CalPERS ‘smoothing’ eases employer rate shock

CalPERS is planning a two-year phase in of a rate increase resulting from a lower earnings forecast adopted yesterday, continuing a “smoothing” policy that softens the impact of rising pension costs on deficit-ridden state and local government budgets.

Lowering the investment earnings forecast from 7.75 to 7.5 percent is expected to increase the annual state payment to CalPERS by $303 million, pushing the total to $3.8 billion.

Critics contend CalPERS and other public pension funds use overly optimistic earnings forecasts to “discount” or reduce future pension debt, concealing a massive “unfunded liability” and the urgent need for cost-cutting reforms.

But CalPERS says its earnings averaged more than the 7.75 percent target over the last two decades. The new forecast stays the course and does not change the basic average investments are expected to earn, 4.75 percent.

What the board lowered is the forecast for 3 percent price inflation, which when added to the basic 4.75 percent return totaled 7.75 percent. The new inflation forecast of 2.75 percent drops the total earnings forecast to 7.5 percent.

“Your proposal is driven by an inflation assumption that I just don’t buy,” board member J.J. Jelincic told chief actuary Alan Milligan at a committee hearing. “I do admire your courage for bringing it forward.”

Jelincic, the apparent lone “no” in a board voice vote, argued that the U.S. Federal Reserve and central banks in other countries have “flooded” their economies with money, a stimulus likely to lead to inflation.

Milligan said a hired consulting firm, GRS of Texas, recommended lowering the inflation forecast to 2.75 percent. The board rejected Milligan’s recommendation to drop the total forecast to 7.25 percent to provide a cushion or “margin for adverse deviation.”

One of the 1,573 local governments who have 2,044 separate California Public Employees Retirement System plans urged the CalPERS board to pick the high end of the GRS inflation forecast range, 2.5 to 3 percent, and avoid a rate increase.

The Santa Clara County benefits director, Peter Ng, said that after 10 years of county deficits, and closing a $220 million gap this year, the proposed rate hike would create a roughly $34 million shortfall just as county finances seem to be stabilizing.

The Sacramento Metropolitan Fire chief, Kurt Henke, told the board his agency closed six of 42 fire stations, cut the budget from $159 million to $132 million and obtained $28 million in labor concessions.

Henke said the proposed rate increase would cost his agency $2 million to $2.5 million, adding to an expected loss of $6 million in revenue as Sacramento area property values continue to drop. He made a passionate plea for a two-year phase in.

“You have a lot of local agencies that are on the verge of economic hardship and or bankruptcy, and to implement this in one fell swoop would push a lot of those entities over the edge,” Henke said.

Because personnel is a big part of most local government budgets, sometimes 80 percent or more, the pension rate hike has a big impact. Local pension costs for miscellaneous workers go up 1 to 2 percent of payroll, safety workers 2 to 3 percent.

For the state, pensions are a smaller part of the budget. Of the $303 million CalPERS increase for state workers, $167 million is from the deficit-ridden general fund that spends on schools, prisons, higher education, health, welfare and other programs.

Gov. Brown proposed a $92.6 billion general fund for the new fiscal year beginning in July, with an estimated $9.2 billion deficit that includes a shortfall carried over from the current year.

The proposal has a $1.8 billion general fund payment to CalPERS. The rest of the $3.5 billion CalPERS payment ($400 million would be shifted to CSU for the first time) is from special funds such as transportation that have a total budget of $39.8 billion.

With the $303 million CalPERS rate hike, state retirement costs would be roughly $7.5 billion next fiscal year:

CalPERS $3.8 billion, California State Teachers Retirement System $1.3 billion, retiree health $1.7 billion, and (2010-11 data) Social Security $500 million and Medicare $240 million.

Usually, the $303 million CalPERS state increase and a $137 million hike for non-teaching school employees would begin next July. The local government increase would not begin until a year later due to calculation time needed for 2,044 separate plans.

But as part of a motion by board member George Diehr supported during public comment by three representatives of the Service Employees International Union, Milligan was directed to prepare plans to phase in the increases over two years.

CalPERS previously adopted several polices that helped “smooth” the rate impact from massive investment losses. The CalPERS investment fund peaked at $260 billion in the fall of 2007, fell to $160 billion in March 2009 and is now about $236 billion.

In 2005, the rate impact of investment gains and losses were spread over a 15-year period, well beyond the typical three to five years. As a limit, the actuarial value of assets were not to exceed a “corridor” of 20 percent above or below their market value.

In 2009, the heaviest losses were isolated and amortized over 30 years with a rate increase phased in over three years. The corridor was expanded to 40 percent one year, 30 percent the next before dropping back to 20 percent from market value.

The smoothing policies are part of the reason the state CalPERS payment, $3 billion in fiscal 2008-09, had only increased to $3.5 billion this year. Another reason is union contracts that increased most worker CalPERS contributions by 3 percent of pay.

But delaying employer rate hikes has helped lower the CalPERS funding level. As of June of last year, the average CalPERS plan had roughly 74 percent of the projected assets needed to pay pensions promised in future decades to current workers and retirees.

Delaying rate hikes also uses up smoothing possibilities, making it more difficult to avoid a sharp rate increase if a sagging economy or stock market crash punches another big hole in investment funds expected to pay for two-thirds of future pensions.

A delay in rate hikes can increase future costs. Some unfunded liability payments are said to be less than the interest on the debt. And there is a moral issue, if a rate delay forces future generations to pay for pensions earned for services to the current generation.

As CalPERS considered the smoothing policy in June 2009, former Gov. Arnold Schwarzenegger complained that delaying a major rate hike was “using our kids’ money” to gamble that investment earnings will grow faster than pension obligations.

“Our pension system needs reform,” Schwarzenegger said, “and without meaningful and sustainable pension reforms that reduce future costs, the state should decline to participate in any effort to shift more costs to our children.”

His administration sought a $1.2 billion rate increase, pushing the state CalPERS payment to $4.2 billion and a funding level of 80 percent. As pensions faded among other state budget pressures, CalPERS adopted a $200 million increase for 60 percent funding.

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 15 Mar 12

8 Responses to “CalPERS ‘smoothing’ eases employer rate shock”

  1. Ted Steele, Poodle fixer Says:

    smoothing is good.

    They complain the rate was too high and now watch the doom sayers complain about the lowering!

    I have to laugh.

    Take it away troll!

  2. Captain Says:

    An elongated 15 year smoothing policy, expanded corridors, 30 year amortization, reduced retirement ages, pensions that replace more than the 65-75 percent retirement experts claim you need post employment, adding a full menu of “optional benefits” to contracts, compensation rising faster than inflation, adopting the lower end of the actuaries 25- 50 basis point recommendation, and then smoothing that over two years – maybe it’s not the payments that are the problem.

    Maybe we just can’t afford the CalPERS 1999 Cadillac SB400, with or without all the options. That would help explain the need for what amounts to cash-out refinancing of the home equity to pay off the car thereby spreading what was once payment terms on a three year loan (smoothing) over 15-30 years. If you need to do that you probably couldn’t afford the luxury vehicle in the first place. Time to quit providing plans that pay more than 60%.

    “As of June of last year, the average CalPERS plan had roughly 74 percent of the projected assets needed to pay pensions promised in future decades to current workers and retirees.”

    As of March 12, 2012, the Market Value funding ratio is about 68.5%.

    On the bright side, I guess CalPERS has 50-50 chance of meeting their new target rate of return – I’ll take heads! On the down side….

    Excellent article Mr. Mendel!

  3. spension Says:

    Stock market returns have a lot of variability… a 20 year record of 7.75% is not at all grounds to assume that rate in long term. A much better strategy is to plan for the unlucky fluctuation that might happen over 20 or 30 years… that is 3% or so. Then, don’t assume a 20 year run on the up side is due to `this time is different’ or due to the cleverness of the pension managers… assume it is just randomness. So a few up years should *never* be used as an argument to reduce contributions, which is what the current pension plans due.

  4. gery katona Says:

    I go along with the Captians comments here. The Governor has stated he wants a sustainable pension system that is fair for both employees and taxpayers. Don’t we all. I will never vote for a tax increase until the pension system is reformed and nor should anybody else. A tax increase will just cover up the problem, not solve it.

  5. Ted Steele,-- it's so cozy up here in poodle's tiny head! Says:

    Reform is comming. The temporary tax increase is comming.

  6. john moore Says:

    If CalPERS was 100% funded as of April 1, 2012, how much would the fund have?

  7. Ted Steele, Poodle fixer Says:

    lol John– great question. Someone out here will answer it but of course based on some fuzzy fuzzy math! Go look at your mortgage and see how much P and I will occur before you get the title! —-and of course you’re not worried about that are you John!— Enjoy the answers! I know I will ! — Teddy

  8. Captain Says:

    Hey John Moore, “the pig man”, I think you’ll understand the friendly reference as you read on (although others wont):

    “Vallejo’s budget on track this year, but facing future structural deficits

    http://www.timesheraldonline.com/ci_20169846/

    Overall, Vallejo’s budget was looking good at the mid-year point, the city’s finance director said in an update Tuesday.

    However, by next year, the city may face a “structural deficit” of nearly $6.7 million if the city does nothing to avoid it, Finance Director Deborah Lauchner told the Vallejo City Council. That type of deficit could be offset by city reserves and “one-time funds,” as opposed to more consistent revenue, however.

    Councilwoman Stephanie Gomes expressed disappointment that the city was facing a structural deficit now, as it did when it entered bankruptcy in May 2008. She acknowledged, however, that Vallejo is not alone in that problem.

    “I just want to make it really clear that this budget, while we’re balanced right now … it’s a very tenuous balance,” Gomes said, pointing to increasing expenditures for county animal shelter services and the continuing high percentage that employee labor costs represent in the city budget.

    Lauchner and Councilwoman Marti Brown discussed the fact that Vallejo’s 5-year business plan, approved as a spending blueprint in bankruptcy court, projected that it would take years before the city stood fully on its own two feet, without annual overspending. The city’s reserve fund is up to 9.4 percent of city spending, ahead of the projected 5 percent spending reserve goal to be reached by 2016.

    City Manager Dan Keen, in his first Vallejo council meeting, urged caution.

    “I think it’s important to remember that much of that growth in reserves is the result of one-time funds,” Keen said, referring to vacant city staffing positions that were budgeted for, but not filled. “That structural deficit is still there. Until we solve that structural problem, it’s still a pretty serious problem.”

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