Archive for February, 2012

Proposed budget shows lower CalPERS payment

February 21, 2012

Under the new budget proposed by Gov. Brown, the annual state payment to CalPERS drops from $3.5 billion this year to $3.1 billion in the new fiscal year.

The payment falls, at a time most pension costs are rising, because a $404 million payment to CalPERS for California State University pensions is shifted from the state budget to CSU.

The change is part of a proposal that could freeze state support for CSU and UC pensions. The nonpartisan Legislative Analyst’s Office said CSU would be faced with a potential burden “out of proportion” to its limited ability to control future pension costs.

“For this reason, we recommend that the Legislature reject the governor’s approach,” the analyst said in a report this month.

The governor’s plan to shift some of the unpredictable future pension risk out of the state budget, where the general fund has been running huge deficits for a decade, could play a role in the debate over public pensions.

Next month CalPERS will look again at changing its earnings forecast. The board rejected actuarial advice last year to lower the forecast from 7.75 percent to 7.5 percent, which would have increased the state CalPERS payment by an estimated $400 million.

An increase from a lower earnings forecast and a decrease from the CSU accounting shift could offset each other. Barring other changes, the state CalPERS payment might remain roughly the same as this year.

The heart of the pension debate is whether soaring pension costs, driven by overly generous benefits and massive investment losses in a deep recession, will divert too much money from basic government services.

Recent increases in the state CalPERS payment have been gradual, going from $3.3 billion last year to $3.5 billion this year. CalPERS adopted a “smoothing” policy in 2005 that spreads gains and losses over 15 years, far beyond the usual three to five years.

When the CalPERS investment fund plunged from about $260 billion to $160 billion before rebounding to $235 billion last week, the heaviest losses during a stock market-crash year were given special actuarial treatment to avoid a sharp rate increase.

A state CalPERS payment once projected to be $3.9 billion this fiscal year was reduced to $3.5 billion after state worker unions agreed to increase employee pension contributions, most going from 5 percent of pay to 8 percent.

The Legislative Analyst said state savings from increased employee pension contributions will be largely offset by pay raises at the end of the labor contracts. But the strain on the state budget is eased during a time of deep spending cuts.

Importantly for the pension debate, CalPERS also has avoided a sharp rate increase that can be cited by advocates of sweeping structural pension reform, such as switching new hires to a 401(k)-style investment plan now common in the private sector.

Now if the governor’s budget proposal is adopted and the earnings forecast is lowered, the state payment to the California Public Employees Retirement System might show little change or a much smaller increase.

The payment amount would depend on how much of the increased payment from the lower forecast is offset by the shift of $404 million from the state budget to CSU.

The CalPERS chief actuary, Alan Milligan, told the board last week that a decision to lower the earnings forecast would increase state CalPERS payments in the new fiscal year beginning in July.

“This is something that could have a very significant impact, and we want to make certain that any review of this assumption is done in the full light of day and with lead time and notice to stakeholders,” he said.

When lowering the earnings forecast was discussed last year, Milligan said, a drop from 7.75 to 7.5 percent would have increased state CalPERS payments by 2 to 3 percent of pay for miscellaneous workers and 4 to 5 percent for of pay for police and firefighters.

The state budget proposed by Brown last year wrongly assumed the CalPERS board would lower its earnings forecast. His Department of Finance estimated that a drop of one quarter of one percent would increase the state CalPERS payment about $400 million.

The CalPERS actuaries also will take a new look at price inflation and wage inflation. Though unlikely, a decrease in the wage inflation forecast could lower the state CalPERS payment.

“I doubt very much that I will be recommending a decrease,” Milligan said of the wage inflation forecast. “At this time I have not finalized my recommendation. So I don’t know exactly what I’m going to be recommending to the board.”

CalSTRS followed the advice of actuaries this month, lowering its earnings forecast from 7.75 to 7.5 percent. Like CalPERS, CalSTRS had previously rejected the recommendation of actuaries, lowering the forecast from 8 to 7.75 percent instead of to 7.5 percent.

The change of a quarter of one percent is estimated to add $500 million to the annual increase in contributions CalSTRS previously needed to reach full funding in 30 years, $4 billion a year.

Unlike CalPERS, the California State Teachers Retirement System lacks the power to increase annual pension contributions that must be made by government employers, needing legislation instead.

Legislative approval of a $4.5 billion increase in annual payments — nearly doubling the current payment of about $5.3 billion from schools, teachers and the state — is not realistic, particularly at a time of deep cuts in education spending.

Funding scenarios prepared by CalSTRS for the Legislature to discuss do not begin phasing in new funding until 2016. Five of six scenarios, never reaching full funding, are projected to have funding levels after 75 years ranging from 32 to 14 percent.

But the funding scenarios do keep CalSTRS from running out of money for most of this century and reverting to pay-as-you-go funding, with no revenue from investment earnings.

Before CalSTRS lowered its earnings forecast, actuaries had projected that CalSTRS could run out of money around 2044 if contributions are not increased. Bad as the funding problem portrayed by CalSTRS may seem, some say it is worse.

Citing a number of economic experts, critics contend a 7.5 percent earnings forecast is still too optimistic and unlikely to be achieved. If even a small change in the earnings forecast can result in a significant funding gap, a big change opens an abyss.

Stanford graduate students issued a study two years ago showing how the unfunded liability of the three state pension funds (CalPERS, CalSTRS and UC Retirement) ballooned if a lower earnings forecast is used.

The students used a risk-free bond earning rate, 4.1 percent, arguing that some economists say that is the proper way to measure risk-free pension debt guaranteed by the taxpayers.

The three state pension funds, using earning forecasts of 7.5 to 8 percent based on their diversified investments, were reporting a combined unfunded liability of $55 billion. The lower Stanford forecast pushed the debt to about $500 billion.

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 21 Feb 12


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