When evaluating the financial challenges facing California’s state and local public employee pension funds, a compelling question to consider is when, exactly when, will these funds financially collapse? That is, of course, an impossible question to answer. CalPERS, for example, manages hundreds of billions in assets, which means that long before it literally runs out of cash to pay benefits, tough adjustments will be made that will restore it to financial health.
What is alarming in the case of CalPERS and other public sector pension funds, however, is the relentless and steep rate increases they’re demanding from their participating employers. Equally alarming is the legal and political power CalPERS wields to force payment of these rate increases even after municipal bankruptcies where other long-term debt obligations are diminished if not completely washed away. Until California’s local governments have the legal means to reform pension benefits, rising pension contributions represent an immutable, potentially unmanageable financial burden on them.
SOUTH PASADENA’S PAYMENTS TO CALPERS ARE SET TO DOUBLE BY 2025
The City of South Pasadena offers a typical case study on the impact growing pension costs have on public services and local taxes. Using CalPERS own records and official projections, the City of South Pasadena paid $2.8 million to CalPERS in their fiscal year ended 6/30/2017. That was equal to 25% of the base salary payments made in that year. By 2020, the City of Pasadena is projected to pay $4.3 million to CalPERS, equal to 35% of base pay. And by 2025, the City of Pasadena is projected to pay $5.9 million to CalPERS, equal to 41% of base pay.
Can the City of South Pasadena afford to pay an additional three $3.0 million per year to CalPERS, on top of the nearly $3.0 million per year they’re already paying? They probably can, but at the expense of either higher local taxes or reduced public services, or a combination of both. But the story doesn’t end there. The primary reason required payments to CalPERS are doubling over the next few years is because CalPERS was wrong in their estimates of how much their pension fund could earn. They could still be wrong.
Annual pension contributions are calculated based on two factors: (1) How much future pension benefits were earned in the current year, and how much money must be set aside in this same year to earn interest and eventually be used to pay those benefits in the future? This is called the “normal contribution.” (2) What is the present value of ALL outstanding future pension payments, earned in all prior years by all participants in the plan, active and retired, and by how much does that value, that liability, exceed the amount of money currently invested in the pension fund? That amount is the unfunded pension liability, and the amount set aside each year to eventually reduce that unfunded liability to zero is called the “unfunded contribution.”
Both of these annual pension contributions depend on a key assumption: What rate-of-return can the pension fund earn each year, on average, over the next several decades? And it turns out the amount that has to be paid each year to keep a pension fund fully funded is extremely sensitive to this assumption. The reason, for example, that CalPERS is doubling the amount their participating employers have to pay each year is largely because they are gradually lowering their assumed rate of return from 7.5% per year to 7.0% per year. But what if that isn’t enough?
IF THE RATE-OF-RETURN CALPERS EARNS FALLS, PAYMENTS COULD RISE MUCH HIGHER
It isn’t unreasonable to worry that going forward, the average rate of return CalPERS earns on their investments could fall below 7.0% per year. For about a decade, nearly every asset class available to investors has enjoyed rates of appreciation in excess of historical averages. Yet despite being at what may be the late stages of a prolonged bull market in equities, bonds, and real estate, the City of South Pasadena’s pension investments managed by CalPERS were only 73% funded. As of 6/30/2017 (the most recent data CalPERS currently offers by agency), the City of South Pasadena faced an unfunded pension liability of $35 million. Using CalPERS own numbers, if they were to earn 6% per year on their investments in the coming years, instead of their new – and just lowered – annual return of 7%, that unfunded liability would rise to $58 million.
As it is, by 2025 the City of South Pasadena is already going to be making an unfunded contribution that is nearly twice their normal contribution. Another reason for this is because CalPERS is now requiring their participating agencies to pay off their unfunded pension liabilities in 20 years of even payments. Previously, attempting to minimize those payments, agencies had been using 30 year payoff terms with low payments in the early years. Back in 2017, based on a 6% rate-of-return projection, and in order to pay off a $58 million unfunded pension liability on these more aggressive repayment terms, the City of South Pasadena would have to come up with an unfunded pension contribution of $5.0 million per year, along with a normal contribution of around another $2.4 million per year.
But why should it end there? Nobody knows what the future holds. These rate-of-return projections by definition have to be “risk free,” since otherwise – and as has happened – taxpayers have to foot the bill to make these catch up payments. How many of you can rely on a “risk free” rate-of-return,” year after year, for decades, in your 401K accounts of six percent, or even five percent? At a 5% rate-of-return, the City of South Pasadena would have to pay an unfunded contribution of $6.2 million, along with a normal contribution of $2.8 million.
These scenarios are not outlandish. Most everyone hopes America and the world are just entering a wondrous “long boom” of peace and prosperity, ushered in by ongoing global stability and technological innovations. But the momentum of history is not predictable. Imagine if there was an era of deflation. It has happened before and it can happen again. The following chart shows how that might play out in the City of South Pasadena. Notice how at a 4% rate-of-return projection, in 2017 the City of South Pasadena would have had to pay CalPERS $9.8 million; at 3%, $11.4 million.
City of South Pasadena – FYE 6/30/2017
Estimated Pension Payments and Pension Debt at Various Rate-of-Return Projections
And what about the rest of California? How would a downturn affect all of California’s public employee pension systems, the agencies they serve, and the taxpayers who fund them? In a CPC analysis published earlier this year, “How to Assess Impact of a Market Correction on Pension Payments,” the following excerpt provides an estimate:
“If there is a 15% drop in pension fund assets, and the new projected earnings percentage is lowered from 7.0% to 6.0%, the normal contribution will increase by $2.6 billion per year, and the unfunded contribution will increase by $19.9 billion. Total annual pension contributions will increase from the currently estimated $31.0 billion to $68.5 billion.”
That’s a lot of billions. And as already noted, a 15% drop in the value of invested assets and a reduction in the estimated average annual rate-of-return from 7.0% to 6.0% is by no means a worst case scenario.
To-date, meaningful pension reform has been thwarted by powerful special interests, most notably pension funds and public sector unions, but also many financial sector firms who profit from the status quo. But a case to be decided next year by the California Supreme Court, Cal Fire Local 2881 v. CalPERS, may provide local agencies with the legal right to make more sweeping changes to pension benefits. The outcome of that ruling, combined with growing public pressure on local elected officials, may offer relief. For this reason, it may well be that raising taxes and cutting services in order to fund pensions may be a false choice.
CalPERS Annual Valuation Reports – main search page
CalPERS Annual Valuation Report – South Pasadena, Miscellaneous Employees
CalPERS Annual Valuation Report – South Pasadena, Safety Employees
CalPERS Annual Valuation Report – South Pasadena, Miscellaneous Employees (PEPRA)
CalPERS Annual Valuation Report – South Pasadena, Safety Employees, Fire (PEPRA)
CalPERS Annual Valuation Report – South Pasadena, Safety Employees, Police (PEPRA)
Moody’s Cross Sector Rating Methodology – Adjustments to US State and Local Government Reported Pension Data (version in effect 2018)
California Pension Tracker (Stanford Institute for Economic Policy Research – California Pension Tracker
The State Controller’s Government Compensation in California – main search page
The State Controller’s Government Compensation in California – South Pasadena payroll
The State Controller’s Government Compensation in California – raw data downloads
California Policy Center – Resources for Pension Reformers (dozens of links)
California Policy Center – Will the California Supreme Court Reform the “California Rule?” (latest update)
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California law prohibits government officials from using taxpayer dollars “for the purpose of urging the support or defeat of any ballot measure.” But on February 13, in the meeting room of the Santa Ana Unified School District, school officials revealed a political campaign that began with shaping public opinion and will end in November with a district-wide vote on a bond measure that will cost residents hundreds of millions of dollars.
Under the guise of measuring public opinion, Santa Ana school officials are trying to shape it – and they’re using taxpayer dollars to pay for it.
In April and May, Santa Ana Unified School District officials papered the city with mail that looks like a poll. The direct-mail campaign included questions about how residents would spend $479 million to “support high quality instruction, repair deteriorating facilities, provide modern science labs, replace failing heating and ventilation systems, and replace portable classrooms.”
Officials asked the questions in anticipation of a district-wide vote on a multi-million-dollar bond. On a 4-1 vote last month, the district’s board of trustees placed the bond on the November ballot.
State law allows government officials to communicate nonpartisan information, but not to engage in politicking.
“This mailing was neither a scientific survey or a poll or mere educational outreach,” said Will Swaim of the California Policy Center. “It was a push poll, an attempt by Santa Ana Unified officials to persuade voters, and that would be illegal under state law.”
A push poll is meant to promote a political message under the pretense of collecting public feedback.
The Santa Ana survey is part of a broader trend in California politics. “It’s now common for local officials seeking tax increases or bond issues from voters to hire campaign consultants on the fiction that they will provide unbiased information to the voting public,” said veteran political commentator Dan Walters.“These consultants conduct polling to determine which angles of proposals are most attractive to voters, write the measures to stress those popular features and then produce literature and ads to trumpet those selling points.”
On first glance, the Santa Ana mailing looks like an actual survey. The front page states, “Santa Ana Unified School District wants to hear from you.” On the second page, respondents are told that “developing a plan for the future of our schools should be a community-driven process.”
But the “survey” strongly implies that the bond is essential – and that it’s so likely to succeed at the polls in November that voters should start thinking about how they’d like to spend hundreds of millions of dollars.
These millions will come from Santa Ana residents and businesses – a fact the district downplays.
A bond is a loan that will be repaid by local taxpayers over a period of years. Public officials have priced the November bond all over the map – from $479 million when they first launched it, they soon raised the price tag to $518 million. More recently, without explanation, the district announced the bond was $232 million. None of those numbers include interest payments that will double the cost to taxpayers. The district is still paying off two previous bonds.
“Santa Ana’s campaign strategy is a little like sending your kids a bill in January for all the toys you gave them in December,” said Swaim. “Everybody’s excited to think about spending. It’d be great if district officials told their residents about the costs to individuals and businesses.”
One of the first things respondents saw on the April-May survey was a message in capital letters: “Improving the Quality of Local Schools.” The accompanying note from the district superintendent emphasizes the district’s pressing need for more cash.
Further, the survey asks respondents to rank their priorities on bond spending. The menu of options ranges from upgrading classrooms and repairing deteriorating roofs and electrical systems, to replacing failing heating and ventilation systems.
Critics say the district’s approval of every proposed teacher pay raise and rising pension debt is consuming so much money that almost nothing is left for facility maintenance or hiring new teachers. Hence, the November bond.
“Santa Ana can ill afford another tax increase,” says Art Pedroza, a Santa Ana resident and publisher of the website New Santa Ana. “Our residents include many seniors on fixed incomes and young families struggling to survive. This latest bond measure will raise their cost of living.
“Ultimately this bond measure is a gift to the unions at taxpayer expense.”
Kelly McGee is a Rhodes College (Memphis) graduate and CPC journalism intern.
It’s 1999, and Bill Clinton is one year removed from his affair with Monica Lewinsky becoming public. Destiny’s Child is a hit with its single “Bills, Bills, Bills,” and the San Antonio Spurs have won the NBA championship. Meanwhile, the Santa Ana Unified School District (SAUSD) is proposing a $145 million bond measure to fund the construction of 13 new schools, replace portables with permanent classrooms, and renovate facilities.
The measure passed. A few years later, it was revealed the district hadspent $450 million building just five schools instead of the 13 promised.
Flash forward to 2008. The New York Giants beat the undefeated Patriots, Katy Perry is on top of bubblegum radio with the hit single “I Kissed a Girl,” Barack Obama becomes the first African American president – and SAUSD is pushing forward yet another bond, Measure G.
Almost a mirror image of Measure C, that bond was also successful. An independent auditor says Measure G funds were handled more responsibly than Measure Cfunds. But there’s still this weirdness: The $200 million generated by Measure G targeted precisely the same problems that were supposed to have been corrected under Measure C – the replacement of portable classrooms with permanent buildings, and implementing upgrades to facilities throughout the district. Both bonds won’t be paid off until 2040. That’s three more decades of higher taxes.
Now it’s 2018. Donald Trump is president, the Houston Astros are the defending World Series champs – and there’s another SAUSD bond measure. Depending on which day you talk to district officials, the proposed November 2018 bond measure would raise either $479 million, $518 million or, most recently, $232 million. The purpose of this new bond? You guessed it: fix deteriorating roofs, upgrade older schools, and, yes, replace portable classrooms with permanent ones.
In 19 years, SAUSD has proposed three bonds at a cost of more than a billion dollars (counting interest) – and is still unable to fix those portables or maintain its other facilities. At the same time, they have told state officials their facilities (the very facilities they say are in need of an upgrade) are good or even exemplary. In the meantime, government union-backed trustees have ignored official warnings of a looming financial crisis.
The country has changed so much since 1999, but not the SAUSD. There’s clearly a problem in Santa Ana that more tax dollars won’t fix.
Kelly McGee is a Rhodes College graduate and a journalism intern at California Policy Center.
School officials in California’s sixth-largest school district are working overtime to promote a massive $1.2 billion bond tentatively scheduled for a districtwide vote in November. Yet behind their chatter about improving Santa Ana Unified facilities is a stark fact: Student enrollment there has been falling steadily for over 15 years. And declining enrollment means declining revenue from federal, state and local sources – about $10,000 per student. But at the same time, district spending, particularly on teacher salaries and benefits, has been rising. Where those two trends intersect – falling revenue, rising costs– is crisis.
Just last summer, the crisis claimed its first victims when the district declared it would have to lay off 287 teachers. The same teacher’s union that had pushed for the pay increases that precipitated the crisis helpfully provided district officials with the hit list – all of it based on one metric only: the last hired were the first fired.
But the crisis didn’t begin in 2017. An SAUSD demographer’s 2016 report illustrates a steady decline in SAUSD enrollment starting in 2003. That year, total student enrollment was 60,973. By 2012, enrollment had fallen to 53,493. This equates to an approximately 12% drop in enrollment and a $75 million loss in revenue. Long-range projections through this school year predict that the decline will continue.
As recently as June 26th — school trustees backed by the powerful teaches union approved regular annual salary increases. In addition to this most recent salary increase, teacher salaries were also raised from 2013-2015.
Losing cash, union-backed trustees ordered district staff to find a solution. Facilities maintenance was delayed. Major renovations were impossible. And so they settled on the November bond.
A bond is basically an IOU — the district’s promise that it will repay Wall Street lenders interest on a multi-million-dollar loan. District officials first pegged the amount of the loan at $479 million – enough, they said, to repair damage created by time and mismanagement. But in the past few weeks the amount of the bond has fluctuated from $518 million back down to $232 million. Neither figure includes interest payments on the loan, which will more than double its cost.
Santa Ana Unified hasn’t even finished paying off two existing loans, from 1999 and 2008. They should be paid off by 2040. By that time, last month’s graduates will be about 40 years old, some with children of their own attending Santa Ana schools that will boast well-paid adults, falling test scores, failing infrastructure – and perhaps still laboring beneath hundreds of millions of dollars in repayments on the Great Bond of 2018.
Kelly McGee is a Rhodes College graduate and a journalism intern at California Policy Center.
Call it a tale of two school districts: The Santa Ana Unified School District (SAUSD) is sending out conflicting messages regarding the status of its schools: their facilities are amazingly good — unless they’re amazingly bad.
According to the School Accountability Report Cards (SARCs) posted on the SAUSD website, all of the district’s high schools are in “good” or even “exemplary” shape. But in promoting a bond measure on the November ballot, district officials say they’re struggling with “deteriorating systems.”
SARCs are state-required reports meant to provide parents and community members with an update of local school facilities. Schools are rated on such safety measures as fire hazards, structural integrity, overall cleanliness, and electrical/water systems.
SAUSD rated six of their 10 high schools “exemplary,” and declared the other four “good.” Yet the SAUSD Twitter account paints a different, very bleak picture. In promoting a $479 million bond measure on the November ballot, the district says its campuses are plagued by failing heating and ventilation systems, aging portable classrooms, and “deteriorating systems.”
Further, surveys sent out by the SAUSD to potential voters ask respondents to rank priorities in spending money from the proposed bond: upgrading classroom facilities, repairing deteriorating roofs and electrical systems, replacing failing heating and ventilation systems, and other measures. That catalogue of collapsing structures fails to match with the SARC reports in every way possible.
The surveys are part of a high-priced campaign managed by TBWB, the district’s bond consultant. They’re intended to excite voters about the potential of state-of-the-art facilities becoming a reality in the district.
SAUSD parents and community members need to know the truth behind these contradictions. The schools are either in exemplary condition or deteriorating. Or perhaps they’re deteriorating in exemplary fashion.
Kelly McGee is a Rhodes College graduate and a journalism intern at California Policy Center.
When speaking about pension burdens on California’s cities and counties, a perennial question is how much are the costs going to increase? In recent years, California’s biggest pension system, CalPERS, has offered “Public Agency Actuarial Valuation Reports” that purport to answer that question. Notwithstanding the fact that CalPERS predictive credibility is questionable – i.e., they’ve gotten it wrong before – these reports are quite useful. Before delving into them, it is reasonable to assert that what is presented here, using CalPERS data, are best case scenarios.
In partnership with researchers at the Reason Foundation, the California Policy Center has compiled the data for every agency client of CalPERS, including 427 cities and 36 counties. In this summary, that data has been distilled to present two sets of numbers – payments to CalPERS for the 2017-2018 fiscal year, and officially estimated payments to CalPERS in the 2024-25 fiscal year. In calculating these results, the only assumption we made (apart from the assumptions made by CalPERS), was for estimated payroll costs in 2024. We used a 3% annual growth rate for payroll expenses, the rate most commonly used in official actuarial analyses on this topic.
So how much more will cities and counties have to pay CalPERS between now and 2024? How much more will pensions cost, six years from now?
On the table below, we provide information for the 20 cities that are going to be hit the hardest by pension cost increases. To view this same information for all cities and counties that participate in the CalPERS system, download the spreadsheet “CalPERS Actuarial Report Data – Cities and Counties.”
CalPERS Actuarial Report Data
The Twenty California Cities With the Highest Pension Burden ($=M)
If you are a local elected official, or if you are an activist, journalist, or anyone else with a keen interest in pensions, these tables merit close scrutiny. Because they not only show costs estimates today, and seven years from now, but they break these costs into two very distinct areas – the so-called “normal” costs, which are how much employers have to pay into the pension fund for current workers who are vesting one more year of future benefits, and the “catch-up” costs, which are what CalPERS charges employers whose pension plan is underfunded.
Take the first city listed, Millbrae. By 2024, we predict Millbrae will have the highest total pension payments of any city in California that belongs to the CalPERS system.
The table presents are two blocks of data – the set of columns on the left show current costs for pensions, and the set of columns on the right show the predicted cost for pensions. In all cases, the cost in millions is shown, along with the cost in terms of percent of total payroll.
Currently, as can be seen on the table, for every dollar it pays active employees in base wages, Millbrae must contribute 59 cents to CalPERS. This does not include payments to CalPERS that Millbrae collects from its employees via withholding. The same data show that, by 2024, for every dollar Millbrae pays active employees in base wages, they will have to contribute 89 cents to CalPERS. Put another way, while Millbrae may expect its payroll costs to increase by $1.4 million, from $6.3 million today to $7.7 million in six years, their payment to CalPERS will increase by $3.1 million, from $3.7 million today to $6.8 million in 2024.
But here’s the rub. Nearly all of this increase to Millbrae’s pension costs are the “catch-up” payments on the city’s unfunded liability. In just six years Millbrae’s payment on its unfunded liability will increase by 99%, from $2.9 million today to $5.8 million in 2024.
What are the implications?
It is difficult to overstate how outrageous this is. Here’s a list:
1 – Virtually every pension “reform” over the past decade or so has exempted active public employees from helping to pay down the unfunded liability via withholding. Instead, their increased withholding – in some cases supposedly rising to “fifty percent of pension costs” (the PEPRA reforms) – only apply to the normal contribution.
2 – In order to appease the unions who, quite understandably, lobby for the lowest possible employee contributions to pension funds, the “normal cost” is calculated based on financially optimistic projections. The less time an actuary predicts a retiree will live, and the more an actuary predicts investments will earn, the lower the normal contribution.
3 – In order to cajole local elected officials to agree to pension benefit enhancements, the same overly optimistic, misleading projections were provided, duping decision makers into thinking pension contributions would never become a significant burden on cities and counties, and by extension, taxpayers.
4 – Because cities and counties couldn’t afford to pay down the growing unfunded liabilities attached to their pension plans, tricky accounting gimmicks were employed, where minimal catch-up payments were made in the present in exchange for bigger catch-up payments in the future. The closest financial analogy to what they did would be the “negative amortization” mortgages that were popular prior to the housing crash of 2008.
5 – The consequence of this chicanery is that today, as can be seen, catch-up payments on the unfunded liability are typically two to three times greater than the normal contribution. And it’s getting worse. In 2024, Millbrae, for example, will have a catch-up contribution that is nearly six times as much as their normal contribution.
6 – When a normal contribution isn’t enough, and the plan becomes underfunded, the level of underfunding is compounded every year because there isn’t enough money in the fund earning interest. The longer catch-up payments are deferred, the worse the situation gets.
Yet the normal contribution has always been represented as all that should be required for pension plans to remain fully funded. Just how bad it has gotten can be clearly seen on the table.
Take a look at Pacific Grove, fourth on the list of CalPERS cities with the highest pension burden. Pacific Grove is already paying 40 cents to CalPERS for every dollar it pays to its active employees. But in six years, that amount will go up to 75 cents to CalPERS per dollar of salary to active employees. And take a look at where the increase comes from: Their catch-up payment goes from 1.7 million to $4.4 million in just six years.
Why isn’t Pacific Grove paying more, now, so that it can avoid more years of having too little money in its pension plan, earning interest to properly fund future pensions? The reason is simple: Telling Pacific Grove to go out and find another $2.7 million, right now, is politically unpalatable. In six years, most of the local elected officials in Pacific Grove will be gone. But where is Pacific Grove going to find this kind of money? Where are any of California’s cities and counties going to find this kind of money?
One final point: These pension plans are underfunded after a bull market in stocks has doubled since it’s last peak in June 2007, and has nearly quadrupled since it’s last low in March 2009. When stocks and real estate have been running up in value for eight years, pension plans should not be underfunded. But they are. CalPERS should be overfunded at a time like this, not underfunded. That bodes ill for the financial status of CalPERS if and when stocks and real estate undergo a downward correction.
CalPERS, and the public employee unions that dominate CalPERS, have done a disservice to taxpayers, public agencies, and ultimately, to the individual participants who are counting on them to know what they’re doing. They were too optimistic, and the consequences are just beginning to be felt.
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As of a few days ago, high-wage earners have a new reason to leave California: their state income taxes are no longer deductible on their federal income tax returns. Can California’s union-controlled state legislature adapt? Can they lower the top marginal tax rates to keep wealthy people from leaving California? The short answer is, no, they cannot. They cannot conceive of the possibility that California’s current economic success is not because of their confiscatory policies, but in spite of them.