Old cause of pension debt gets new attention

CalPERS may soon report investment earnings for the fiscal year ending June 30 that are near or even above its long-term target of 7 percent, up from a return of 0.61 percent the previous year.

But the nation’s largest public pension system will still be seriously underfunded.

Like most public pension funds nationwide, CalPERS has not recovered from huge investment losses a decade ago. Going into the financial crisis in 2007, CalPERS had 101 percent of the projected assets needed to pay future pension costs.

Despite a lengthy bull market that followed a stock market crash in 2008, CalPERS recently was only 65 percent funded. Now CalPERS is worried about a downturn that might drop funding below 50 percent, a red line actuaries think makes recovery very difficult.

Two causes of the shortfall are often mentioned: overly optimistic forecasts of investment earnings, expected to pay nearly two-thirds of CalPERS future pension costs, and generous retroactive pension boosts at the turn of the century.

Last month, the Society of Actuaries issued a study reflecting a new focus on a traditional but lesser-known cause of debt — not promptly paying down debt, the “unfunded liability” from below-target investment earnings, longer life spans, or other factors.

The unfunded liability continues to grow if annual contributions to the pension fund only cover the normal cost of a pension earned during the year, but are not large enough to also pay the interest (currently 7 percent for CalPERS) on the debt from previous years.

It’s called “negative amortization.” The Society of Actuaries study, looking at 160 public pension systems nationwide from 2006 to 2014, found that most set an annual contribution target that allowed debt to continue to grow.

“Many plans with negative amortization contributed at least as much as their target contribution,” said the study. “However, at the peak in 2010, 76% of target contributions entailed negative amorization. By 2014, the percentage fell to 67%, roughly the same level as 2006.”

The study looked at two traditional methods of paying debt over a 30-year period that allow negative amortization in the early years, even though the debt is expected to be paid off by the end of the period.

“If plan assets earn less than the assumed rate of return during the negative amortization period, the unfunded liability will grow because of two factors: negative amortization and less-than-expected investment returns,” said the study.

As in the Society of Actuaries study, reports from the Pew Charitable Trusts in April and Moody’s rating service last year developed their own methods for measuring negative amortization in public pension funds.

Moody’s “tread water” indicator tracks the amount of the annual government contribution needed to prevent pension debt from increasing, if investment earnings hit the target and other assumptions are met.

“A contribution below the “tread water” level in effect suppresses expenditures by leaving implied interest on net pension liabilities unpaid, akin to borrowing at the assumed rate of investment return for operations,” said a Moody’s explanation of the measurement.

In a three-year forecast last month based on a sample of 56 public pension plans, Moody’s projects that government contributions generally will continue to be short of “tread water” due to factors such as “backloading” amortization and “smoothing” investment returns.

Under the most optimistic Moody’s scenario, in which cumulative investment returns over the next three years are 25 percent, the net pension liability reported under government accounting rules would be little changed, down 1 percent.

The government contribution needed to “tread water” would increase 17 percent under the same Moody’s optimistic scenario.

CalPERS Comprehensive Annual Financial Report June 30, 2016, p. 116

CalPERS unfunded liability soared after a huge loss during the financial crisis and stock market crash in 2008, when the investment fund plunged from about $260 billion in 2007 to $160 billion in 2009.

The latest CalPERS annual financial report (see chart) shows an unfunded liability of $111.3 billion as of June 30, 2015, up from $31.7 billion in 2007. The CalPERS investment fund was valued at $323.6 billion last week.

Until a change four years ago, CalPERS paid off some debt with what actuaries call “rolling” or “open” amortization. The debt is refinanced each year and theoretically might never be paid off, unless booming markets produce a period of full funding.

CalPERS debt payment also had been slowed by an unusual, if not unique, “smoothing” period that spread gains and losses over a 15-year period, well beyond the standard smoothing period of three to seven years.

The first of four increases that will double many government employer rates did not begin until 2012, four years after the stock market crash. The investment earnings forecast was dropped from 7.75 percent to 7.5 percent, then dropped again last year to 7 percent.

The switch to a more conservative “direct” debt payment method in 2013 was a significant reform. But it does not pay down debt promptly to keep the pension system near full funding as, for example, is required for New York state pensions.

CalPERS still phases in rate increases, as urged by employers wanting to avoid sudden and unpredictable budget shocks and, on occasion, unions wanting to leave money on the bargaining table for rate increases.

The recent drop in the earnings forecast used to discount future pension obligations will be phased in over three years, starting with the fiscal year that began this month. Rate increases are phased in over five years, beginning with 20 percent of the new base rate.

A rate increase for a change in actuarial “assumptions,” like those for the lower earnings forecast last year or longer expected life spans in 2014, is paid off over 20 years. The negative amortization stops in year five, said Amy Morgan, a CalPERS spokeswoman.

Investment losses are paid off over 30 years, and the negative amortization stops in year nine. The 20-year and 30-year debt payments are both phased out over the final five years, beginning with 80 percent of the base rate.

In addition to increasing cost, long amortization periods push debt to future generations. Advocates of “intergenerational equity” say the cost of pensions, regarded as deferred compensation, should be paid by the generation that receives the services of the pensioner.

The Governmental Accounting Standards Board recommends that investment losses be paid off over five years and actuarial assumption changes be paid off over the average time employees will remain on the job.

The “average remaining service life” calculated by the California Public Employees Retirement System for the employees in its more than 2,000 state and local government pension plans is four years.

CalPERS encourages local governments to pay down debt more quickly by including 10-year and 15-year amortization schedules in annual valuations to show the potential savings. Newport Beach is among several cities planning to make extra pension payments.

Gov. Brown’s proposal to borrow $6 billion from a state cash-flow fund to make an extra payment for state worker pensions, saving an estimated $11 billion over two decades, emerged from the Legislature with no significant changes and is expected to be signed soon.

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 10 Jul 17

21 Responses to “Old cause of pension debt gets new attention”

  1. larrylittlefield Says:

    “Going into the financial crisis in 2007, CalPERS had 101 percent of the projected assets needed to pay future pension costs.”

    One problem is that wasn’t true in either 2007 or in 2000.

    Expecting historically average returns from the peak of an asset bubble is, in effect, double counting. High asset values mean low dividend yields and interest payments relative to those asset values.


    Generation Greed politicians and unions lied to justify lower pension contributions and/or retroactive pension increases.

  2. Tough Love Says:

    Several times I have opined that an intelligent discussion of “full funding” (or the lack thereof) cannot take place without the “generosity” of the underlying pension Plans being part of that discussion ……. because the calculated annual pension contribution to achieve “full funding” is A FUNCTION OF (and moves IN DIRECT PROPORTION TO) the Plans’ generosity.

    I didn’t see even minor mention of the ROOT CAUSE of the pension mess impacting Americas States and Cities…………. grossly excessive Public Sector pension “generosity”, specifically, Defined Benefit Public pension promises that are ALWAYS MULTIPLES greater in “value upon retirement” than those of comparable Private Sector workers who retire at the SAME pay, with the SAME years of service, and at the SAME age …… ROUTINELY 2 to 4 times greater for non-Safety workers, and 4 to 6 times greater for Safety workers.

    * value upon retirement is a determined not only by the Plans’ per-year-of-service “formula factor”, but also by the age at which a participant can retire without an actuarial reduction (young ages costing a LOT MORE), the existence and extent of subsidized early retirement adjustment factors, by COLA increases (including those of past years if COLAs are now suspended), and of course the financial cost of all retroactively granted pension increases (including changes in “provisions” that enhance a pension’s value).

  3. John Moore Says:

    Declaring a financial emergency and freezing salaries until the CaLPERS debt is paid off, allows agencies to eliminate the pension debt without cutting services or raising revenues. Agreed that it would require most agencies to act, otherwise employees would flock to the most corrupt agencies that refused to reform. But as San Diego proved by it’s 401k plan for new hires, all positions have been filled and an extra thousand applied for fire positions

  4. S Moderation Douglas Says:

    “Several times I have opined”

    Several times?

    And several times I have replied, you can not legitimately compare pensions outside the context of total compensation.

    A. Yes, at the lower levels, total compensation for public sector workers is greater than for similar private sector workers.
    B. No, for higher level workers, even with their pensions and benefits, public workers earn less than their private-sector peers, much less.
    C. And no, for a large number of public and private sector workers in the middle ranks, their total compensation is roughly equal. They have higher pensions, but they are not, by definition, “GROSSLY EXCESSIVE” because they balance out the lower salaries.
    This pattern is agreed to by all the major studies. The only disagreement is where the “average” lies.

    4) Seriously, are you new at this? It’s not rocket surgery.

    Or, as Juvenal says…
    ” you are just wrong about the comparison of public sector and private sector total compensation (except at the level which requires no education–sorry for giving them benefits other than Medi-Cal).) ”

    #23%bulls hit

  5. Tough Love Says:

    S Moderation Douglas,

    We could argue forever about the conflicting studies on Public vs Private Sector compensation ….. including whether they properly adjust for actual hours worked/week, and whether per-hour-worker “productivity” is really equal, but one thing is undeniable……….

    “Deferred compensation” in the Public Sector (in the form of pensions and retiree healthcare benefits) has a fatal flaw. Unlike in the Private Sector, where great care is factored into Deferred Compensation promises ….. because the Corporation’s money and existence is on the line if things go badly …… no such controls exist in the Public Sector.

    Not only do the Elected Officials who grant pensions and benefits have no “skin-in-the-game” (with Taxpayers often looked upon as an unlimited source of revenue to be taken at will), but they BENEFIT from over-promising and under-costing those promises ….. all to garner the block votes of pension-happy Public Sector workers, the votes of general citizenry (who while not understanding the dire impact of over-promising with under-costing pushed into the future) are happy that they are not now called upon to pay for these excessive promises.

    And of course, the Public Sector Unions respond to this excess with more and more campaign contributions and election support.

    To head-off the tangent you have often taken in the past, for the Private Sector, I am talking about Single Employer Corporate-sponsored pension Plans, NOT multi-employer Union Plans.

  6. John Moore Says:

    Regarding your private v public battle: if pension debt and the annual cost for pension debt is treated(counted) as a benefit for the employee, in Ca. the cost for the public employee is double and rising.

  7. S Moderation Douglas Says:

    Also undeniable……….

    Private sector Corporations provide much lower (if any) pensions, but, except at the lower levels, pay much higher salaries than for equivalent public sector jobs. And for all the “great care .. factored into Deferred Compensation promises …..” Many private corporations are suffering the same problems as public sector pensions.  That includes single employer and multi-employer plans. Something about that “greatest recession” that affected everyone.

    Since 2008, almost all states have instituted and/or negotiated pension reforms and pay freezes or reductions. How much do you suppose those damn unions provided in “campaign contributions and election support” to win those rollbacks?

    That was your tangent, not mine…

    Posted by Tough Love on April 16, 2016 at 5:02 pm

    The groups impacted by MPRA are FAR FAR different than Public Sector workers, where pensions are so absurdly generous (and so fraudulently obtained from Union-BOUGHT Elected Officials) that they were NEVER justifiable ….and SHOULD BE materially reduced.

    These workers have run-of-the-mill pensions, clearly very modest (and MULTIPLES LESS) than those granted Public Sector workers.

    My only point was, you were (as usual), so damned adamant about expressing your own biased opinion that you never bothered to verify the claim.

  8. Calvin Coolidge Says:

    Check out ‘A Generation of Sociopaths” by Bruce Gibney. The problem with pensions is just the tip of the iceberg that baby boomers have caused. The book is a call to address the problems and how to address the aging baby boomers themselves.This will be the issue of the next decade. Baby boomers may wish to leave us before judgement of their kids and grandkids is rendered.

  9. Tough Love Says:

    Quoting SMD………..

    ” Many private corporations are suffering the same problems as public sector pensions.”

    False. Single-employer Corporate-sponsored Private Sector pension Plans have an average funding ratio of just under 80% (using the CONSERVATIVE assumptions & methodology required of Private Sector Plan in the valuation of their pensions).

    Public Sector Plan funding ratios are in the high 60s (using the very liberal valuation assumptions & methodology used by Govt-sponsored Plans). If these Plans wee valued using the SAME assumptions & methodology required of Private Sector Plans, those high-60s funding ratios would drop below 50%……….. horrible by any and every standard.

    Quoting SMD ……

    “Since 2008, almost all states have instituted and/or negotiated pension reforms ”

    True, but (with few exceptions) near-meaningless from a financial-savings point of view, because few pension changes apply to anyone OTHER THAN “new” workers.

  10. S Moderation Douglas Says:

    John Moore,

    If only it were so simple. That is one of the difficulties in the comparison. Sometimes “cost” is conflated with “value”. They are not the same thing.

  11. Tough Love Says:

    You can’t make this stuff up …………

    Until now the worst Union-greed case I had heard of was a CA City’s Firefighters suing to be able to continue to “spike” their pensions. Their reasoning ….. everyone that came before them got away with it, so they should as well.

    Well, that’s been topped …………



    A battle is brewing at Western Michigan University this summer between a group of hungry goats and a labor union.

    The 400-member American Federation of State, County and Municipal Employees has filed a grievance contending that the work the goats are doing in a wooded lot is taking away jobs from laid-off union workers.

    “AFSCME takes protecting the jobs of its members very seriously and we have an agreed-upon collective bargaining agreement with Western Michigan,” said Union President Dennis Moore. “We expect the contract to be followed, and in circumstances where we feel it’s needed, we file a grievance.”

  12. jskdn Says:

    Why should the attention to amortizing, or not, pension debt, and the consequences of those choices, be new? For well over a decade, I have written consistently to reporters and in comments explaining the basic concept, which is a crucial understanding. Yet it is regularly ignored by those who pass for journalists or even explained incorrectly, like the LA Times/CalMatters supposed “explanatory” journalism on the state’s pension problems.

    “Today, the difference between what all California government agencies have set aside for pensions and what they will eventually owe amounts to $241 billion, according to the state controller.”

    It ain’t eventual, UAAL is what’s owed today, with enormous carrying costs relative to other debt. And politicians can choose increase that debt without so much as telling the public about it.

  13. S Moderation Douglas Says:

    “The switch to a more conservative “direct” debt payment method in 2013 was a significant reform. But it does not pay down debt promptly to keep the pension system near full funding as, for example, is required for New York state pensions.”

    I would like to read more about how New York managed this, if Ed Mendel or anyone else can cite some articles. New York state workers have higher total compensation than California, and lost as much in 2008, but are now back up to full funding. And, as I understand, ultimately they saved money by getting money back into their system earlier rather than later.

    How painful was it?

  14. S Moderation Douglas Says:

    Well, if you put it that way…

    “Their reasoning ….. everyone that came before them got away with it, so they should as well.”

    “A battle is brewing at Western Michigan University this summer between a group of hungry goats and a labor union.”

    Pardon me, miss. Your bias is showing. Neither of those are true statements. If this is your idea of union bashing, you lose.

  15. Calvin Coolidge Says:

    Goats don’t expect a pension. That is a true statement.

  16. Tough Love Says:


    That Quote was directly from the linked article. If you believe it’s false go complain to the publisher …. Battle Creek Enquirer

  17. Tough Love Says:

    Quoting Calvin Coolidge …..

    “Goats don’t expect a pension”.

    Don’t give the Public Sector Unions any ideas. They’ll set up a goat-leasing business and demand pensions & benefits for their new “employees”.

  18. S Moderation Douglas Says:

    “Goats don’t expect a pension”.

    Ignoratio elenchi

    True, but irrelevant.

  19. Tough Love Says:

    UPDATE (below) from my earlier comment where I stated……………..” Single-employer Corporate-sponsored Private Sector pension Plans have an average funding ratio of just under 80%”


    “The aggregate funded ratio for U.S. corporate pension plans decreased by 0.4 percentage points to end the month of June at 83.1%, according to Wilshire Consulting, the institutional investment advisory and outsourced-CIO business unit of Wilshire Associates Incorporated. ”

    Source …. http://www.plansponsor.com/Pension-Funded-Status-Sees-Decline-for-June-and-Q2-2017/

  20. Calvin Coolidge Says:

    SMD, Gibney identifies you perfectly. He said there will be denial, kicking,and screaming that there is no problem by the sociopaths, who caused the problems. That is your generation and your legacy. He notes it was the normal social contract in America to leave the next generation, a better world, and not burden them with excessive debt. That contract has been broken. The problems need fixing and the sociopaths have no intention of doing that.

  21. CalPERSon Says:

    “The $323.6 billion California Public Employees’ Retirement System reported it earned a net return of 11.2% on its investments in the fiscal year ended June 30.” Pensions and Investments

    11.2%. So much for those overpaid consultants who say that 7% is too optimistic.

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