How much do big pensions widen funding gap?

As local governments scrambled to meet a Jan. 1 reform deadline for giving lower pensions to some new hires, a top target was a big increase bargained by police and firefighters during the last decade.

A CalPERS-sponsored bill, SB 400 in 1999, gave the California Highway Patrol a 50 percent pension increase. Then in labor negotiations, local governments were urged to match the new benchmark as a way to remain competitive in the job market.

The landmark bill also gave all state workers a large retroactive pension increase. And retirees received a 1 to 6 percent increase in their pensions. All this could be done, said a CalPERS brochure given to legislators, without costing taxpayers “a dime.”

When critics say pension costs are “unsustainable,“ they often cite the SB 400 increase along with below-forecast investment earnings. Frequently mentioned: Police and firefighters retiring at age 50 with 90 percent of final pay after serving 30 years.

The California Public Employees Retirement System no longer claims that “superior” investment returns cover all SB 400 costs. But CalPERS does not view benefits as a key driver of pension costs, pointing instead to rising pay and market cycles.

Gov. Brown’s pension reform, which took effect Jan. 1, resulted in new and narrow calculations of how higher pensions increase annual costs paid by local government employers.

The bill, AB 340, ended bargaining for higher pensions and imposed a single statewide formula for new hires, lower in most cases than the pension formulas used before the SB 400 increase.

But the employer’s formula for new hires before Jan. 1 is used if the employee, through a previous employer, is already a member of CalPERS, the California State Teachers Retirement system or one of the 20 county systems operating under a 1937 act.

Although a few missed the Jan. 1 deadline, CalPERS said 135 local governments successfully scrambled to lower their new-hire pension formulas, more than a third cutting the SB 400 formula that spread to local police and firefighters.

One example of the cost of higher pensions surfaced in an unusual way. Bucking the trend, Antioch scrambled to reverse a cut in the police formula adopted shortly before the last-minute pension reform legislation abruptly appeared in late August.

The police chief persuaded the Antioch city council that restoring the SB 400 formula would give the city a competitive edge and help attract experienced police officers, needed to guide rookies as cuts in the police force are restored.

Antioch originally had the SB 400 pension formula: 3 percent of final pay for each year served at age 50. The cut dropped the formula for new hires to “3 at 55,” still well above the original Highway Patrol formula before the SB 400 increase: “2 at 50.”

CalPERS told Antioch that reversing its cut would add $4,502 a year to the pension cost of a typical police officer. The “3 at 55” annual pension cost, $23,054, would increase under the “3 at 50” formula to $27,556.

One of the few, if not only, attempts to calculate the broad state cost of SB 400 came as pensions moved into the spotlight during the financial crisis. To respond to growing criticism, CalPERS created an aptly named website, “CalPERS Responds.”

A chart labeled “Breakdown of the Change in State Contributions between 1997-1998 and 2009-2010” attributed 51 percent of the increase in state CalPERS payments to higher pay, 27 percent to SB 400 and 8 percent to other benefit changes. (See chart here.)

It was a period of extreme highs and lows. A booming stock market gave CalPERS a brief surplus around 1999, apparently producing the optimistic view that investment earnings would cover much of the cost of the SB 400 pension increase.

As often happens with public pension funds, being fully funded at 100 percent or more resulted not only in a pension increase for employees but also in a contribution “holiday” for employers.

The powerful CalPERS board, which sets an annual rate the state must pay, dropped the state contribution from $1.2 billion in 1997-98 to $160 million in 1999-00, the year SB 400 was enacted.

The state contribution to CalPERS, held down for six years during the time of plenty, did not go back up to $1.2 billion until 2002-03, three years after SB 400. This year the state contribution to CalPERS is $3.7 billion.

One of the puzzling things about the pie chart showing state contribution changes during the decade is the small slice for investment earnings, which are expected to provide about two-thirds of CalPERS revenue.

Investment gains and losses are lumped with demographics and actuarial methods and assumptions for a combined 14 percent of the changes. CalPERS had huge losses during a decade ending in a recession, a global financial crisis and a stock market crash.

The CalPERS investment fund peaked at $260 billion in the fall of 2007, then plunged for a year and a half before finally bottoming out at $160 billion in March 2009. The fund is about $254 billion this week, still below the peak reached five years ago.

In a Wilshire report last year, CalPERS investment earnings ranked at the bottom among public pension funds with more than $10 billion in assets during a five-year period ending Dec. 31, 2011, averaging 0.57 percent compared to 6.12 percent for top funds.

Part of the reason CalPERS investment earnings were a small part of contribution changes during the decade ending in fiscal 2009-10 is a radical “smoothing” period that spreads asset gains and losses over 15 years, well beyond the usual three to five years.

It’s probably no coincidence that CalPERS adopted 15-year smoothing in 2005, when former Gov. Arnold Schwarzenegger briefly backed a proposed ballot measure to switch all new state and local government employees to a 401(k)-style plan.

Smoothing and other CalPERS actuarial policies avoid rate “shock,” a sharp increase in employer contributions. A big jump in pension costs, particularly when other government programs are being cut, is a prime argument for radical pension reform.

But another argument is that making pension costs more predictable and taking a smaller budget bite during hard times aids government employers, if delaying or phasing in needed rate increases does not undermine long-term pension funding.

Smoothing is not the main issue for critics who contend the CalPERS earnings forecast is too optimistic, concealing massive debt. The CalPERS response is that the earnings over the last two decades hit the target, averaging 7.5 percent.

So why is CalPERS only 70 percent funded?

The CalPERS chief actuary, Alan Milligan, mentioned three factors when asked the question last fall: starting the 20-year period with a shortfall, big gains in the first half that led to reduced contributions, and pension benefit increases.

“It’s not that big of a jump,” Milligan said of the cost of SB 400 and other smaller pension increases. “But certainly in combination with the other two (factors) that is a part of it.”

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 31 Jan 13

20 Responses to “How much do big pensions widen funding gap?”

  1. Tough Love Says:

    The current Public Sector Defined Benefit Plans should be hard frozen (with ZERO future growth) and everyone, INCLUDING all CURRENT workers should be switched to a Defined Contribution Plan via a constitutional amendment.

    THAT is the only thing that can corral the Politicians insatiable need for power & money and the Public Sector Unions insatiable greed for MORE MORE & MORE … and the Taxpayer be damned.

    Doing so would end almost all of the benefits of the Unions/Politician horse-trading of campaign contributions and election support for favorable votes on pensions.

  2. Dream On Says:

    Only in CA can the laws of physics and math be suspended. If a 260B fund at this point can grow at 7.50% for any sustained length of time, I suppose cows can fly over the moon too and the moon is indeed made of cheese. Size matters hell of a lot in investments. Even the greatest compunding machine that we have ever seen(in terms of length of time at least) Berkshire is not forecasting those kind of returns go foward and Berkshire is smaller than Calpers AND MORE IMPORTANT has lesser conflict of interest than the incompetent folks at Calpers

  3. Robert Mitchell Says:

    California PERS and Hotel California – you check out but you can never leave. Until CalPERS prices their product to produce an actual guarantee of benefits, they will remain publicly LIARS about pension costs. Remember that no one at CalPERS goes to jail nor gets fired for understating pension costs. They can do anything they want with no consequences.

  4. spension Says:

    DC plans are way more expensive than DB plans… DC plans really transfer lots of money in fees to the financial industries. Averages for fees in DC plans are around 1%, as compared to 0.2% for DB plans. DB plans also are more efficient in that the money goes to the employee and not their heirs.

    A constitutional amendment to require DC plans is corporate welfare for the DC industry.

    The historical average return (*after* inflation is taken into account) for the stock market is about 6.6%… prior to inflation it is 8.6% or so.

    The assumption of long term 7.5% is quite reasonable, but the deeper problem is the people who run *California’s* DB plans didn’t plan well for ups and downs that can happen even over long investment periods like 30 years… see the link above. 30 year returns (after inflation) have been as low as a 2.6% on an annual basis. *California’s* DB plans didn’t take that into account, and relied on hiking the taxpayer’s contribution as the backstop, which is reprehensible.

    On the other side of the fluctuation, when the stock market was up, the DB plans stopped contributions altogether (UCRS is the worst offender there). And also conservative politicians (including Pete Wilson) tried to remove funds from California’s DB plans when the stock market was up. These are really ignorant moves.

    A solid DB plan would have a fixed percentage of salary as the contribution (say, 15%) and then set the benefits so that appeals to the taxpayer for additional money never happen. The old tradition was that public salaries were a 10% or so below the private sector in return for the better pension.

    BTW, lots of states and public entities in the US didn’t mess up their DB systems… I’ve given lists before. The screwups of California, Illinois, Rhode Island, etc shouldn’t be used to pretend that *nobody* can run a public DB system. Public DB systems have worked just fine elsewhere.

  5. Tough Love Says:

    Spension, While the mortality-sharing of DB plans is a definite plus, the actual “cost difference” with DC Plans is not very material if you don’t ignore the remainder funds that (as you said) go to the deceased employee’s heirs.

    In the end game, DC plans win by a landslide as the best choice in the PUBLIC Sector arena because the Public Sector Unions in cahoots with our self-interested elected officials will always find a way (with DB Plans) to cheat the taxpayers. That’s VERY hard to do with DC Plans.

  6. SeeSaw Says:

    DB plans to go to heirs if the retiree has named one or more beneficiaries. The retiree forfeits a percentage of the unmodified amount, off the top, according to the age of the beneficiary. I had a former subordinate who passed without ever applying for his CalPERS benefits. CalPERS did a good-faith search to find any heirs so that they could refund his contributions.

  7. spension Says:

    Seesaw… as far as I know the actual pension can only go to a spouse… although their are frequently death benefits that do go to heirs; they don’t amount to nearly the value what the pension benefits would have been.

    Tough Love… see Vanguard for the surprisingly large consequences of the large fees on retirement fund growth… and although DC plans with low fees do exist, they aren’t utilized sufficiently in the US.

    But plenty of public DB plans in the US *DO NOT* have the excesses that most of California’s plans have suffered. The flaw is not do to public DB plans, but due to the specific implementation of public DB plans ***in California***.

  8. Tough Love Says:

    Spension, DB Plans with benefit levels comparable to what was (but now rarely still is) available to Private Sector workers would be manageable for Taxpayers and provide for a reasonable retirement for career workers along with Private savings (just like Private Sector workers must do).

    Reasonable benefits would max out with a formula-factor per years of service of 1.25% of final 5 year average BASE pay, and be payable (w/o reduction) at age 65…. with NO post-retirement COLAs.

    The problem is that REASONABLE DB Plans never have, don’t now, and never will exist in the Public Sector (due to that Union/politicians collusion I’ve mentioned quite often). The TYPICAL DB Plan for non-safety Public Sector workers is 2-4 times more valuable at retirement than the reasonable Plan I described above, and 5-6 times greater in value for the TYPICAL Plan granted safety workers.workers.

    The ONLY solution is NO DB Plans in the PUBLIC Sector.

  9. SeeSaw Says:

    No spension, I could name my children if I did not want to name my spouse; or I could have named my spouse and the two children. I would have forfeited more because they are younger. (I have a former colleague who has a spouse, and her son will get her’s when she goes.) A spouse must agree and sign, regarding all options. There are five options. I could have taken more up front and left my spouse half. I chose the option that leaves the same amount I am getting now, to my spouse, if I pass on first. There is also a pop-up option where I could have taken less and popped up to the original, unmodified amount, if my spouse were to pass away first–he would also have gotten less, if I went first. There is also an option where, if my spouse and I were both to go before my own contributions were used up–8 to 9 years–the unused contributions would have gone to my children.

  10. SeeSaw Says:

    DB public pensions plans for teachers in CA are 99 years old, TL; DB pension plans for public, miscellaneous and safety workers in CA are 80 years old. I think, that if these plans are as evil as you think, such would have been discovered long before this recent recession. You have an irrational hatrid toward unions. The public sector unions have existed for a lessor number of years than either of CA’s public DB pension plans.

  11. Tough Love Says:

    Hardly Seesaw, It’s a very justifiable distaste for extraordinarily greedy Unions and the politicians whose favorable votes are bought with Union money … and with total disregard for the Taxpayers.

  12. Captain Says:

    spension Says: DC plans are way more expensive than DB plans

    Spension, while that may be true I seem to be paying for both my DC plan that I fully self-fund, which doesn’t guarantee a rate of return, and am also paying for public employee union members guaranteed 7.75% rate of return (and it is still 7.75%). Just how is that less expensive to me?

    Now we here of a rush of public employees trying to take advantage of purchasing upto five years of service credits before the scheme ends. It was only a year or two ago that CaLPERS fessed up to the fact they were under charging members by as much as 32% -32%! Now we are expected believe that, according to another article, that the mad ruch to purchase more service credits at the supposedly more accurate cost is cost neutral. Cost neutral? Really?

    I wonder if the people rushing to purchase five years of service credits really represents the true universe of CalPERS members. CalPERS claims some live longer and some die early; cost neutral. My guess is that the people purchasing the service credits come mostly from a gene pool that with a history of longevity. That would add cost to the DB plan which will be paid by the taxpayer, whom also pays for his/her own DC plan.

    “The powerful CalPERS board…”. Why is that so. I see absolutely nothing from these CalPERS Board members that justify anything beyond scrutiny. I think our politicians are nothing but a bunch of COWARDS.

  13. Captain Says:

    “Part of the reason CalPERS investment earnings were a small part of contribution changes during the decade ending in fiscal 2009-10 is a radical “smoothing” period that spreads asset gains and losses over 15 years, well beyond the usual three to five years.”

    Radical is right but that’s not the beginning or ending of the CalPERS SHELL GAME. Regarding the radical CalPERS smoothing policy, pension expert Girard Miller says it best (Pink Slips and Pension Red Ink):

    “How high will this flood crest? Local employers are now skeptical that they have been told the full truth about how high their pension costs will ultimately surge. Unlike the vast majority of public pension funds, CalPERS uses a 15-year actuarial smoothing process that camouflages the genuine economic impact of market fluctuations. I have no issue with normal industry-standard actuarial smoothing periods of 5 years, in light of the average length of a business cycle — which is 6 years based on 14 recession cycles in the past 84 years. But the CalPERS process is opaque and flunks the transparency test that taxpayers, public managers and municipal bond investors are entitled to expect. As I have explained before, such extraordinary “smoothing” practices deserve SEC investigation as an “artifice and device” to conceal relevant financial information from the investment community — as well as the employers who must now bear the financial brunt of unsustainable pension benefits.

  14. SeeSaw Says:

    For those last minute purchasers buying air-time: It will take a long, long time before you begin to benefit from such purchases, if ever. I hope you had competent financial advice before you parted with that money.

    Never fear, Captain. The abolishment of air-time purchases should never have been part of the pension reform measure. It doesn’t take a penny from your pocket. It was just put out there to appease the public sector haters. CalPERS will probablly be the main beneficiary there.

    My own property taxes are slightly less than $500/yr. in CA so don’t see how I or anybody else in my category could be having all their blood drained to benefit pensions. We all pay the same percentage of sales taxes and our cars are taxed according to the quality of auto we drive. I happen to be a tax payer myself so you can all get off your hight horses about who pays taxes. All the citizens pay taxes, and we public employees do not, respectively, have two heads! I’m also paying a couple hundered dollars in AZ property taxes right now–I hope it is helping some poor minimum wage worker in that Red state.

  15. spension Says:

    Our politicians do… pretty much what the voters vote they want. Don’t blame the politicians, blame their boss… the voters.

    Here is a report about 6 DB public pension funds in the US that are run pretty well… they have avoided California’s excess…

    Click to access final_june_29_report_lessonsfromwellfundedpublicpensions1.pdf

    As to `paying’ for the 7.75%… the 200 year average return of the US stock market is about 8.6%…

    What has happened is the pension financial gurus forgot that those returns are not smooth, they are lumpy. And so when the market was up in the 1990’s and 2000’s, pension contributions were reduced… and politicians (including Pete Wilson) advocated raiding the pension funds. Had those missing contributions been made the funds would be in way better shape.

    Conversely, when the returns are down, we are in the current situation… taxpayers (including me, BTW; I’m in DC plans) are asked to make up the difference. It is reprehensible, as I’ve said.

    But the problem is *not* DB. It is benefits that were made to large… california’s are way bigger than the 6 cited above… as well as mismanagement of the funds/contributions, as discussed above.

    Throwing out DB in favor of DC mainly is (more) corporate welfare for the investment industry… the industry average fees for DC management is 1%, which amounts to billions per year if DB’s are converted to DC.

    The fees for DB plans in California, at least for CalSTRS and UCRS, are around 0.2%, a saving of *billions* per year over DC.

  16. Captain Says:

    Seesaw says: “For those last minute purchasers buying air-time: It will take a long, long time before you begin to benefit from such purchases, if ever…Never fear, Captain. The abolishment of air-time purchases should never have been part of the pension reform measure. It doesn’t take a penny from your pocket.”

    Seesaw, that is a ridiculous statement. Have you learned nothing over the past several years? Airtime purchases have cost taxpayers plenty already. Just one more CalPERS SPONSERED tax-dollar give-away to add to the long list!

    And how many unqualified CalPERS pension board members — or former presidents/vice presidents of various unions, does it take to control CalPERS and all the influence that comes from MIS-MANAGING 250 BILLION in ASSETS? Apparently the number is 6, plus any one of 4 other UNION funded democrats that happen to be appointed to the CalPERS Board. Essentially we have six UNION officialls dictating and controlling the policy of the entire 252 billion in CalPERS assets, while also gouging taxpayers.

    I just do NOT see any difference between what’s happening at CalPERS and what the New York Mob was getting away with in their hay-day.

  17. Captain Says:

    spension Says: “Our politicians do… pretty much what the voters vote they want. Don’t blame the politicians, blame their boss… the voters.”

    Spension, in California the politicians do what the unions want. The only thing that will stop the madness are the new GASBy rules which will change the way Pension/OPEB debt is reported on government financial statements, and the changes in the way credit rating agencies like Moody’s view Pension and Other Post Employment Benefit (OPEB) costs/debt. We aren’t too far away from a new level of transparency that will finally shed light on the irresponsible spending coming from both Sacramento and about 70% of the cities and counties in this state (and special districts).

    Once these entities, and more importantly the taxpayers, begin to realize the enormity of the problem there WILL be a DEMAND for change. Unfortunately, to date, the unions have spent hundreds of millions in CA to muddy the message of those seeking reforms and they‘ve been successful. Eventually the math will rule the day and not even hundreds of millions of UNION dollars spent on fighting propositions, reform, or promoting union friendly politicians will conquer the truth behind the MATH.

  18. spension Says:

    Captain… you’re saying that unions control politicians, and big business interests don’t? It is easy to go to the Secretary of State’s website and get a big list of all the big political contribution checks written by Exxon, BP, waste processing companies, etc.

    What do you think, all those business interests donate out of the goodness of their heart for all that is right and good? Huh, Captain?

    Moody’s, what a joke. Most likely a wholly owned subsidiary of Wall Street crooks, who payed big money to the ratings agencies so their collaterallized debt obligations, credit default swaps, and structured investment vehicles would get AAA ratings… when they should have been rated B-. The level of transparency I’d like is the ratings agencies cleared out of all their crooks and liars.

    Now that would be refreshing: if taxpayers not only heard about the influence of unions, but also the influence of the wall streeters who bragged about the $trillions in bailouts (way more than just TARP, if you include all the federal reserve bailouts; in fact, the special inspector general for TARP pegged the ultimate liability at $24 trillion).

    But of course on these boards we only hear the complaints about the unions, and yes, they have influence. But big business steals taxpayers dollars at least as frequently; since we never hear about that (except from me and sometimes the pro-pubilic pension folks) it is fair to conclude, Captain, you might be snugly in the pocket of big business. Now maybe you’re not, but your comments sure as heck indicate you might just be a paid poster for big business’s political games.

  19. Captain Says:

    spension Says: Captain… you’re saying that unions control politicians, and big business interests don’t?

    Spension, speaking in terms of degrees of correctness that’s right – that’s what I’m saying. And I’m not impressed with your above argument. I do appreciate your comments.

  20. spension Says:

    Well… in the end it is the voters who elect the politicians and pass the ballot propositions. The buck stops with the voters.

    In any modern democracy it is clear that organized interest groups can be very effective… whether they are unions in the US, big business in the US, the NRA in the US, or, say, the Muslim Brotherhood in Egypt.

    Either you’re for democracy or not, and if you are, you are pretty much stuck with influence by organized interests.

    The real point is: anyone who doesn’t like union influence, or big business influence, or whatever, best get out and do a better job than they do and win the election. BTW, fascinating data lately that TV ads actually don’t sway elections, usually.

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