CalPERS responds: reports to show earnings risk

CalPERS will begin showing state and local governments how much their costs will go up if investment earnings fall short, a risk critics say has been concealed in the past.

The giant public pension fund told legislators that a major benefit increase for state workers a decade ago, SB 400 in 1999, could be paid for with investment earnings, leaving state costs unchanged for a decade.

What legislators weren’t told was that CalPERS actuaries had made a remarkably accurate forecast of what could happen if earnings fell short — annual state costs that had been $160 million in 2000 could soar to $3.9 billion by 2010.

Unfortunately, that’s almost precisely what happened as earnings sagged during the past decade, then plunged in a historic stock market crash two years ago.

Now the giant California Public Employees Retirement System, responding to criticism, is changing the annual reports given to the state and the 3,000 local governments and school districts in the system.

Actuaries told the CalPERS board this week that the annual valuation report to government employers will be expanded with an “investment return sensitivity analysis” that shows five scenarios.

In addition to the usual forecast, two scenarios will show what happens to the employer’s cost if the earnings are a little or a lot below the target of 7.75 percent. Two more scenarios will show what happens if earnings are above the target.

“Staff believes providing this sensitivity analysis will allow employers to better budget for the future by being more aware of the potential risk to their employer contribution rates,” said a report from CalPERS actuaries David Lamoureux and Alan Milligan.

“This will also be a useful tool for any employer contemplating a benefit improvement by ensuring they are fully aware of potential increases in employer rates in the event of another investment loss,” said the report.

The expanded report is an acknowledgement that California public pension funds, once limited to investment in fixed-income bonds, now get most of their revenue from stocks and other unpredictable investments.

A ballot measure in 1966, Proposition 1, allowed pension funds to put up to 25 percent of their investments in blue-chip stocks. Another measure in 1984, Proposition 21, completely lifted the limit, allowing any “prudent” investment.

In the decade before SB 400 made a big increase in state worker pensions in 1999, CalPERS received 78.6 percent of its revenue from surging earnings, 12 percent from the state, and 9.4 percent from workers.

CalPERS had a large surplus that was expected to help fund the major benefit increase for current and retired workers. The annual state CalPERS payment, $1.2 billion in 1997, was dropped to $160 million by 2000, what some call a contribution “holiday.”

An Assembly floor analysis of SB 400 said the sponsor, CalPERS, expected to pay for the big benefit increase with surplus assets, investment earnings and an accounting change inflating the value of assets from 90 to 95 percent of market value.

“They anticipate that the state’s contribution to CalPERS will remain below the 1998-99 fiscal year for at least the next decade,” said the Assembly analysis. The state contribution to CalPERS in fiscal 1998-99 was $766 million.

An unusual 17-page CalPERS sales brochure for SB 400 told legislators the same thing. A quote from the CalPERS president at the time, William Crist, said the benefit increase would not cost “a dime of additional taxpayer money.”

SB 400 sailed through the Legislature on a 39-to-0 vote in the Senate, 70-to-7 in the Assembly. But what the bill analysis and the sales brochure did not say is that actuaries had given the CalPERS board three SB 400 scenarios.

If earnings fell short, said one of the forecasts, the state contribution to CalPERS could be $3.9 billion by 2010 — a virtual bullseye on the new state rate last month, a $600 million increase from last fiscal year in an era of deep budget cuts and big tax increases.

The new CalPERS plan to give government employers five scenarios, the bad and the good, should no longer conceal risk. The expanded CalPERS reports also address the criticism of “hidden” debt.

The critics contend that the annual earnings rate assumed by CalPERS, 7.75 percent, is too optimistic. CalPERS hit the target during the last two decades, a period that included a long bull market.

What happens if earnings fall short was dramatically revealed by a Stanford graduate student study in April. Using a risk-free bond rate of 4.1 percent, they calculated that the three state pension funds have a staggering unfunded liability of $500 billion.

The combined unfunded liability reported at the time by CalPERS, the California State Teachers Retirement System and the UC retirement system was about a tenth of that amount, $55 billion.

CalPERS is mid-way through a year-long look at its earnings assumption. Some consultants are forecasting a 7.3 percent earnings rate during the next decade. CalSTRS is considering lowering its earnings rate from 8 to 7.5 percent.

The new CalPERS plan to give employers five scenarios, including two when earnings fall short, should give government employers a view of how pension costs could soar if the critics are right.

The Governmental Accounting Standards Board is considering a proposal that would have public pensions use a bond-based earning rate to report some of their debt. Any change is several years away, and there are mixed reports about the impact.

This week the federal Securities and Exchange Commission accused New Jersey of fraudulently claiming its pensions were properly funded. The action was said to be intended to dissuade other governments from hiding bad fiscal news about pensions.

“In New York, California and other places, financial advisers have told lawmakers that benefits could be sweetened at virtually no cost, only to be proved wrong once those benefits were adopted,” a New York Times story said.

Gov. Arnold Schwarzenegger is pushing to roll back state worker pensions for new hires to the pre-SB 400 level. He has agreements with a half dozen labor unions, including the trendsetting California Highway Patrol.

Pension reform got an endorsement this week from former Gov. Gray Davis, who was ousted by Schwarzenegger in a recall election seven years ago. Davis told Reuters he thinks controlling pension costs will be the next governor’s biggest challenge.

“Pension reform is essential. You just can’t afford the benefits that have been promised because all the actuarial studies turned out to be wildly optimistic,” said Davis, who signed SB 400. “We have no choice now and if I was governor I would be doing exactly what Arnold is trying to do, which is require people to contribute more to their pensions.”

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 20 Aug 10

4 Responses to “CalPERS responds: reports to show earnings risk”

  1. roger Says:

    Dont mess with my pension!

  2. john moore Says:

    Pacific Grove just enacted pension reform that limits the contibution and the liability of the city to 10% of salary. It applies to current employees. In my view the enacted reform will create a “nominal” defined benefit plan: Employees may opt for a defined benefit plan,but employees must pay any contributions that exceed 10% of salary,and if the plan administrator fails to achieve the actuarial rate of return necessary to pay for the pensions,the size of the pension will be reduced pro rata. Fortunately,Pacific Grove has a Charter that specifically provides that employees are at will and have no expectation of any vested benefits. Other cities would need to become a charter city with similar provisions to legally enact similar relief.

  3. Charles Sainte Claire Says:

    This is a nonsensical article. Anyone who understands investing money knows there are many possible outcomes depending on assumed versus actual earnings. It is preposterous to state that Calpers somehow intentionally fooled anyone, except for a fool.
    Their basis was not accurate, but certainly not an attempt at subterfuge.

  4. john moore Says:

    Mr. St. Claire has a point. Calpers real sin is that after it became obvious that its’ actuarial model was flawed,leading to liabilities preposterous in size,it has taken the position that the promises,tho based on mistaken assumptions, are sacrosanct,and can never be changed,even by a creator

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