartedly!” Under the federal Internal Revenue Code reducing accrued pension benefits for private pensions is illegal. If the public sector PERA pension were covered under this I.R.C. law and held to the same standards as private pensions, then last February’s theft of accrued benefits by the Colorado Legislature would not have been attempted. Essentially, federal law provides higher protection to private pensions than it does to public sector pensions. Public pension members are forced to appeal to the courts to prevent the theft of their benefits. (Happening.)
Members of the Legislature pointed out many times, to no avail, that the so called “pension reform bill” was a violation of contracts to which the State was a party. Here are some examples (on tape from the floor debate):
Rep. Lambert: “I have heard from my constituents, as many of you have, that this proposal will breach retiree’s contracts.”
Rep. Swalm: “We’re breaking new territory in this state by trying to reduce the COLA. We’re probably going to get a lawsuit out of that. If we cut the 3.5 percent COLA there will be a lawsuit.
Rep. Gerou said that it is a disservice to the state to rush a bill through when her committee knew that it will go to litigation, and said what we are doing to the retirees is wrong.
Rep. Delgroso said that it is tough for him to tell people that he is going to break their contract.
Senator Harvey said “We have made a commitment. We have a contract with current retirees. That is already in place. Reforms should be made for new hires. We do not have that commitment to new hires.
Senator Spence said “The bill places an unfair burden on retirees.”
Senator Scheffel said “We are breaching our promises to existing retirees.”
Senator Lundberg said “This bill is a deal that was cut before this body met.”
The cavalier abandonment of contractual obligations brings shame to the state of Colorado, aligns Colorado with Third World countries like Bolivia. No person, Republican or Democrat should countenance the breach of contracts. Conservatives support contract law as the foundation of capitalism.
So, why is the SB1 theft more egregious than the Madoff theft? The Colorado Legislature stole money from retirees who are less well off than Madoff’s pre-qualified hedge fund clients.
The Madoff victims were taking risks to seek a higher return on their investments, the Colorado PERA victims simply trusted that their contracts would be honored.
Colorado PERA and the Legislature justified their theft on false premises, citing 2008 market numbers when they knew the markets had recovered approximately 20 percent in 2009. PERA’s General Counsel stated on tape before the 2010 legislative session began that he expected a pension return “north of 15 percent”) for 2009.
It appears that Colorado PERA used the very resources of PERA members to hire a team of lobbyists (up to a dozen) to take earned benefits from those same members. That’s just insane.
Many members of the Legislature acted in ignorance. Spoonfed by the lobbyists, they ignored the legal rights of PERA retirees, and swallowed whole without question the assertions of PERA’s CEO and its chief legal counsel. If the members had read any case law, (for example, the state defined benefit pension case law summary by Prof. Amy Monahan at the University of Minnesota School of Law, Google it!), or even the 2004 Colorado AG opinion on pension benefits (retiree benefits are inviolate) they would not have supported the bill.
PERA’s own General Counsel was quoted in a 2008 Denver Post article as follows: “The attorney general’s opinion seems clear that fully vested employees — those retired or with enough years of service to retire — cannot see any benefits reduced, including cost-of-living adjustments, Smith said.”
Although members of the Colorado PERA Board of Trustees are fiduciaries, charged to act only in the interests of the members and the retirees, they recommended SB1, acting primarily in the interests of PERA employers who were concerned with keeping their contribution rates low.
Adding insult to injury the Legislature stole more money than it needed. The pension theft bill sought to increase PERA’s funded level to 100 percent, although an 80 percent funded level is considered well-funded among pension experts. You don’t have to pay off your pension tomorrow, neither does the state and other PERA employers.
There were many other options available to address the pension shortfall, options that have been adopted, or are under consideration in dozens of states. See the legal, prospective pension reform that was accomplished in Utah this year.
Members of the Legislature have taken an oath to uphold the constitution and yet voted to violate the Contract Clause and the Takings Clause. Proponents of the bill refused to see that the retiree COLA (annual benefit increase) is set forth in Colorado law with the same force, status and weight as is the base retirement benefit. Only tortured legal reasoning, and wishful thinking, lead them to believe otherwise.
The Legislature had the ability to investigate the legality of its actions up front, but chose to act with no legal advice. Throughout the floor and committee debates on SB1 the members displayed an ignorance of, or an intentional disregard for the relevant case law. They failed to conduct the due diligence expected of an elected body. State legislatures across the nation are examining the legal limitations on their actions regarding pension reform, exploring all legal options prior to acting. (PERA claimed to have a legal opinion to justify their actions, but never released it.)
PERA has been disingenuous by claiming that the reform bill represents “shared sacrifice” among employees, employers, and retirees, by not making it clear that retirees bear most of the burden of their proposed reforms, for many retirees the confiscation of benefits will reach one-quarter of their total retirement benefits received over the rest of their lives. In debate, the bill’s sponsors said that retirees would bear 90 percent of the cost of the reform. In any event, I am not relieved of my contractual obligations just because someone else has better terms in their contract. The entire premise is ludicrous.
While ignoring its own contractual pension obligations (underfunding of $2.7 billion in the last seven years according to PERA’s own actuaries) the State of Colorado has pumped half a billion dollars into pension obligations that are not its responsibility, those of local governments (Old Fire Police Pension obligations).
The Legislature made a pact with unions to support the “pension reform bill” (SB1) to protect union jobs. Incredibly, these union members tossed their former members, their retired “brothers” under the bus. From the beginning the plan was “let’s steal the money we need from retirees.”
Finally, Madoff eventually admitted to his crime, but the Colorado General Assembly is still pretending that their theft of pension benefits is something to be celebrated. They tout it as a “bi-partisan accomplishment. This will be a long-standing embarrassment to and black mark on our state.
October 25, 2010 at 5:53 pm
How come in all this reporting nobody and I mean nobody ever mentions the lawsuit where the state and municipalities claimed that if calpers had all those extra earnings that they were being overcharged and the resulting huge refunds they convinced the courts to give them and the moratorium on payments for ten years or more as part of the cause of this mess. This attempt to hijack the money in PERS was one of the real reasons they have a shortfall now. If they hadn’t convinced the courts they were paying too much they would have continued to pay at the old rate and the pension fund would have made considerably more money over the period in question. Was there some kind of gag order regarding this or did both sides sign a non-disclosure agreement or what.
This fiscal irresponsibility by the state and the municipalities is the true reason for the current crisis and I haven’t heard one single word reported about it.
Regards
Paul
October 25, 2010 at 7:49 pm
If you want a truly transparent pension system, then you need a defined contribution plan. Defined benefit plans are subject to great uncertainty, politicized, self-interest driven assumptions of returns and necessary contributions (which also are very pro-cyclical in a state with a very pro-cyclical revenue stream), uncertainty about who will end up being the counter parties on the hook for faulty assumptions with those persons so obligated not really being a party to the decisions that created their future obligations. Defined contributions are present-time transactions where money is taken from current taxpayers and given to current employees. If those arrangements are unacceptable, everyone is clear about what they are and they can be changed through the political process. The horrible corrupt scheme of SB400 was exactly the opposite. It obligated taxpayers and other parties not at the table, indeed not even unaware of the stakes. How is that a legitimate contract? If the government employee unions had wanted higher pensions in a defined contribution system, the politicians would have to had voted to take more money from taxpayers and we could have had a debate over whether that was the right thing to do.
With regard to the need to do multiple calculations based on different return assumptions, I just don’t understand the problem. Wouldn’t it just require using the existing tables with the only factor to change being the assumed rate of return? How is changing one value in an existing spread sheet so difficult?
October 26, 2010 at 7:59 pm
Good Article. My points are as follows: 1) While I cannot comment on PERS state-wide, I can say that as a union rep during the late 90’s, employers I dealt with induced their employees to pay for retirement benefit improvements, even if it has been forecast that investment income would cover the cost; and 2) that PERS’ decision to forgive and even refund employer contributions during that time period, although taken in good faith, did not help PERS present-day financial health. I might add that those events made possible especially dire sounding statements of required “percentage increase” in employer contributions.
And 3) If we all used the assumed the return on Treasury notes when completing the boxes in retirement calculators, no one would ever retire,
October 28, 2010 at 1:47 pm
What the fans of Defined Contribution need to recognize is, in spite of the well-known advantages of DC, there are some substantial disadvantages to it that are not as widely-discussed. With a DC plan, everyone individually has to save as if they will live a very long life. In a DB plan, you need only save for average life expectancy. This single factor makes a huge difference in the total cost to fund retirements.
October 28, 2010 at 5:19 pm
Jim Austin is right about the need for proper planning. Furthermore having retirement saving in individual accounts subjects people to wide variations in return risk, high management costs and possible mismanagement. The solution is individual shares of a pooled pension system where return on contributions is averaged among all participants and pensions are annuitized based upon actuarial underwriting so they never run out before someone dies. The current 401k individual accounts system has been a disaster for many people.
The transparency of defined contribution system isn’t incompatible with retirement income security if the proper systems are put in place.
November 9, 2010 at 7:09 pm
Perhaps issuing retirees both cash and revenue sharing bonds might help?