New pension forecasts: what if earnings falter?

A new advisory panel, following a move by CalPERS last year, recommends that public pensions take a small step that touches on a big issue: What happens if pension fund earnings fall below the forecast?

Investment earnings are expected to provide two-thirds or more of the money needed to pay pensions in future decades. Critics say earnings forecasts, 7.75 percent a year for CalPERS and CalSTRS, are too optimistic and conceal massive taxpayer debt.

To make more pension information public, the first report of an actuarial panel recommends, among other things, that retirement systems add a “sensitivity analysis,” which is likely to show what happens if earnings miss their target in the next few years.

It’s not a long-term forecast like a Stanford graduate student study two years ago. Using a lower risk-free bond rate advocated by some economists, 4.1 percent, the study showed how state pension debt ballooned from the reported $55 billion to $500 billion.

Pension debt has become a political issue cited by reform advocates, who say public pensions must be overhauled to prevent the growing cost from eating up money needed for basic government services.

A short-term “sensitivity analysis” is intended to be practical, a way to help state and local governments know how much their annual pension costs may vary in the next few budget cycles if investment earnings or other factors miss their target.

For the first time, the annual California Public Employees Retirement System actuarial report last fall on state and non-teaching school pensions included a sensitivity analysis.

The report showed how employer contributions could vary if, all other factors remaining unchanged, earnings during three fiscal year are above or below the target by a little or a lot.

For example, if earnings hit the target of 7.75 percent the employer contribution in fiscal 2015-16 for most state workers would be 19.5 percent of pay. (The employee contribution, 8 percent of pay, is bargained with labor and presumably unchanged.)

But if total investment earnings this fiscal year and the next two fiscal years show a loss, minus 3.64 percent, the employer contribution in 2015-16 would increase by about half to 28.9 percent of pay.

Falling short of the 7.75 percent target with earnings of 2.93 percent would increase the 2015-16 contribution to 22.6 percent of pay. Exceeding the target with earnings of 19.02 percent would produce little change, dropping the rate to 18 percent.

The sensitivity analysis may not be the long-term debt calculation sought by reformers. But it does clearly show the risk of how a double-dip recession, and another plunge in the stock market, could drive up government costs.

The California Actuarial Advisory Panel, with eight members appointed by public officeholders and agencies, was created by legislation recommended by the California Public Employee Post-Employment Benefits Commission four years ago.

“There is no single clearinghouse for funding policies and practices from around the state and country which can be used to evaluate the actuarial assumptions, crediting rates, or proposed actions of a particular retirement system,” the commission said.

Actuaries have a key role in setting the annual payment that state and local governments must make to pension funds. During a push to cut pension costs, former Gov. Pete Wilson obtained legislation giving lawmakers control of the CalPERS actuary.

A labor-backed initiative, Proposition 162 in 1992, returned control of the actuary to the CalPERS board, while also giving all public pension boards control of their administration and pension funds to prevent Wilson-like “raids” on “surpluses.”

The importance of actuary control was seen in a major state pension increase, SB 400 in 1999. The trendsetting benefits now called “too rich” and “unsustainable” by some are being rolled back for new hires and blamed for soaring pension costs.

CalPERS, the SB 400 sponsor, told legislators the increased pensions would be paid for by a surplus, investment earnings and inflating pension fund assets, leaving state pension costs unchanged for a decade, said a legislative bill analysis.

A 17-page CalPERS brochure touting SB 400 that was distributed to legislators said in capital letters: “NO INCREASE OVER CURRENT EMPLOYER CONTRIBUTIONS IS NEEDED FOR THESE BENEFIT IMPROVEMENTS.”

The bill negotiated by public employee unions and the administration sailed through the Legislature in September 1999 during the last two days of the session, passing the Assembly 70-to-7 and the Senate 39-to-0 without questions or debate.

A report issued by the nonpartisan Legislative Analyst’s Office in December 1999 estimated the SB 400 pension increase would cost the state $420 million the first year. But CalPERS agreed to two actuarial changes lowering the net cost to $205 million.

CalPERS had used its actuarial power as leverage, agreeing to the cost-cutting changes only if pensions were increased. The worth of assets was increased from 90 to 95 percent of market value, and the amortization of excess assets was shortened.

“Coupled with the benefit increases, PERS agreed to change the two actuarial valuation methods discussed above, but only if the increases were adopted,” said the analyst’s report. “(PERS could have made these changes independent of the improved benefits.)”

Legislators also were not told of an accurate forecast made by CalPERS actuaries in 1999. If investment earnings hit the target, then 8.25 percent, the state payment a decade later in fiscal 2010-11 would be $679 million, similar to the 1988 payment.

But if earnings averaged 4.4 percent, the actuaries predicted that the state payment in fiscal 2010-11 would be $3.9 billion — almost precisely the amount expected before unions agreed to employee contribution increases lowering the current payment to $3.5 billion.

If legislators had been shown something like the sensitivity analysis recommended by the actuarial panel, would there have been some discussion of SB 400 in the Senate, possibly even opposition?

The public pension “disclosure” recommendations issued by the panel last month are the first step. The panel is working on a “model for actuarial polices and methods” that may be released for comment early next year.

A bill enacted last year, AB 1247, requires CalPERS to issue an annual report showing state pension contribution rates and liabilities if investment earnings miss the target, currently 7.75 percent, and are 2 percent above or 2 percent below.

Within 30 days of receiving the CalPERS report, the chairman of the actuarial panel (currently Alan Milligan, the CalPERS chief actuary) or someone named by the chairman is supposed to give a legislative hearing an analysis of the report.

But the panel would like to work with lawmakers on two concerns about the new law: targeting the work of another public agency actuary, which is outside the scope of the panel charter, and the ability of the panel to handle the additional workload.

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 23 Jan 12

39 Responses to “New pension forecasts: what if earnings falter?”

  1. Steven Robert Says:

    Coulda, woulda, shoulda…none of this matters, nor does a guessing game about the future. The closest thing we can do about predicting the future is to look at the past. If you do that, CalPERS and CalSTRS will be just fine and this type of Chicken Little, out-of-breath reporting would be replaced by accurate assessment of these funds. Cropping the picture to focus only on the recent economic downturn paints an inaccurate picture of the issues at hand.

  2. Tough Love Says:

    Two comments/observations:

    (1) Quoting …”A 17-page CalPERS brochure touting SB 400 that was distributed to legislators said in capital letters: “NO INCREASE OVER CURRENT EMPLOYER CONTRIBUTIONS IS NEEDED FOR THESE BENEFIT IMPROVEMENTS.”

    It is simply beyond pale that an HONEST organization could have done this without a safety-net provision (as part of the law) that ends the increase for future service if the predictions do not pan out.

    (2)Quoting ..”Coupled with the benefit increases, PERS agreed to change the two actuarial valuation methods discussed above, but only if the increases were adopted,” said the analyst’s report. “(PERS could have made these changes independent of the improved benefits.) Legislators also were not told of an accurate forecast made by CalPERS actuaries in 1999. If investment earnings hit the target, then 8.25 percent, the state payment a decade later in fiscal 2010-11 would be $679 million, similar to the 1988 payment.”

    The underhanded method of operation by CalPERS clearly shows that it cannot be trusted. It has morphed from it’s mandate to accurately administer Plan provisions and act as investment fiduciary to one of EMPLOYEE ADVOCATE, clearly an improper role.

    CalPERS management and Board must be thrown out and replaced by a Board responsive to TAXPAYERS interests as primary.

  3. Dr. Mark H. Shapiro Says:

    Good observation Seven. CalPERS has maintained an average return above the 7.75% projection for more than the past 25 years.

    As long as everyone, both employers and employees, make their pension contributions in good times as well as bad the pension funds will be just fine.

    They get in trouble when returns are high and the public agencies decide that they don’t need to contribute. But, recent changes in the laws should prevent that from happening again.

  4. spension Says:

    Really important missteps are discussed in this article… that Wilson tried to grab apparent `extra’ funds in the pension funds, and that SB 400 raised benefits due to mathematical incompetence of actuaries (and politicians, but every politician in human history has been mathematically incompetent).

    Solid careful work mathematical work need to underpin contributions and payout benefits in group pension funds. California messed up big time, and there is every reason to believe that the future will be very bleak for its pension funds and budgets.

  5. SeeSaw Says:

    No TL. There were Board Members in 1999, who were not totally clean, when it came being acceptable to being bribed, by former member and placement agent Villollobos. The Board CalPERS has now is completely clean, because measure have been taken to assure so. Of course, we are not going to throw them out!

  6. Tough Love Says:

    Sorry SeeSaw …. CURRENT Board members are WAY too beholden to the Public Sector Unions and member participants.

    The Board’s primary responsibility and obligation (beyond accurately administering Plan provisions and investing it’s assets as a fiduciary) should be to the TAXPAYERS.

  7. Ted Steele, Beat Framer Says:

    tl– how do you figure the fid duty is to the taxpayers first when the fund like any annuity is full of member investments???

  8. Tough Love Says:

    Ted, We both know that employEE contributions accumulated WITH all investment gains right through retirement RARELY pay for more than 10-20% of the their pension’s total cost.

    The balance is the responsibility of taxpayers via THEIR contributions any investment gains. Seems pretty clear CalPERS PRIMARY obligation should be to the Taxpayers.

  9. RexTheWonderDog Says:

    Just ignore TL – he is a jealous pension basher from sea to shining sea.

  10. Tough Love Says:

    So ….. is someone who finds it objectionable that with no less (than their Private Sector counterparts) in “cash pay”, Public sector workers get 2, 4, (even 6 for safety workers) times greater pensions, 80-90% at Taxpayer expense ….. really a “jealous pension basher”?

    No, not at all.

  11. Ted Steele, Beat Framer Says:

    TL– name any other pension/annuity that does not consider a fiduciary relationship between all investors and the board/managers…any……..

  12. Tough Love Says:

    Ted, The fiduciary relationship certainly extends to the protection of and appropriate investment of Plan assets, as well as to accurate record-keeping and administration of benefit formulas as written by legislators. CalPERS has these fiduciary obligations. However CalPERS should have no roll …. as most certainly has no fiduciary roll …. as one who advocates for better pensions for it’s members. That roll belongs (entirely) to legislative bodies.

  13. Ted Steele, Beat Framer Says:

    Love– the fiduciary you are trying to talk about is a “fiduciary relationship” which calpers certainly has with its investors– the primary relationship like in any annuity extends first to the beneficiaries;vis—-the annuitents….

  14. Tough Love Says:

    Ted, no matter how you spin it, CalPERS should not be advocating for better benefits for it’s participant members. This is without question an improper roll and clearly the consequence of it’s Union and Labor dominated Board.

    An article today discussing Fountain Valley’s hiring of a new Fire Chief (with their already passed new pension formula of 2%@50 for new hires) illustrates CalPERS interference in areas when it should have no roll. Clearly CalPERS is inappropriately resisting the new lower pension of 2%@50, perhaps because it will set a president for other towns to follow.

    Quoting from this article ……

    “City Manager Ray Kromer said the city’s preferred candidate, whose name hasn’t yet been released, is undergoing a background check and is in the final stages of the hiring process. But, Kromer said, the city hit a snag with California Public Employees Retirement System, which did not want to accept the city’s new rate of 2 percent at 50 years of age.”

  15. Ted Steele, Beat Framer Says:

    I see your point Love– but I don’t think calpers is advocating here. I think they are concerned about the overall wealth of the fund and how much who contributes and when etc.There may be some tech issues about the underlaying contract between the agency and CP re contribution and distribution rates and perhaps a non filing of new plan changes by the city etc— who knows????

  16. Tough Love Says:

    Quoting Ted …”I think they are concerned about the overall wealth of the fund and how much who contributes and when etc.”

    Well, if you’re suggesting that CalPERS is concerned that the lower level of contributions (associated with an equally lower pension formula, 2%50 vs 3%@50) will impact …”the overall wealth of the fund ” …. then you’re suggesting that the contributions of THIS employees are needed to pay the benefits of those that preceded him.

    Now that logic sounds an awful lot like a Ponzi scheme, doesn’t it ?

  17. Ted Steele, Beat Framer Says:

    Lover— lol like a ponzi scheme??— not at all! LOL— I have cleared that up on many prior posts– but— you’re civil– so I’ll do it again…(this is why these boards are such a waste of time!)

    “ponzi” schemes are a technical term of art for a particular type of fraud that as you know requires pay out from the new fish paying in….but that’s not all— It also requires in every single US jurisdiction a “specific intent” to defraud.

    I have tried a few of these before juries amigo– this aint close! Civilians, so to speak, like yourself…sadly and our Gov….use the term in an ignorant manner. Madoff and Ponzi went to prison for fraud. Fraud requires a specific intent like all gneric theft cases. Have a nice day!

  18. Tough Love Says:

    Ok, perhaps “Ponzi” is not technically correct. But, I think you get my point, that being that CalPERS shouldn’t and must not count on contributions from new employees in order to be able to fund the pensions of those already employed.

    The contribution level establish for the new employee (both the employee and employer share) are set to cover that person’s expected pension costs. No part of those contributions are expected to be available to cover funding shortfalls associated with prior workers.

    To the extend that CalPERS objection to the lower 2%@50 formula for Fountain Valley’s new Fire Chief is based on the need for those contributions for any purpose other than funding that person’s pension, CalPERS is in deep trouble and running a very deceptive operation bound to fail at some point.

  19. Ted Says:

    Deceptive? Huh? Calpers methodologies are well published, vetted, legislatively created, and well within the scope of all other known pensions……deceptive? Huh? If that’s deception I guess they are very bad at deception. These comment sections are mindless.

  20. Tough Love Says:

    Ted, I think this one has run it’s course. Good Night.

  21. spension Says:

    Contributions from existing employees not yet retired reduce *risk*, that is, they make the worst case situation less bad than it otherwise would have been.

    Carefully planned defined benefit systems don’t assume the most likely value for investment returns… they base their contributions and payouts on a worst case scenario.

    If you take a way the ongoing contributions from existing employees, the worst case gets worse, and either more contributions are needed or benefits must be reduced. That is in no way a Ponzi scheme, but simply good planning.

    The most risky situation of all is the 401(k)/403(b)/457 situation, where there is just one person making contributions, usually for two pensioners (contributor + spouse). That is why DC plans are way more expensive than DB plans… the worst case analysis is far, far worse in the DC than in a DB plan, for the same benefits.

    Of course the CalXXXX system neglected `worst case’ and did planning based on the most likely value for returns… so they guaranteed way, way more benefits than they ever should have guaranteed. And I guess that is a different form of risk… innumeracy of the actuaries. But the masses who have DC plans are even more innumerate… most retirees need something like $800,000 in the DC plans at age 65, and only have only saved $50,000 or $100,000.

  22. Captain Says:

    “Steven Robert Says:
    January 23, 2012 at 4:14 pm
    Coulda, woulda, shoulda…none of this matters, nor does a guessing game about the future. The closest thing we can do about predicting the future is to look at the past. If you do that, CalPERS and CalSTRS will be just fine and this type of Chicken Little, out-of-breath reporting would be replaced by accurate assessment of these funds. Cropping the picture to focus only on the recent economic downturn paints an inaccurate picture of the issues at hand.”

    Good one! I’m looking at the past 12 months of 1.1% returns for CalPERS and 2.3% returns for CalSTRS, which are both significantly below the 12-13% both need to return just to stop the bleeding. Looking at the 10 year returns of about 4.3% both agencies fall well short. Going back 20 years, according to CalPERS, average returns of 8.3% sounds good on the surface but….

    The problem with the 8.3% return number, which only sounds good to those not paying attention, is that unhjfunded liabilities have grown during that same time frame when would expect them to decrease, even though tax payer contributions have increased dramatically.

  23. Captain Says:

    “Ted Steele, Beat Framer Says:
    tl– how do you figure the fid duty is to the taxpayers first when the fund like any annuity is full of member investments???”

    Hard to believe you can even ask that question. The entitlement mentality contained in that question, and all of your arguments really, is both disturbing and part of the problem.

  24. Captain Says:

    “Ted Says:
    Deceptive? Huh? Calpers methodologies are well published, vetted, legislatively created, and well within the scope of all other known pensions……deceptive? Huh? If that’s deception I guess they are very bad at deception. These comment sections are mindless.”

    CalPERS methodologies are…”vetted”…of course they are(?)…”and well within the scope of all known pensions”…sure, what planet do you live on?…”if that is deception I guess they are very bad at deception”… people are starting to wake up and are just beginning to understand the harm this organization is causing our state…. but like the common criminal/loan shark facing mountains of evidence – they deny, deny, deny, which seems to be the same motto you fully embrace.

  25. Ted Steele, Beat Framer Says:

    lol wow—– Cappy— entitlement? Huh?

    Let’s see– YOU hired these workers. YOU contracted with them to do a job for 30 years. YOU promised them this compensation. They did all the work. Now YOU want to back out of the contract.

    LOL Entitlement?

  26. Ted Steele, Beat Framer Says:

    Cappy— and on the fiduciary question…… Are you telling me that the calpers bod does NOT have a fiduciary relationship with the investors/annuitents? Seriously?

  27. Captain Says:

    “Ted Steele, Beat Framer Says:
    Cappy— and on the fiduciary question…… Are you telling me that the calpers bod does NOT have a fiduciary relationship with the investors/annuitents? Seriously?”

    They (CalPERS/CalPERS B.O.D.) clearly have an incestuous relationship with the annuitants. Not so much with the tax paying investors, aka – the golden goose in union dominated CalPERS B.O.D. terms.

    Seriously!

  28. Captain Says:

    Ted Steele, Beat Framer Says:
    lol wow—– Cappy— entitlement? Huh?

    Let’s see– YOU hired these workers. YOU contracted with them to do a job for 30 years. YOU promised them this compensation. They did all the work. Now YOU want to back out of the contract.

    LOL Entitlement?”

    At the risk of giving you too much to contemplate at one time, have you considered that contracts are modified or deemed invalid happens on a daily basis in this country? If you listened to the OBAMA State of the Union Address, you might have heard him tell the banking industry that they should modify loans for anyone that is current on payments – regardless of their credit standing. While I think that proposal makes sense – it is a modification of a contract. What makes you think your contract is so special?

    It seems to me that loan modification just may benefit the true middle class, as will modifying bloated CA City, county and state government pensions.

    What do you think, Teddy?

  29. Ted Says:

    Capper— Oh my gosh– I’d have to give you a contracts one and the second semester of contracts two to correct all that is unknown to you about contracts. Sorry.

    Modification requires two parties. Contemplate that– I’ll give you more later!

  30. Captain Says:

    “Ted Says:
    Capper— Oh my gosh– I’d have to give you a contracts one and the second semester of contracts two to correct all that is unknown to you about contracts. Sorry.

    Modification requires two parties. Contemplate that– I’ll give you more later!”

    Is avoidance your only response? You haven’t even challenged the content of this article. I guess it’s just easier for you to pick and choose a random sentence from a post, provide a semblance of an argument, and claim your superiority. You might impress yourself – but that’s probably about the extent of your impression.

    Why was the current CIO asked to make his public comments more positive? Who asked him to do that? Who controls the hiring,firing, reviews, and compensation increases of the CalPERS CEO? Who controls the B.O.D’s? Can you answer those questions?

  31. Tough Love Says:

    Quoting Captain …(re: Ted): …”I guess it’s just easier for you to pick and choose a random sentence from a post, provide a semblance of an argument, and claim your superiority.”

    I noticed that as well …. Ted’s not really big on truly responding to “issue” at hand.

  32. Captain Says:

    “Tough Love Says: Quoting Captain …(re: Ted): …”I guess it’s just easier for you to pick and choose a random sentence from a post, provide a semblance of an argument, and claim your superiority.”

    I noticed that as well …. Ted’s not really big on truly responding to “issue” at hand.”

    Ted doesn’t have much to say about anything. Just the same tired robotic response.

  33. The Gigantic Ted Says:

    I love how you fellows like to throw around legal terms and then pretend that your definition has some real meaning. YOU threw out the term “modification” Cappy, not me. It was the cornerstone of your thesis. It has a meaning. It requires two parties to engage in a mutual exchange of consideration and bargained for promise. I am sorry that you like to live in a world that you make up. Is it cozy all up in there?

  34. Encinitas Cletus Says:

    If 7.75% were a realistic rate of return, anyone would be able to buy immediate annuities that pay more than that (because the insurance company stops paying and keeps your principal when you die, so they can offer a higher rate while you’re alive).

    Plug in a 40-year-old female (youngest/healthiest option available) into this annuity calculator and you’ll get an annual payment of 4.5% — meaning the market is saying long-term returns will be even less than that!

    Yet the politicians have put taxpayers in the position of guaranteeing 7.75% returns.

    We are so screwed.

  35. B. Gary Says:

    At the market’s lowest point in 2008, CalPERS assets had dropped by $100 billion. Today CalPERS has regained $70 billion and in September, its market value of assets is $235 billion. In the last 24 years, CalPERS has had 20 years of positive returns, 16 of which were 10 percent or greater.

  36. Tough Love Says:

    No Encinitas Cletus, Says, the WORKERS are screwed, because the Taxpayers won’t pay.

    The WORKERS should expect expect a 50-75% haircut on their pensions.

  37. SeeSaw Says:

    I think you get a bill with interest added, if you don’t pay your taxes, TL.

  38. SeeSaw Says:

    Medical Insurance premiums already take 32% of my pension, TL–you just want mine voided. I don’t think that will happen.

  39. Emotional Says:

    I clicked on this Google link to my inquiry as to whether CalPERS pensions were guaranteed. Nothing here informs me on my question, but I am sure that with the opinions voiced here that perhaps one or more of you may know. If I were a CalPERS pensioner, would I be guaranteed a fixed annual payment (in whole dollars) with or without a COLA?

    If the answer is yes, that is where my heartburn begins. I understand that this is may be a contractual obligation that my elected officials signed me up for (and I will live with that), but if CalPERS refuses to modify the agreement in light of unanticipated economic downturns such as the current recession, and if CalPERS refuses to assume the same market driven risks (losses and gains) that non-pensioners must, then they also must assume the mantle of GREEDY. Someone hast to pay, and CalPERS is asking those who have lost the most in these downturns to pay more. That is staggering.

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