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