Archive for November, 2010

CalPERS local rate: up 55% over next three years

November 11, 2010

Annual rates paid by some of the 2,000 local government plans in the giant California Public Employees Retirement System could soar roughly 55 percent over the next three years, a CalPERS board member estimates.

Tony Oliveira, who also is president of the California State Association of Counties, made the calculation this week when a CalPERS workshop received new data on the impact of investment losses and a forecast of lower CalPERS investment earnings.

Oliveira, a Kings County supervisor, got general agreement from Alan Milligan, the CalPERS chief actuary, when he used knowledge of his county’s retirement system to estimate that investment losses would boost the rate 35 percent in the next three years.

Then Oliveira added the impact of lowering the forecast of annual average investment earnings. The board chose an investment portfolio during the workshop likely to lower the current earnings forecast, 7.75 percent a year, to 7.5 or 7.25 percent.

“If you take the previous 35 percent increase we are going to have because of the loss,” Oliveira said, “dropping the discount rate from 7.75 to 7.5, Kings County would look at a 55 percent increase in employer contributions over the next three years.”

Oliveira said the increase for some local governments will be significantly higher. He said Kings County operations tend to be “conservative.” CalPERS rates vary due to different pension benefits, member pay and other factors.

The first CalPERS rates for cities, counties and special districts that reflect huge losses in the stock market crash two years ago are scheduled to go out around the end of this month.

The rates for the new fiscal year that begins the following July are usually sent out in October. But as happened last year, the delay is the result of state budget-cutting worker furloughs ordered by the governor, even though CalPERS is self-funded.

A three-year phase in of CalPERS rate increases to cover investment losses began last July for state workers and non-teaching school employees. Local government rates lag a year because calculations for 2,000 plans require more time.

Like many public pension funds, CalPERS expects investment earnings to provide 75 percent of the money needed to pay pensions. When there is an investment loss, the replacement needed from the smaller contribution side is correspondingly greater.

The government employer is obligated to increase contributions to cover the losses in public pension funds, not the employee. Many local government workers have not been contributing to their pensions.

In this era of deep government budget cuts, a common change sought in contract talks with public employee unions, in addition to lower benefits for new hires, is an increase in employee pension contributions.

The largest state worker union, the 95,000-member Service Employees International Union Local 1000, announced approval of a new contract this week that increases employee pension contributions from 5 percent of pay to 8 percent.

The employer contribution for most state workers is 20 percent of pay, up 3 percent this fiscal year. The annual state payment to CalPERS increased to $3.9 billion last July, up $600 million or 18 percent.

At the workshop this week, the CalPERS board was shown the option of returning to an all-bond investment portfolio. What some call “liability-driven investing” is more predictable, avoiding the big swings of portfolios based on stocks and other investments.

Public pension investments in California were limited to bonds in the early years. Then Proposition 1 in 1966 allowed 25 percent of the portfolio to be invested in blue-chip stocks. Proposition 21 in 1984 lifted the lid, allowing any “prudent” investment.

Arguably, a bond-based portfolio might have avoided the big pension increases of a decade ago triggered by a CalPERS-sponsored bill, SB 400, which supporters said could be paid for by investment earnings from a booming stock market.

Now new state worker labor contracts negotiated by the outgoing Schwarzenegger administration roll back the SB 400 increase for new hires. The pensions promised current workers are protected by contract law and cannot be cut.

A CalPERS staff report said returning to a bond-based portfolio would require “unrealistic contribution increases to meet funding goals.” CalSTRS was 138 percent funded a decade ago as the stock market surged.

Today CalPERS is about 65 percent funded. The CalPERS investment fund peaked at $260 billion three years ago, dropped to $160 billion in March of last year, and has rebounded to $221 billion.

At the workshop the board was told that CalPERS liabilities have been growing 8.5 percent annually since 2000. Total contributions this year are $10.4 billion, benefit payments $13.1 billion.

Perhaps not surprisingly, the board chose to continue a stock-based portfolio, needing earnings well above current bond yields to restore the funding level. The staff was given broad directions for a portfolio expected to be adopted in December.

Joe Dear, the CalPERS chief investment officer, said the new portfolio would have the same risk as the current portfolio. But the assumed annual earnings will be 7.5 percent or lower, below the current 7.75 percent forecast.

The portfolio adopted by the board in December will be used in February by the chief actuary, Milligan, when he recommends a “discount” rate to offset the calculation of pension debt in the decades ahead.

During the last adjustment in February 2008, the assumed earnings rate was 8.04 percent. But following a recommendation by the actuary to allow for “conservatism,” the CalPERS board adopted a discount rate of 7.75 percent.

The governor’s pension advisor, David Crane, and others argue that overly optimistic discount rates conceal pension debt. Corporate pension funds use a discount rate of around 6 percent.

Some economists argue that pension debt should be reported using a risk-free government bond rate, around 4 percent, because pensions are risk-free debt, guaranteed by the taxpayers.

Stanford graduate students using a risk-free rate of 4.1 percent reported that the debt of the three state pension funds (CalPERS, the California State Teachers Retirement System and UC Retirement) is $500 billion, not $55 billion as reported by the funds.

The CalPERS board is relying on forecasts by a number of experts who expect earnings to drop a little during the next decade, but not a lot. At CalSTRS, for example, a staff recommendation would drop the forecast from 8 to 7.5 percent.

There’s nothing academic about the decision facing the CalPERS board, which unlike CalSTRS has the power to set employer contribution rates. Lowering the earnings forecast triggers a need for a big increase in contributions.

The CalPERS board was told that lowering the discount rate to 7.5 percent results in an estimated increase in state employer contributions of 2.3 percent of pay. If the discount is lowered to 7.25 percent, the contribution increase is 4.8 percent of pay.

For local governments, Milligan gave the CalPERS board an estimate of the combined impact of a three-year phase in of investment losses and lowering the discount rate.

“You are looking at 6 to 10 percent of pay for a miscellaneous plan or 10 to 16 percent of pay for a safety plan — the combined effect, that’s over three years,” he said, “and the high end of that would be going to a 7.25 percent discount rate.”

Reporter Ed Mendel covered the Capitol in Sacramento for nearly three decades, most recently for the San Diego Union-Tribune. More stories are at Posted 11 Nov 10

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