Annual state report begins showing pension debt

Following new accounting rules, the annual state financial report issued this month shows a “net pension liability” of $63.7 billion, a dramatic increase from the $3.2 billion “net pension obligation” reported last year.

It’s mainly the result of including, for the first time, the large debt or “unfunded liability” of the two big statewide pension systems: the California Public Employees Retirement System and the California State Teachers Retirement System.

New rules from the Governmental Accounting Standards Board are directing state and local governments to report more of their pension debt, a “hidden” and “unsustainable” long-term drain on basic services in the view of some critics.

“The GASB accounting rules will help to increase transparency, which will in turn focus local and state governments on ensuring they adequately plan for these important long-term obligations,” state Controller Betty Yee said in a news release.

Following the old rules, the Comprehensive Annual Financial Report last year only reported the pension debt for single-employer state plans, a $3.2 billion obligation for judges and a closed plan for legislators.

The new report this month for the fiscal year ending last June 30 includes the debt for the five plans in the main CalPERS fund, $39.4 billion, and the state share of more than a third of the CalSTRS debt, $22 billion.

“During the 2014-15 fiscal year, the State implemented GASB statements No. 68 and 71, which resulted in the elimination of the June 30, 2014 net pension obligation of $3.2 billion and the recognition of a net pension liability of $63.7 billion at June 30, 2015 — a net increase of $60.5 billion in long-term obligations,” said the report.

Next year the new accounting rules will be used to report the debt for retiree health care promised state workers, estimated to be $74.1 billion in an update issued by Yee in January.

This year a much lower state worker retiree health care debt is reported, a “net OPEB obligation” of $22.3 billion under old rules based on the contribution shortfall. (Retiree health care is labeled “other post-employment benefits” in the financial reports.)

Half of the state’s reported overall “negative unrestricted net position” of $175.1 billion, which includes long-term obligations paid over decades, is debt owed employees. Well over a third of the total is outstanding bond debt, $67.1 billion.

The debt owed employees, totaling $89.9 billion, is the $63.7 billion net pension liability, the $22.3 billion retiree health care obligation, and $3.9 billion owed for compensated absences. The chart below shows net position growth under the new rules.

CAFR

A decade ago, the accounting board had a major impact with new rules directing state and local governments to begin calculating and reporting the debt or “unfunded liability” for retiree health care.

In 2007 former state Controller John Chiang, now state treasurer, issued the first actuarial estimate of the debt owed for retiree health care promised state workers, $47.8 billion over the next 30 years.

The retiree health care debt grew to $74.1 billion, much larger than the $43.3 billion state worker pension debt, because it’s been mainly pay-as-you-go, costing $1.6 billion this year. Gov. Brown announced a plan last year to begin trimming the debt.

During bargaining with unions for new labor contracts, the state wants employees to begin contributing to their retiree health care in a pension-like prefunding expected to cut costs with investment earnings over time.

State workers have an unusually generous retiree health care plan that can pay 100 percent of the insurance premium for retirees and 90 percent for their dependents. For active workers, the state pays 80 to 85 percent of the premium, depending on bargaining.

Legislation in the early 1990s created a state worker retiree health care fund. But no money was put in the fund. Employer-paid retiree health care is rare in the private sector.

To help local governments prefund retiree health care, CalPERS created the California Employers Retirement Benefit Trust Fund in 2007 that has grown to $4.4 billion and 474 employers.

Now, the impact of the new pension accounting rules remains to be seen. The rules are intended to put a public spotlight on pension debt, but will not be used by actuaries to set annual rates paid by employers.

A central issue in the debate over public pensions is the earnings of their investment funds. CalPERS expects its fund, valued at $301 billion last week, to provide about two-thirds of the money needed to pay future pensions.

Critics say the CalPERS earnings forecast of a 7.5 percent average is too optimistic, concealing massive debt and the need for a large and painful rate increase to pay for future pensions, which reformers think might trigger action to control costs.

Moody’s, a Wall Street rating agency, has used a 5.5 percent earnings forecast for pension debt. Some economists advocate an even lower risk-free bond rate because pension payments are guaranteed.

In a compromise, the new accounting rules allow pension funds to continue to use their earnings forecasts to discount future pension debt. But if their projected assets fall short, they must “crossover” to a risk-free bond rate to discount the remainder of the debt.

The CalPERS state plans passed the crossover test. A risk-free bond rate was not used for their share of the new $63.7 billion net pension liability. Under the old rules, the “unfunded liability” of the CalPERS state plans was $43.3 billion on June 30, 2014.

CalSTRS feared the new rules would require reporting the nation’s largest pension debt, $167 billion, perhaps increasing the cost of school bonds. But a major legislative rate increase in 2014 dropped its net pension liability to $58.4 billion.

The new rules required school districts to begin reporting their share of CalSTRS pension debt. For example, the pension debt of the state’s fifth largest district, Elk Grove Unified, went from zero to $414.6 million.

Among the county pension systems, Sen. John Moorlach, R-Costa Mesa, reported this month that the new rules result in a debt adjustment totaling $20 billion in nine counties. John Dickerson is tracking new county debt reports at Yourpublicmoney.com.

Last week, U.S. Rep. Devin Nunes, R-Tulare, announced the reintroduction of a bill requiring public pension funds to report debt using a “fair market valuation,” like a risk-free bond rate, or the plan sponsor would lose the federal tax exemption on its new bonds.

A Nunes news release said a Stanford finance professor, Joshua Rauh, “estimates that the fiscal hole for state and municipal public employee public pension plans is an astounding $3.4 trillion,” far more than the $1.2 trillion reported under GASB rules.

Reporter Ed Mendel covered the Capitol in Sacramento for nearly three decades, most recently for the San Diego Union-Tribune. More stories are at Calpensions.com. Posted 28 Mar 16

3 Responses to “Annual state report begins showing pension debt”

  1. Bob Says:

    “Moody’s, a Wall Street rating agency, has used a 5.5 percent earnings forecast for pension debt. Some economists advocate an even lower risk-free bond rate because pension payments are guaranteed.”

    Yet, Fitch, another Wall Street Rating Agency, uses a 7% rate of return. http://www.ncpers.org/Files/2011_enhancing_the_analysis_of_state_local_government_pension_obligations.pdf

    Is there any reason, Ed, that you didn’t mention this?

  2. Tough Love Says:

    Bob, Public Sector pension payments are supposedly GUARANTEED, and the PROPER way (agree to by 99+% of the worlds economists) to value liabilities, is to discount expected future payments using an interest rate that reflects the strength of those “guarantees”.

    The real problem with Public Sector Plan accounting/actuarial rules & procedures is that (UNLIKE in Private Sector Plans) Plan liabilities are discounted using the assumed earnings rate on Plan ASSETS.

    Pure economic theory calls for discounting GUARANTEED Public Sector Plans liabilities at a “near” risk-free rate …. perhaps 3% to 3.5%. I believe that Moody’s has chosen the 5.5% middle ground to reflected a reasonably conservative return that might be expected to be earned on Plan ASSETS, with the much lower theoretically correct near risk-free rate appropriate for discounting guaranteed Plan LIABILITIES.

    In ALL OTHERS investment circles, those who invest for a 7.5% return (via equities) PERSONALLY assume the risk that those investments will not pan out, and that they very well might earn less, or even lose money. Public Sector Unions/workers/retirees want the best of all worlds …… the GUARANTEE of 7.5% returns WITHOUT assuming ANY of the risk ….. because THEY do not assume that risk, they pass along all shortfalls to the Taxpayers for ADDITIONAL pension contributions.

    This Public Sector Union/worker/retiree “heads-we-win and tails-Taxpayers-lose” structure needs to end.

  3. Tough Love Says:

    Bob,

    The Fitch Report linked in your comment was published in Feb 2011 with data from no later than 2009. Given the SIGNIFICANT reduction in expected investment returns (especially fixed income) since then, do you NOT believe than Fitch would today suggest something lower than 7% if writing that report today ?

    Additionally, Fitch did NOT say that they believed that the 7% rate was the appropriate rate to use in such valuations, but that it was choosing a single rate (the 7%) to restate Plan liabilities and funding ratios using ONE rate for ALL Plans studies …. “for comparison purposes” (see quote below).

    Specifically the Fitch report stated:

    “To enhance pension analysis, Fitch will create standardized investment return and asset valuation scenarios. Fitch believes that this will improve comparability and facilitate an increased focus on pension obligations as part of the broader analysis of state and local government credits. This report provides several investment return and asset valuation scenarios. Fitch will consider the funded ratio with a 7% investment return assumption adjustment, which Fitch considers a reasonable adjustment for comparison purposes, rather than the funded ratio as reported by the system. The asset valuation adjustment will remove the impact of disparate smoothing methods by calculating a system’s funded ratio based on a rolling five-year average of market value of assets.”

    What surprised me was where Fitch went on to say …

    “Fitch generally considers a funded ratio of 70% or above to be adequate and less than 60% to be weak, while noting that the funded ratio is one of many factors considered in Fitch’s analysis of pension obligations.”

    I attribute that statement to the report being published in 2011, and DOUBT that they would repeat that (or agree with it) today. Much study and reporting has been published on what are APPROPRIATE funding ratios and direct you attention to a report (called an “Issue Brief”) from the American Academy of Actuaries:

    http://www.actuary.org/content/pension-practice-council-publishes-issue-brief-80-percent-funded-ratio-myth

    That Report is in fact rebuffing the MYTH that even an 80% is “adequate”. Quoting from that report:

    “Actuarial funding methods generally are designed with a target of 100% funding—not 80%. If the funded ratio is less than 100%, contribution patterns are structured with the objective of attaining a funded ratio of 100% over a reasonable period of time.”

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