CalPERS warns of rate hike

CalPERS thought it had found the sweet spot four years ago — a way to avoid big pension cost increases that could trigger a backlash against generous benefits for state and local government employees.

But how do you plan for an historic stock market crash?

Nearly a third of the value of the California Public Employees Retirement System investment portfolio was wiped out by last fall, possibly leaving the big fund far short of the money needed to pay projected retirement costs in the decades ahead.

So CalPERS warned that the annual pension contribution that must be paid by state and local governments could increase by nearly a third — starting July 1, 2010, for the state and schools and July 1, 2011, for local government agencies

It’s exactly what wasn’t  supposed to happen when CalPERS adopted an unusual “smoothing” policy in 2005 that changed the three-year period for calculating investment gains and losses to 15 years, well beyond the average for most pension funds.

“This plan will help end the whiplash employers experience when contribution rates dramatically increase and decrease year to year,” the CalPERS board president, Rob Feckner, said in a news release.

Now CalPERS is waiting to see what  happens to the value of its investment portfolio by the end of the current fiscal year, June 30, the period that will be used to calculate a new contribution rate.

The average CalPERS contribution rate paid by state and local governments is currently about 13 percent of payroll.

If the investment loss is 20 percent for the full fiscal year, CalPERS estimates that contribution rates could be increased by 2 to 5 percent of payroll. If the loss is more than 20 percent, the increase would be even higher.

On the other hand, if the stock market recovers by July and losses shrink, the rate increase could be much smaller. For example, if the investment loss is 10 percent, the CalPERS contribution rates might only go up 0.2 to 0.5 percent of payroll.

The CalPERS investment portfolio, peaking at $260 billion in 2007, had dropped to $180 billion by early last month, a loss of about 31 percent. But only 20 percent of the loss was in the current fiscal year,  the period to be used for the next rate calculation.

As CalPERS waits for its fiscal year-end damage report, the health of all pension funds after the stock market crash is a hot topic. The cover story of the February issue of Reason magazine, “The Next Catrastrophe,” sketches an alarmist scenario.

The article by Jon Entine argues that “state, local and private pension plans covering millions of government employees and union workers” are “teetering on the brink of implosion” because of the crash and politically driven investments.

A consulting firm, Mercer, reported last week that the pension funds of 1,500 large corporations in a Standard & Poor’s index were underfunded by $409 billion at the end of last year, a dramatic crash-driven change from a $60 billion surplus in 2007.

Mercer said the pension expenses of the corporations are expected to jump from $10 billion last year to $70 billion this year — a seven-fold increase far beyond what CalPERS is warning of now.

But it was amid controversy over soaring contribution rates that the CalPERS board adopted the new smoothing policy in March 2005. The state’s annual pension payment to CalPERS had reached $2.6 billion, up from $160 million five years earlier.

CalPERS said the new smoothing policy was adopted because member agencies wanted more predictable contribution rates, with gradual changes. But the “whiplash” from big rate changes also was causing political problems.

Gov. Arnold Schwarzenegger cited the need to control runaway pension costs as he backed a proposed initiative that would give new state and local government workers a 401(k)-style investment retirement plan, rather than guaranteed monthly payments.

Schwarzenegger, in April 2005, dropped his support for the initiative, which opponents said would eliminate death and disability benefits. Yet the issue of pension reform lives on.

In what has become a common complaint, critics said much of the run up in state pension costs was caused by an overly generous  pension increase signed by former Gov. Gray Davis in 1999 at the urging of politically powerful public employee unions.

The legislation signed by Davis, the first Democratic governor in 16 years, undermined a cost-cutting reform backed by former Republican Gov. Pete Wilson that lowered pension benefits for most new state workers.

Still, the nonpartisan Legislative Analyst estimated that about $600 million of the increased state costs resulted from the benefit increase. Most of the increase was said to be due to sagging investment returns from the giant CalPERS investment portfolio.

Big investment gains during the high-tech boom of the late 1990s allowed employer pension contributions to drop, in some cases all the way to zero. But when the stock market weakened, contribution rates went up to cover the gap.

The CalPERS in-house actuarial staff had told lawmakers that the 1999 benefit increase would not require higher contributions. The miscalculation put the CalPERS power over public purse strings in the spotlight for the second time in a decade.

Legislation pushed by Wilson in 1991 shifted control of the actuaries from CalPERS to the Legislature and governor — part of a move, overturned by the courts, to use a $1.8 billion CalPERS “surplus” to help balance the state budget.

Public employee unions struck back with Proposition 162, approved by 51 percent of the voters in 1992. The measure returned control over the actuaries to CalPERS along with authority over investment decisions and administration of the pension system.

Actuaries, wielding great power, make the financial and demographic estimates about revenue needed to meet future pension obligations. For example, CalPERS assumes investment yields will average 7.75 percent a year over the next several decades.

A drop of a percentage point or two in the assumed annual investment yield could create the need for a major contribution increase. Assuming a higher annual investment yield could do the opposite, lowering the contribution rate.

The smoothing policy adopted by CalPERS in 2005 attempted to allow for big market swings by giving actuaries more wiggle room — an expansion of the “corridor” for evaluating the market value of assets from 10 percent to 20 percent.

A CalPERS spokesman, Edd Fong, said it’s still possible that the smoothing policy, despite the historic stock market plunge, may help avoid a major contribution rate increase, if the market recovers enough of the losses by June 30.

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 12 Jan 09

9 Responses to “CalPERS warns of rate hike”

  1. Jeff Says:

    A smoothing policy delays the contribution requirement impacts of changes in portfolio value. This has the advantage of reducing wide contribution swings tied to temporary swings in value. But it also delays the necessary changes in contributions required of more permanent swings in value. If we have had an asset bubble, then the long-term value of financial assets would by definition have been overpriced.

    Of course this all begs the question of what the relationship between government employees and rest of society ought to be. What moral philosophy suggests that government employees ought to have retirements vastly better than those who have to pay for them? Once liberalism embraced the thinking of John Rawls. Now it is but bastion of interest-group corruption. The Dills Act should be recognized as the pivotal moment in the downward spiral of this state. Government unions are labor trusts that operate in a monopoly with a corrupt relationship with politicians to boot.

  2. Dr. Mark H. Shapiro Says:

    While CalPERS investments have suffered over the past year, they actually have done much better than most investment funds. 401Ks are now 101Ks, and as you note in the article most private pension funds are worse off.

    Government worker pensions, in general, are not that lavish. Most government workers trade lower salaries during their working years for more pension security in retirement. Unfortunately, corporate greed over the past two decades has decimated retirement security for private sector workers. The problem is not that public pensions have gotten all that better, but that private pensions have gotten immeasurably worse.

  3. Robert Schussel PhD Says:

    Dr Sharpiro

    Without overtime Patrol Officiers and Firefighters ( lowest grade rank) average $110K per year without overtime. They also get FREE health insurance ,3@30,5 weeks vacation after 12 years ,a 22% raise over the first 25 months in a new position etc.

    Vallejo is Bankrupt due to the incompetent City Councils who were endorsed by the Unions that got all of the excesses in the MOUs.

    Please go to http://www.IBVallejo.com and read all of the analyses about the excesses in the contract and how the large unfunded liability from Health Insurance and Pensions are unsutainable. Then tell me they the benefits aren’t lavish

  4. Kurt Hahn Says:

    Those interest groups representing CalPERS retirees and unions representing those who will receive pensions in the future should pay far more attention than they have to CalPERS investments.

    Many investments in the past (and possibly some more recently) have been politically driven which is wrong. Some were in very risky real estate ventures. Other investment actions were driven by political correctness. All violated their fudiciary respobsibily to us.

    These actions plus what we all have otherwise experienced in the market contributed to unprecidented losses last year.

    The CalPERS Board needs to provide new direction to it’s recently hired Investment Officer.

    The CalPERS Board must also pay careful attention to how it is to fund it’s very large unfunded liability for State retiree health benefits something that seems have have been forgotten during the current budget fiasco.

  5. Rich Rifkin Says:

    “CalPERS warned that the annual pension contribution that must be paid by state and local governments could increase by nearly a third — starting July 1, 2010, for the state and schools and July 1, 2011, for local government agencies. … If the investment loss is 20 percent for the full fiscal year, CalPERS estimates that contribution rates could be increased by 2 to 5 percent of payroll. If the loss is more than 20 percent, the increase would be even higher.”

    Ed,

    Since you posted this piece, the markets have fallen much further. If nothing changes between now (3-3) and July 1st, how much will the rates increase in 2011?

  6. S H Dietrich Says:

    While the loss in asset value is obvious to all, there is little attention paid to the Calpers assumption that their yield will be 7%. As others have noted, the market has fallen considerably since the analysis was released, making greater contributions likely.

    Calpers is also learning the brutality of front end investing in real estate projects, especially those with a “social” purpose or politically guided.

  7. Kurt Hahn Says:

    CalPERS should demand changes to Obama Healthcare Reform.

    While CalPERS has long supported a Single Payer Plan the current House Plan would over time distroy it excellent mix of health insurance options

    First broadening the health insurance premium subsidy of increasing numbers of Medical enrollees will be costly and drive up our premiums. In addition by emposing the Exchange based Public Plan with a requiement that the government negotate with providors rates near Medical are which are 15-20% below actual costs our CalPERS health insurance premiums will increase further to make up the difference.

    CalPERS health benefits are among the best in the country and most CalPERS enrollees especially those retired are very happy with what they have. We face losing this excellent coverage as enrolles are faced with increasing cost shifting and higher premiums for existing coverage as people move to the public plan.

    CalPERS enrollees should contact their Congress memberr and clearly state don’t mess with us. Drop the Public Plan.

  8. Kurt Hahn Says:

    SENATE FINANCE COMMMITTEEE BAUCUS MARK_UP WILL TAX SOME CALPERS PPO OPTIONS

    Where are those running for the CalPERS Board when it comes to the Obamacare debate. Now we see that the tax provisions of Senator Baucus markup would extend the defination of gold plated plans to some CalPERS PPO plans and apprarently some sponsored by the Central Valley Trust and LA Schools Trust for Teachers.

    RETIREES AND OTHER CALPERS ENROLLEES BETTER GET ON THE PHONE TO SENATORS FEINSTEIN AND BOXER TODAY OR WE WILLL END END BEING TAXED

  9. » California’s HELOC economy » 949.769.1599 Says:

    […] and even worse cutbacks in 2010-11 if their projections are too optimistic, and they get hit with substantial increases in PERS contributions that […]

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