Orange County Pensions At Risk – Unions Just Call Critics “Extremists”

“Just as the overseer of Detroit lied to the public about Detroit’s unfunded pension liability, these extremists are likewise lying to the taxpayers of Orange County, and they’re following his playbook.”
–  Jennifer Muir, Communications Director, Orange County Employees Association

We’re not lying, Jennifer. We’re not even stretching the truth.

What government union spokesperson Muir is referring to is an analysis released last week by the California Public Policy Center entitled “Are Annual Contributions Into Orange County’s Employee Pension Plan Adequate?

They aren’t adequate. They aren’t even close to adequate. No lie.

The problem with pensions, unfortunately, as Teri Sforza aptly put it in her coverage of the CPPC study on September 10th in the Orange County Register, is “the nature of America’s public pension systems is to peer 20 to 30 years into the future – and the crystal ball can get a bit murky.”

And hiding behind this convenient murkiness, defenders of the system – inadequate payments included – can call anyone concerned about the long-term solvency of the system “liars,” and “extremists.”

It’s much easier, and certainly much more effective, to disparage the critics than grapple with facts. But anyone familiar with the real estate and credit crash of 2008 should understand that ignoring financial fundamentals is a dangerous game. Here are the financial facts:

As of 12-31-2012 the Orange County Employee Retirement System had invested assets of $9.47 billion. For the plan to be fully funded, those assets needed to be equal to the liabilities; defined as the present value of the system’s financial obligation to pay all active participants – working and retired – retirement pensions. Here’s where the crystal ball gets murky – because how big that liability is today depends on what rate of interest the assets will earn each year, for the next 20-30 years. At a projected rate of return of 7.25%, those liabilities are valued at $15.14 billion. Underfunding = Assets – Liabilities.

OCERS is officially underfunded – according to their own annual report, by $5.67 billion. No lie. Fact.

Now it is fair to argue over what rate of return is truly realistic. But even if we use a higher rate, say, 7.5%, that liability only shrinks to $14.69 billion. Put another way, if you increase the projected rate of return by one-quarter of a percent, your unfunded liability will go from $5.67 billion down to $5.22 billion.

To verify these numbers, download the spreadsheet created by CPPC analysts and see for yourself. Go to table 1 “unfunded liability” and enter .075 in the yellow highlighted cell D23, and look at the result in the green highlighted cell D26. To construct this spreadsheet, the CPPC relied on those extremists at Moody’s Investor Services, whose formulas are meant to provide credit analysts with accurate tools to perform what-if analysis.

The point of all this?

In order to pay down their unfunded liability of $5.67 billion – or $5.22 billion if you want to use something approximating the union’s number – during 2012 OCERS contributed $218 million. Was that enough?

If there were no interest at all on this unfunded liability, at a rate of $218 million per year, it would take OCERS 26 years to pay off $5.67 billion; 24 years to pay off $5.22 billion. But it isn’t that simple.

Pension plans like OCERS rely on investment returns for most of their annual contributions. The assets they’ve got invested are supposed to earn – presumably – 7.25% per year. Investment returns, not contributions, are the intended source for most of the money OCERS needs to fund current and future pension payments. And if OCERS were fully funded, their investments would be earning $1.1 billion each year, that’s $15.14 billion times 7.25%. But because OCERS was only 63% funded in 2012, because they only had $9.14 billion of invested assets, at their projected rate of return of 7.25% they would only have earned $687 million. To earn the required $1.1 billion, at a 63% level of funding OCERS would have to have earned 11.6% – and they would have to do that every year just to avoid going further in the hole.

Does anyone really think OCERS is going to average a return of 11.6% per year for the next 25 years? Should only “liars” and “extremists” be concerned?

The reason OCERS got away with contributing a mere $218 million during 2012 towards a liability of $5.67 billion is because they intend to eventually increase these annual payments. Meanwhile, OCERS CEO Steve Delaney acknowledged that during 2012 the OCERS unfunded liability experienced “negative amortization,” despite better than normal investment returns. How much do these payments need to increase?

If OCERS were serious about restoring adequate funding, they would adopt the recommendations of Moody’s Investor Services – those extremists with the green eye shades – who in April 2013 called for a “20 year level payment” plan for reducing the unfunded liabilities of pension plans. At 7.25%, that would equate to $546 million per year. And if reality reveals over time that OCERS can only earn 6.2% per year on average, that payment would increase to $685 million per year. By this reasoning, the OCERS unfunded contribution was well over $300 million short in 2012, and the longer they wait to increase their annual unfunded contribution, the greater – above and beyond $300 million – the required increase.

By adopting graduated repayment schedules instead of telling the truth about just how perilous the situation is for OCERS, defenders of the status quo are putting the entire system at risk of a complete collapse. They are committing precisely the same unsustainable excess as the issuers of subprime mortgages ten years ago – financial instruments with graduated payment plans that mislead borrowers into thinking they could buy things that they couldn’t possibly afford.

Jennifer Muir, Nick Berardino, and others who have been outspoken critics of pension reformers, are invited to download the spreadsheet the CPPC has produced to evaluate the financial health of OCERS. Before trotting out the insults, perhaps they might first familiarize themselves with the liberating reality of algebra, a discipline that is indifferent to lies, extremism, and all other flights of wishful fancy.

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Ed Ring is the executive director of the California Public Policy Center, and the editor of UnionWatch.

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