How CalPERS has Created a Ticking Time Bomb

During the Stockton bankruptcy Judge Klein called CalPERS the “bully with a glass jaw.” Klein meant that CalPERS, as a servicing company, has no standing in the bankruptcy because the pension obligation is between the public agency and their employees and retirees.

That means as opposed to lobbying for increased benefits as they have beginning in 1999 when they convinced the state legislature to increase the pensions of safety employees from 2% to 3% per year of service retroactively, and threatening litigation if Vallejo or Stockton cut benefits, the role of CalPERS is to simply (1) determine the required employer and employee contributions necessary to responsibility fund each pension plan they manage, (2) invest the contributions, and (3) send retirees checks for their promised monthly benefits.

So how well is CalPERS doing its job as a servicing company?

20151130-CPC-CalPERS
CalPERS headquarters in Sacramento

With the new on line website PensionTracker.org recently developed by the Stanford University Institute for Public Research we can view objective data regarding CalPERS’ performance, along with all of California’s other state and local retirement systems. Combined, the total unfunded pension liabilities for all state and local government workers in California hit $281 billion at the end of the 2013 fiscal year (6/30/2013), the last year data is available for.

Unfunded liabilities for each system are estimated as:

  • CalPERS public agencies (the Public Employee Retirement Fund, Judges’ Retirement Funds I and II, and the Legislators’ Retirement Fund): $116.7 billion.
  • Independent county, city and special district systems: $88.2 billion.
  • California State Teachers’ Retirement System (CalSTRS) agencies: $56.5 billion.
  • The University of California Retirement System (UCRS): $12.0 billion.
  • Pension Obligation Bonds issued: $8.1 billion.

These numbers, however, are based on a 7.5% discount rate on the liability. That is, the estimated value of all future payments to current and eventual retirees was discounted to a present value based on a 7.5% rate of return. For a retirement system to be 100% funded, the total invested assets in the fund have to be equal to this discounted future liability, based on the assumption that these invested assets will earn 7.5% annual returns, on average, over the next several decades. And because some of California’s government employers have borrowed money to make their annual pension fund contributions, these “Pension Obligation Bonds” also have to be taken into account when calculating the unfunded liability. PensionTracker.org calculates California’s pension system’s aggregate unfunded liability as follows:

“Total Unfunded Liabilities reflects the aggregate liabilities for the California Public Employees’ Retirement System (CalPERS), the California State Teachers’ Retirement System (CalSTRS), independent pension systems, the University of California Retirement System (UCRS), plus Pension Obligation Bond (POB) balances, minus the aggregate Market Value of Assets (MVA).”

While the formula to calculate a pension system’s unfunded liability is fairly straightforward, the assumptions that are made are not straightforward at all. The result is extremely sensitive to what annual rate-of return assumption is used. When the Institute applied a lower discount rate of 3.7%, the rate that CalPERS uses if an agency wants to exit their system, the unfunded liability tripled to $946 billion, an astonishing $75,000 worth of debt for every household in California. If this rate of return is so preposterously low, why is it the rate that CalPERS uses if an agency wants to exit their system?

But these numbers, as unaffordable as they seem, do not include unfunded retiree healthcare liabilities. A 2014 study of the 20 independent county pension systems by the California Public Policy Center, “Evaluating Total Unfunded Public Employee Retirement Liabilities in 20 California Counties,” indicates when bond debt and unfunded retiree healthcare benefits were added to the county systems, the total unfunded liability for retiree benefits in those counties almost doubled from $37 billion to $72 billion.

To create this mountain of debt CalPERS has been and continues to use several accounting gimmicks.

Smoothing of Investment Returns

Up until 2006 CalPERS smoothed its investment gains and losses over 4 years. Then in 2006 they went to a 15 year smoothing and beginning in 2015 they are moving to a 30 year smoothing. Extending smoothing significantly lowers unfunded liabilities and therefore employer and employee contributions, and passes the costs onto future generations.

Smoothing also masks CalPERS poor investment performances. CalPERS has been one of the worst performing pension funds in the nation with their investments returning only 5% from 2003 to 2013 and last year only 2.5%.

Here is how smoothing works. If the pension fund were to lose $100 million in investment assets in a year using the market value of assets the pension fund would show a $100 million loss from the previous year. But by using a 4 year smoothing the actuarial loss for that year would be $25 million carried forward 3 more years. Using 15 year smoothing the actuarial loss would drop to $6.6 million carried forward 14 more years. Using the new 30 year smoothing the $100 million loss would drop to $3.3 million carried forward 29 more years. Essentially using a 30 year smoothing takes investment returns out of the pension calculation formula. In other words, this is no way to reduce risk and a good way to increase unfunded liabilities.

Beginning in 2015/2016 CalPERS is dropping smoothing of stock market gains and losses and will move from a rolling to fixed amortization of the unfunded liabilities with the intent to pay off all the current unfunded liabilities over the next 30 years. This is still a long period of time to pay off the debts. Under federal ERISA rules for private pensions unfunded liabilities are paid off over 7 years.

Extending Debt Payments on the Unfunded Liabilities

As bad as 15 to 30 year smoothing is, there is more. Following the 2008 stock market crash and the loss of 30% of its assets, instead of amortizing the unfunded pension liabilities and paying them back over 9 years as they were doing, CalPERS went to a 30 year amortization.

This is similar to the difference between what you would pay monthly and over time on a 9 or 30 year mortgage, though a more appropriate comparison would be taking 30 years to pay off a credit card balance, since there is no asset with a useful life being purchased. With a 9 year mortgage your monthly payments are much higher than with a 30 year mortgage but the total cost over time with interest is significantly less over time. Worst of all, by doing this CalPERS is passing a mountain of debt, higher taxes and fewer services onto our children and grandchildren.

Using an Overly Optimistic Discount Rate

Pension funds use a discount rate on liabilities based upon the assumption that their investments are going to return an amount similar to the discount rate. Currently, most agencies use a 7.5% discount rate. However, that rate today is too high for 3 reasons; (1) fixed income investments are currently returning 4%, (2) stocks are projected to return under 7%, and (3) with a 75% funding ratio the pension fund does not have 100% of their liabilities in assets earning income. Taking into account these factors most experts would probably recommend CalPERS to use a 3.7% discount rate. They won’t, however, because as the Stanford study has shown it would triple unfunded liabilities, drastically increase annual pension payments by the employer, and show everyone that the current benefit levels are simply unaffordable. Adequately funding pensions under these assumptions would also push hundreds of California cities and counties into balance sheet insolvency and if more cash was required to be injected into the system as private pensions are required to do with their 90% funding level requirement, into bankruptcy.

CalPERS and Pension Reform

Recently CalPERS has been rushing to play up its good government bona fides just as talk of pension reform next year has been heating up. Earlier this month, former San Jose mayor Chuck Reed and former San Diego City Councilman Carl DeMaio filed two new initiative proposals for next year’s state ballot. CalPERS is right to be concerned, since polling numbers continue to show strong public support for pension reform.

The Reed DeMaio plans are not perfect reform since they only impact new hires, but they have the advantage of being put together by former officials who grasp the depth of the crisis. The CalPERS plan seems like an attempt to coopt pension reform. Given the skyrocketing costs they’re already facing, Californians need to be told the truth about the pension debt they and their children and grandchildren will be paying off for decades.

We need real pension reform now, but it’s not going to happen if public employee unions continue to oppose reform efforts and CalPERS continues to use accounting gimmicks to hide the enormous unfunded liabilities from taxpayers and government employees and retirees who have been promised unsustainable pensions the tax base simply can’t afford to pay.

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About the author:  Ken Churchill is the author of numerous studies on the pension crisis in California and is also the Director of New Sonoma, a pension reform group.

40 replies
  1. S Moderation Douglas says:

    “increase the pensions of safety employees from 2% to 3% per year of service retroactively”

    Often repeated and seldom understood. These are not set percentages, they are retirement FORMULAs.

    3 % @ 50 is a constant benefit factor. Once the employee reaches age 50, his pension will be his Final Average Salary time 3% times years of service, with a maximum of 90% of FAS.

    If he retires at 50 with 30 years service, pension will be 90%.
    If he retires at 55 with 30 years service, pension will be 90%.

    On the 2 % @ 50 formula:

    If he retires at 50 with 30 years service, pension will be 60%.
    If he retires at 55 with 30 years service, pension will be 81%.

    With either formula, if the officer retires at age 55 with 34 years service or more, his pension will be 90%.

    The SB 400 was a “fifty percent increase” ONLY for those who actually retire at age 50*, which is, as I understand, a very small percentage of retirees. Average retirement age for safety employees seems to be about 55.

    *I was told of one local pension system which actually increased miscellaneous pensions 50%, but can’t recall or find those formulas.

  2. Rex the Wonder Dog! says:

    Dougie, why are you so math challenged?????

    #1- a person retiring at age 50 with 90% vs 55 with 90% has a much more valuable pension because they will be collecting it for an additional 5 years.

    #2- NO ONE in real life even gets a DB pension, no one, except possibly a Fortune 50 company, and their DB pension is nothing close to 3%@50.

    #3- SB400 increased pensions- retroactively for no extra work or service- by 50%, and it does not matter WHAT AGE you retire at. A 50% retroactive bump is 50%. And it caused a mass exodus of public safety employees.

    #4- “On the 2 % @ 50 formula:”

    “If he retires at 50 with 30 years service, pension will be 60%.”
    “If he retires at 55 with 30 years service, pension will be 81%.”
    “With either formula, if the officer retires at age 55 with 34 years service or more, his pension will be 90%.”….

    Let me explain simple, 3rd grade, math you you Dougie. If a cop at age 55 retires with 30 years of service on a 2% multiplier he will NOT be at 81% as you have posted, he will be at 60%, just as if he retired at age 50 with 30 years of credit. If BOTH age groups, 50 and 55, retire with 34 years of credit their pension will be 2×34, or 68%.

    See how the multiplier works Doug? Try to keep up- OK. 🙂

  3. Tough Love says:

    SMD, You are correct, and few seem to understand that the 2%@50 formula was not really “fixed” at 2%, but with the 2% rising if you retied older (than 50) or stayed longer (than 20 years). That being said, CA’s making these pension changes “retrocactive” (i.e., applicable to PAST service) was an unconscionable THEFT of Private Sector Taxpayer wealth.

    And the reaction of Taxpayers must be to refuse to pay for it.

  4. John Moore says:

    The problem is that the current system is broke and no one is proposing a fix. We need to create a political way to fix this crisis and no one is articulating a plan that will fix it. Pension reformers, it is the time to describe what is necessary for real reform. As this article proves, it is a broke system and Reed/DeMaio reform(much like PEPRA) doesn’t provide substantial reform. Taxpayer Assns. get off of your rears and reform your local agencies by electing reformers.

  5. S Moderation Douglas says:

    comme ci comme ça

    Life is seldom so cut and dried. With any given formula, there are several factors in computing pensions: age at retirement, years of service, and final average salary.

    I have said several times that I would have been much better off if in 1999, instead of SB400, California had passed an automatic annual COLA tied to CPI.

    My pre 1999 formula was 2%@60, changed to 2%@55 via SB400. At age 63, since both are graduated formulae, the difference is only about 3%.

    Most state workers lost much more than 3% from 1999 through 2012 as a failure to keep up with CPI. The LAO data shows general salary increases through 2007-08. There were no further increases until 2012. Since my (and others) pension was calculated on the lower salary, it was a net benefit for the taxpayer.

    http://www.lao.ca.gov/analysis_2007/general_govt/gen_21_9800_anl07.aspx

    Figure 2
    State Civil Service
    General Salary Increases
    ___________________________

    Yes, I realize there was a recession or two in that time period and things were rough for a lot of people. But. Generally, private sector nominal salaries have kept in step with the CPI although real wages have stayed flat.

    “For most workers, real wages have barely budged for decades”
    (Pew Research Center, Oct. 9, 2014)

    Not so much state salaries. “General salary increases” are sporadic, at best. Nominal wages here have not increased with CPI, so “real wages” have decreased.
    Luckily for me, my wife’s private sector salary was one of those that rose with the CPI.

  6. SeeSaw says:

    Rex, be careful about being so arrogant–the 2% at 50 formula might have been increasing incrementally after age 50–in fact i bet it does. I once had the 2% at 60 formula–that formula increased incrementally past 2% at age 60, topping out at 2.418% at age 63. With state employees, the 2% at 60 formula increased incrementally to 2.5% at age 63. All this was prior to PEPRA, of course.

  7. SeeSaw says:

    There you go, SMD! I had replied to Rex before I saw your post.

    More on the 3% formula–The firefighters who still have the 3% at 50 formula at my former workplace had volunteered to be changed to 3% at 55, because they are not going to retire at age 50, and the CalPERS fees would be less with the latter. Unfortunately it would take new state legislation to allow my former employer to enact that latter formula on the existing employees and they haven’t been able to get sponsorship of legislation to do that.

  8. SeeSaw says:

    The answer to a fix is for the principals to solve the problems at the bargaining table. When I attended the CalPERS CA dialogue in 2010, at the L.A. Convention Center, there were speakers from all over the state and WA D.C. David Crane and others were among them. The consensus of the participants at the end of that day was that the problems would need to be solved at the, respective, bargaining tables. Since the size of the pensions are based on the size of the salaries, it is up to the respective entities and their participants to go to work. The “reformers” want to decapitate the DB pensions–certainly no answer.

  9. SeeSaw says:

    I still ask other commenters–“what are the pensions costing you personally?” Nobody ever gives me an answer to that question. I suspect that the taxpayers’ liability stays the same regardless of whatever circumstances are occurring in the, respective, public entities. At my former employer–many of my former colleagues have been laid off in mid-career so that the level of services provided to the public is not impacted. New people have been hired into those former full-time jobs, some at 36 hrs./per week, and they are considered “hybrid” employees–they get the same benefits as the other employees, with the exception of CalPERS! That is the deplorable solution that has occurred where I formerly worked. My former employer has as exemption that allows it not to have to put these “hybrid” employees on CalPERS! So there it is Mr. Moore–solutions are being enacted–and they are not pretty!

  10. SeeSaw says:

    Nobody said anything about retroactive increases prior to the great recession of 2008, TL. Prior to that, all pension increases in the state of CA throughout the years of the existence of the DB pension plans, were enacted retroactively.

  11. Tough Love says:

    Sponsorship? As thought ANY legislation curtailing the grossly excessive Public Sector pensions could pass (even IF sponsored) with an In-The-Union’s-Pocket Democratic Legislature (always with their hands extended for more Public Sector union campaign contributions) in the majority.

  12. Tough Love says:

    Ending DB pensions for the FUTURE Service of all CURRENT workers is the ONLY “effective” solution. ….. that doesn’t continue to financially rape CA’s taxpayers.

  13. S Moderation Douglas says:

    I’ve explained this at least a dozen times on various boards SeeSaw. If the dog sees the post, he always responds the same way. Even though I have posted the link to the formulas. It’s not rocket surgery, but apparently above the ken of the puppy.

  14. SeeSaw says:

    A legislator has to carry the legislation TL. This particular issue is not one that would even cause a flutter. You don’t live in CA and you purport to know all there is to know about the political doings here. You should probably just turn your attention to the business going on in NJ which would affect you. You will not be affected whatever happens with the working people in CA.

  15. Tough Love says:

    The real thieves are the “enablers’ …. the elected officials and management (CalPERS included) who KNOWINGLY granted pensions and benefits that were unnecessary, unjust, unfair to taxpayers and clearly VERY costly & unaffordable, and who colluded to hide the true cost of Bills with RETROACTIVE pension increases like SB400.

  16. Rex the Wonder Dog says:

    Nobody said anything about retroactive increases prior to the great recession of 2008, TL. Prior to that, all pension increases in the state of CA throughout the years of the existence of the DB pension plans, were enacted retroactively.
    ==
    Total, 100% WHOIPPER lie, everyone said retroactive increases were a SCAM. And besides, CalTURDS withheld material information on SB400, resulting in massive fraud. Those losers running that scam are lucky they are not in a federal prison for RICO violations.

  17. Rex the Wonder Dog says:

    2 % @ 50 incrementally increases to 2.7 % @ 55
    ==
    I was wrong, I did not know they increased the multiplier after age 50. I cannot believe it, Dougie was right, for once!

  18. Rex the Wonder Dog says:

    The answer to a fix is for the principals to solve the problems at the bargaining table.
    ==
    The scam was never hatched at the bargaining table, and it should not be required to end the scam, simple. Fraud is fraud.

  19. Rex the Wonder Dog says:

    I still ask other commenters–“what are the pensions costing you personally?”
    ==
    Straw man argument.

    It does not matter WHAT they cost each person (but I have read $75K PER household), it is the COLLECTIVE cost.

  20. Rex the Wonder Dog says:

    New people have been hired into those former full-time jobs, some at 36 hrs./per week, and they are considered “hybrid” employees–they get the same benefits as the other employees, with the exception of CalPERS! That is the deplorable solution that has occurred where I formerly worked. My former employer has as exemption that allows it not to have to put these “hybrid” employees on CalPERS!
    ==
    So leeches like you are in effect STEALING from the younger generation, because the CalTURDS scam cannot be afforded to apply to EVERYONE. Shame on you seesaw.

  21. SeeSaw says:

    I don’t tell lies, whopper, or otherwise Rex. If you take the trouble to find the Amicus Brief that the former AG Brown filed with the LA Superior Court on behalf CalPERS members regarding OC vs.the OC Sheriffs you could see that AG Brown states in that brief that it was standard procedure in the State of CA to enact pension upgrades retroactively.

  22. SeeSaw says:

    It was up to the individual bargaining groups and the, respective, employing entities to adopt the new formulas or not. Many entities never adopted them. The state never adopted the 3% formula for miscellaneous employees and it was sparsely adopted for miscellaneous city and county employees throughout the state. So you are wrong when you say that the bargaining groups are not stakeholders in the process at all steps.

  23. SeeSaw says:

    Oh come off it! I have nothing to do with the fact that these new people are not being covered. I deplore that situation as much as anybody!

  24. SeeSaw says:

    Well, the bottom line question is? “Are you sustainable?” If you are going to talk about collective cost, everything in life is collective–nothing new. We would all be shocked if we totaled up individual amounts we have spent on any one thing. I paid weight watchers $1500 while shedding my extra weight–while I was doing it, $43/mo.was not a stretch.

  25. SeeSaw says:

    You can look at it anyway you want. If you prefer to whine and moan continuously about unfair everything is, go right ahead. In the meantime your sordid life will continue, until it doesn’t.

  26. SeeSaw says:

    CalPERS is open to any public employee. Is is up to each individual employer-member to make the decision on how to cover the, respective, employees–or not.

  27. SeeSaw says:

    Here is exact wording on the part of former AG Brown in that Brief: “Thus, including prior years of public service to calculate benefits has been a fundamental part of public employees’ pension benefits for at least the past 97 years”.

  28. Rex the Wonder Dog says:

    If you take the trouble to find the Amicus Brief that the former AG Brown filed with the LA Superior Court on behalf CalPERS members regarding OC vs.the OC Sheriffs you could see that AG Brown states in that brief that it was standard procedure in the State of CA to enact pension upgrades retroactively.
    ==
    What you said was “Nobody said anything about retroactive increases prior to the great recession of 2008, TL.” That was a LIE, all kinds of people said it was a scam, BEFORE 2008. I was saying it back in 2003. So were thousands of others, You LIED seesaw. And Klown’s brief in the OC pension case has nothing whatsoever to do with your lie comment.

  29. S Moderation Douglas says:

    Douglas says: December 17, 2012 at 7:32 am

    “CalWatchdog adheres to the Code of Ethics of the Society of Professional Journalists.”

    And yet we begin with a Reedism in the FIRST SENTENCE:

    “a 50 percent retroactive giveaway to all state employees in 1999″

    wrong
    ________________________________________________

     Rex the Wonder Dog! says: December 17, 2012 at 8:35 am

    “a 50 percent retroactive giveaway to all state employees in 1999″
    wrong

    Google SB400. 100% correct
    ______________________________________________
    Douglas says: December 17, 2012 at 9:55 am

    http://www.calpers.ca.gov/eip-docs/about/pubs/member/your-benefits-your-future-state-safety-benef.pdf

    Page 29: 2% @ 50: A “typical” safety worker, retiring at 55 (or over)with 30 years service will receive 81% of his final salary
    _______________________________________

    http://dropafile.com/calwatchdog/calpers-new-shtick-ripping-calpers-ripping-retirees-groan/comment-page-1/#comments

  30. Ken Churchill says:

    Retroactive pension increases became legal in 2001 with the enactment of SB 616. The cap on pensions was raised from 2% to 3% per year of service under SB 1696. This never would have happened without these two bills being signed by Governor Gray Davis.

    These 2 bills paved the way for SB 400 which created the 3% at 50 retroactive increase for safety employees.

    Then the recession hit and we had the double wammy that gave us the debt we have today. Now, for pension funds to hit in investment returns to keep this debt from continuing to increase at these funding levels and todays low interest rates, the stock market will need to double over the next 5 years, and then double again in 5 more years. Think the S&P 500 will hit 8,000 in 10 years? That is what they are saying and betting on.

  31. Kevin K says:

    I’m no finacial or economic expert but it doesnt take one to see how paying people +60% of their salary for 30 years of serivce and allowing them to collect as early as 55 is not a sustainable system. Especially with increasing longevity. Some of the female teachers I met may live to be in there 90’s and the district I worked in was quite wealthy. In 2013 teachers with 30 years of service were making $90,000 a year. 60% of that for 25-35 years. That’s only one example to, the prison guards and general staff, another high salaired industry. Just check out transparencalifornia.com and look at some of the salaries and pensions. Common sense will tell you this is a big bubble waiting to pop. Good article.

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