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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.

What If Every Worker Made What City of Irvine Workers Make?

“Jennifer Muir, a spokeswoman for the Orange County Employees’ Association, which represents more than 18,000 public employees in Orange County, said the California Public Policy Center’s study was a politically motivated attack on public employees and unions. Aside from promoting the center’s anti-public employee union agenda, Muir said, the reports are misleading and shift focus away from the discussions that matter most. Union leaders have long urged for people to consider the possibility that private-industry employees are being undercompensated and should receive retirement benefits and health coverage.”
Orange County Register, April 19, 2013

The study Muir refers to, entitled “Irvine, California – City Employee Compensation Analysis,” was published on April 8th, 2013, by our parent organization, the California Public Policy Center. To call this study “a politically motivated attack on public employees and unions,” as Muir alleges, is itself a distraction. It’s easy, and necessary, to impugn the motives behind information when the information itself is so embarrassing.

As noted, Muir went on to accuse the study of “shifting focus away from the discussions that matter most… that private-industry employees are being undercompensated.”

Let’s recap some of the facts regarding Irvine’s city employee compensation, drawing both from the CPPC study (which itself used payroll data provided by the City of Irvine), as well as from the Orange County Employee Retirement Systems 2011 Annual Report:

  • The average City of Irvine employee receives direct pay of $95,751 per year, and when the cost of employer paid benefits is included, this average goes up to $143,691 per year (Source: CPPC Study, Table 1).
  • The average participant in the Orange County Employee Retirement system who worked 25-30 years and retired last year collects a pension of $70,920 per year. If they worked 30 years or more, like virtually every private sector worker, that average goes up to $81,192 per year (Source: OCERS Annual Report, page 109).

Now let’s suppose that private industry employees are indeed being undercompensated. What are the economic implications of paying them a proper living wage ala Irvine – and every other unionized public sector job in California? Here are some facts:

  • In 2010 there were 8.3 million residents in California over the age of 55, which is the age by which a public employee may reasonably be assumed to have logged 30 years – assuming they completed their education by age 25 and entered the workforce for a full career in public service (source: U.S. Census Bureau). Also in 2010, the GDP of California – its entire economic output – was $1.9 trillion (source: LA Times). This means that if everyone over the age of 55 in California got a pension of $70,000 per year, it would cost $581 billion per year, 31% of California’s entire economic output. Ms. Muir is invited to explain exactly how we’re going to accomplish this.
  • Using the same census data, in 2010 there were 15.8 million people between the ages of 25 and 55. Assume that two-thirds of these people work full-time, and the other one-third are unemployed spouses, stay-at-home parents, or are otherwise supported by a working partner. If every one of these 10.5 million people collected total compensation of $140,000 per year, this would cost $1.47 trillion per year, or 77% of California’s entire economic output.

So according to this utopian vision, if everyone could just receive the same compensation packages as the average full-time worker for the City of Irvine, it would consume 108% of California’s entire economic output.

There’s a bit more to this, however. In the real world, wages and salaries fluctuate between around 44% and 54% of GDP (source: TelltaleChart.org). We may argue over what share of GDP legitimately belongs to workers vs. corporations – bearing in mind that corporate profits are an absolute necessity for a public sector pension plan to have any hope of remaining solvent, and these profits are also necessary to invest in equipment and conduct R&D if we are to have any hope of remaining an economically viable nation – but let’s use an unprecedentedly generous proportion. Let’s assume that 60% of California’s GDP is comprised of wages, benefits, and pension payments.

To complete this thought, we’re now going to have to indulge in some basic algebra (T=trillion), one of those nasty tools of analysis that never plays well in a 30 second TV commercial, but nonetheless is an ideal tool to express cold quantitative reality, rather than utopian union fantasies:

[ .58T (pensions) + 1.47T (wages) ] / .6 (40% for corp. profits) = GDP of 3.48T

Isn’t that terrific? All we have to do is wave a wand and instantly, we’ll nearly double California’s GDP from $1.9 trillion per year to 3.5 trillion per year. Nobody will be “undercompensated” any more! Then we can afford to implement this compelling vision of social justice – total compensation of $140,000 per year for every full-time worker, then after 30 years, a pension of $70,000 per year. It should be easy. Perhaps new legislation is called for.

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UnionWatch is edited by Ed Ring, who can be reached at editor@unionwatch.org