Red Flags: New Study Offers Grim Warning for California Pension Funds

For Immediate Release
July 12, 2016
California Policy Center
Contact: Will Swaim
(714) 573-2231

Stock market overvaluation will lead to ‘major correction,’ trigger benefits cuts and tax hikes

SACRAMENTO, Calif. – There are more red flags for public-sector pension funds that rely on stock investments for most of their income, a new California Policy Center study finds.

Read the entire study here.

“Three key market indicators show that publicly traded U.S. stocks are overvalued by about 50 percent, suggesting that pension funds are headed for a tough correction,” says CPC President Ed Ring, author of “How a Major Market Correction Will Affect Pension Systems, and How to Cope.”

Ring says the likely downturn will have grave implications for all Californians – not just those who depend upon the pension funds for retirement income. Lower returns on their investments will force pension funds to cut payments to government retirees or require California governments to act dramatically to cover the revenue shortfall.

Using a long-range cash flow model that simulates pension fund performance, Ring calculated the impact on California’s state and local government employee pension funds based on a market slide of 50% in 2017, followed by annual returns of 5% per year. In this case, with no changes to retirement benefits, the required annual contribution from governments would rise to 80% of payroll, costing an additional $50 billion per year. In another case, with post-crash returns projected at only 4% per year, the model estimated annual payments to rise to a staggering 113% of payroll, costing an additional $86 billion per year. Currently, California’s pension funds collect from state and local agencies an amount equivalent to about 33% of their payroll.

The study also provides several specific estimates of how much pension benefits would have to be cut (retirement age, annual multiplier, and COLA) after a severe market correction in order to keep the annual contributions from state and local agencies level at 33% of payroll.

The CPC study includes a link to download Ring’s spreadsheet so that anyone can test a variety of pension-fund assumptions.

You can download the spreadsheet here.

Ring’s prediction of an impending correction cites three key stock market ratios:

  • Price/earnings, now at one of the market’s historic highs
  • Price/sales, now at a 50-year high
  • Stocks/GDP, now near its 60-year high

Ring predicts he’ll have many critics.

“It is easy enough to step back and claim that the rules have changed, that these unusually high stock-market multiples can be sustained for additional decades, and that productivity improvements will enable the U.S. economy to support both massive debt and an aging population,” Ring writes. “Those who argue this position are betting that the U.S. economy will remain a stable refuge for wealth fleeing far more tumultuous economies elsewhere in the world. Staking the future of pension fund systems on this argument is a dangerous gamble.”

Ring’s study appears even as officials at California Public Employees Retirement System, the nation’s largest retirement system, prepare Californians for a poor earnings report next week.

Analyst Ed Ring is available for media interviews. Direct press inquiries to:

Ed Ring
President, California Policy Center
(916) 524-7534


Will Swaim
Vice President, California Policy Center
(714) 573-2231

Ed Ring is president of the California Policy Center. He directs the organization’s research projects and is also the editor of the email newsletters Prosperity Digest and UnionWatch Digest. His work has been cited in the Los Angeles Times, Sacramento Bee, Wall Street Journal, Forbes, and other national and regional publications.

The California Policy Center is a non-partisan public policy think tank providing information that elevates the public dialogue on vital issues facing Californians, with the goal of helping to foster constructive progress towards more equitable and sustainable management of California’s public institutions. Learn more at


Comparing Fresno City and County Pension Systems

As the Fresno Bee recently reported, the city of Fresno’s pension systems are in much better financial shape than the Fresno County Employees’ Retirement Association (FCERA). As of June 30, 2015, the city’s two systems reported a combined $349 million of assets (at market value) in excess of actuarially accrued liabilities. By contrast, FCERA’s assets were $1.043 billion below its liabilities. Actuarial surpluses are rare in California, and the discrepancy between the city and county is so great that we thought it would be worth diving into the finances of Fresno’s retirement system to explain the contrast.

The systems provide extensive financial reports on their websites. The two most useful are Comprehensive Annual Financial Report (which includes financial statements and 10-year histories for many data points) and the Actuarial Valuation Study (which provides in-depth data about system assets, contributions and benefit payments). FCERA posts its reports at The two city systems – one for Fire and Police, and one for non-public safety employees – publish their reports at

Table 1 below compares some key metrics across the plans.

The Valuation Value of Assets (VVA) is used by system actuaries to determine future contributions. But for our purposes, VVA is less useful than the Market Value of Assets (MVA). While MVA is simply the total market value of all the bonds, stocks and other investments the system holds, VVA includes various smoothing adjustments – reporting practices, some of them legitimate, that can mask liabilities.


Contributing to the difference in the financial health of Fresno’s city and county systems is the difference in benefit levels. For example, the City of Fresno limits public safety pensions to no more than 75% of final average salary (as per Section 3-333 of the municipal code). The county imposes no similar cap and also provides very generous benefit accrual rates, in some cases exceeding 3% per year of service. According to calculations we performed using the county system’s Benefit Calculator, a Tier 1 public safety employee retiring at age 60 with 30 years of service would get a pension equal to 97% of final salary. Tier 1 employees were hired before 2007; newer county employees receive less generous benefits.

The city does not cap miscellaneous employee benefits, but its employees earn substantially less credit for each year of service. According to the city’s Benefit Calculator, a miscellaneous employee retiring at age 65 with 30 years of service would receive 72% of final compensation, compared to 97% for a county employee retiring at the same age and the same number of service years.


Asset Returns

Another potential distinction between the city and county systems is investment performance. A pension plan can improve its actuarial balance by achieving higher asset returns. Over the five years ended June 30, 2015, the city’s investments outperformed the county’s. FCERA generated annualized investment returns net of fees of 9.8%. The two Fresno city systems, whose assets are jointly managed, achieved net returns of 10.9% over the same period. This 1.1% difference compounded over five years is fairly significant. One billion dollars growing at the county’s rate of 9.8% becomes $1.596 billion after five years, while the same amount growing at the city’s 10.9% annual rate becomes $1.677 billion – $81 million more.

However, when we look at the 10-year period that includes the Great Recession, the performance numbers reverse. Over the 10 years ended June 30, 2015, county assets grew at an annual rate of 6.8% versus 6.4% for the city. Both of these return rates are below the annual asset return rates assumed by each system (more on this below).

Further, it’s worth noting that funding levels for all systems declined over the 10-year period. Between June 30, 2005 and June 30, 2015, FCSERA’s funded ratio based on VVA declined from 91.5% to 80.7%. The Fresno Fire & Police plan saw a decline from 126.4% to 119.6%, while the city’s Employee Retirement System witnessed a funded ratio decline from 139.8% to 109.2%.


Discount Rates

In general, the market value of a plan’s assets is fairly easy to determine and is not subject to substantial estimation error. Most plan assets are invested in stocks and bonds that trade frequently and whose values are easy to establish independently.

By contrast, plan liabilities are based on numerous assumptions. How much a plan will have to pay in the future depends upon when employees retire and when they pass away. Expressing these future benefit payments in current dollars requires the choice of a discount rate – a choice subject to controversy.

Fresno city plans use a higher discount rate than FCERA. The city’s ERS and Fire & Police plans both assume annual returns of 7.50% and then use that rate to discount future benefit payments. FCERA uses a slightly more conservative rate of 7.25%. Both of these assumptions exceed the actual 10-year returns experienced by the city and county pension systems, and thus should arguably be reduced.

But to compare the systems, we don’t need to determine the ideal discount rate; we simply need to apply the same rate to each system. If we reduce the city’s discount rate from 7.5% to 7.25%, pension liabilities across the two city systems would increase about $61 billion and their funded ratio would fall by about 3.5%. (These estimates are discussed in an appendix at the end of this study). While significant, this fact only explains a small portion of the 38.3% gap in funded ratios between the city and county systems.


Mortality Assumptions

While the pension literature includes much discussion of discount rates, less has been written about mortality assumptions. But good death rate estimates are important: if beneficiaries live a lot longer than expected, pension payments will be much greater than forecast. This recently became clear in Detroit, where city officials faced a sudden spike in projected retirement payments after its pensions actuary switched to a new mortality table.

Mortality tables are produced by the Society of Actuaries. Most public pension plans use a table from the Society’s RP-2000 Mortality Tables Report produced in the year 2000. The large increase in Detroit’s projected pension costs occurred after actuarial firm Gabriel Roeder switched to the Society’s new RP-2014 Mortality Tables.

The RP-2000 report included a supplemental schedule that can be used to scale mortality rates to future years. The scaling procedure assumes a steady improvement in longevity, and thus a steady decrease in mortality rates over time. By applying the adjustment factor from the scaling schedule multiple times, an actuary can approximate what a future mortality table might look like. For example, by applying the scaling factors to the 2000 mortality rates 15 times an actuary can approximate 2015 mortality rates. In Detroit, Gabriel Roeder did not apply the scaling factor, thereby causing the big change when it transitioned to the newer mortality table.

Both the Fresno city plans and FCERA use the RP-2000 Combined Healthy Mortality Table and then scale the death rates from this table with factors in Mortality Projection Scale AA. However, there is an important difference. The city performs the scaling six extra times: it uses mortality rates scaled to 2021, while FCERA uses death rates scaled to 2015. This means that the city plans are projecting fewer deaths at any given retiree age – and therefore greater liability – than does FCERA.

The county’s mortality projections are thus more “optimistic” than those of the city plans, in the sense that its approach anticipates shorter-lived recipients – and that translates into lower expected benefit payments. The sooner an employee is assumed to pass away the less he or she is projected to receive from the system. If FCERA performed the same scaling as the city plans, its reported funding level would be worse. Without more data, we cannot say how much worse.

Finally, it ‘s worth noting that retirement rate assumptions differ between the city and county systems. The difference may be justified, and the impact is unclear. Since the plans have different benefit structures, they present different incentives to workers timing their retirements. When an employee retires early, he or she will receive benefits for more years but generally at a lower rate. So a change in retirement-age assumptions, may raise or lower projected system costs.



Overall, our conclusion is mixed. Fresno’s Employee Retirement System and Fire & Police Retirement System offer less generous benefits that the Fresno County Employees’ Retirement Association. This difference in benefit levels makes a substantial contribution to funding disparities between the systems.

FCERA uses a more conservative discount rate, while the city plans use more (financially) conservative mortality assumptions. These modeling differences affect the disparity between reported city and county funding levels, but they do not represent real differences and simply muddy our understanding of relative system performance. Ideally, all California pension systems would use the same actuarial assumptions (unless there are real demographic differences between workforces) so that we would be able to perform accurate comparisons.


Appendix: Recalculating AAL Using a Different Discount Rate

A pension system’s AAL is the discounted amount of future benefit payments. Unless one has a table of projected future benefit payments, it is impossible to precisely calculate AAL using another discount rate.

In 2013, Moody’s adjusted pension liabilities by using more conservative discount rate assumptions. The rating agency’s method of restating liabilities involves projecting forward the system’s reported liability for 13 years and then discounting the result back for 13 years using the more conservative rate. Moody’s refers to the 13-year re-discounting period as a “common duration” and recognizes that applying the same duration to all plans could be a source of estimation error.

Moody’s also noted at the time that more precise estimates would be possible once pension plans implemented enhanced reporting required under Government Accounting Standards Board Statements 67 and 68.

Under these new rules, pension systems must report the “Sensitivity of Net Pension Liability to Changes in the Discount Rate.” This new schedule shows the Net Pension Liability calculated using the current discount rate, a rate 1% higher and another rate 1% lower. For the Fresno city systems, we have Net Pension Liabilities based on rates of 6.5%, 7.5% and 8.5%.

We can estimate the impact on Net Pension Liability by linearly interpolating between the 6.5% and 7.5% values. For the two Fresno systems combined, the estimated impact of a change in discount rate from 7.5% to 7.25% is $69 billion.

Net Pension Liability as reported under GASB Statement 67 is higher than each system’s Actuarially Accrued Liability. In the case of the Fresno city systems, the difference is about 11.5%. If we reduce the Net Pension Liability difference of $68 billion by 11.5%, we arrive at the $61 billion estimate presented in the main text.

The author wishes to thank Lisa Schilling at the Society of Actuaries and Bill Bergman of Truth in Accounting for their assistance with some technical points in this study. Any errors are my responsibility.

Sonoma and Marin county officials voted to hike their own retirement pay

For Immediate Release

April 29, 2016
California Policy Center
Contact: Will Swaim
(714) 573-2231


Retroactive pension bump likely violated multiple state transparency and accounting laws

Sacramento — County supervisors members and other senior county officials in Marin and Sonoma may have violated state law when voting for massive retroactive pension increases for themselves and other government employees, according to John Moore’s analysis published by the California Policy Center.

The retirement pay hikes were available to all county employees, and retroactive to the employee’s date of hire.

In both counties, officials paid outside attorneys to assert state laws were not mandatory.

The apparent violations were initially discovered by the county’s respective civil grand juries following citizen complaints. The Marin grand jury report documented 38 violations of the government code.

Section 7507 of the California Government Code is supposed to ensure that the public knows how tax dollars are spent and that spending increases do not violate constitutional debt limits. Under 7507, before increasing pension benefits, officials are required to:

  1. Secure the services of an enrolled actuary to determine the future annual cost of an increase in order to ensure they are aware of the cost and that the spending does not require voter approval; and
  2. Provide the public with the information at a noticed board meeting so taxpayers know how their money is being spent and can respond to the proposed increase.

In both counties, staff could identify no documents indicating that supervisors relied on actuarial calculations of future annual costs, and were therefore unable to meet the public-disclosure requirements.

Ken Churchill, who filed the grand jury complaint in Sonoma County, said, “Since 2000, our pension costs have grown about 500%, while our unfunded pension liabilities and pension bond debt have grown about 900%. Now we have no money to maintain our roads and basic infrastructure.”

Marin County resident David Brown filed a lawsuit in Marin. Brown said, “I believe that our county government should comply with the law and am simply asking that a judge determine if laws were violated – and if so, what the appropriate remedy should be.”

Find the complete report with links to the grand jury’s reports and the county’s responses here.

Read the story of David Brown’s lawsuit here.

Retroactive pension increases erupted in other California counties with their own pension systems, including: Alameda, Contra Costa, Fresno, Imperial, Kern, Los Angeles, Mendocino, Merced, Orange, Sacramento, San Bernardino, San Diego, San Joaquin, Santa Barbara, Stanislaus and Ventura.

Grand juries in those counties along with taxpayer groups can investigate how the increases were enacted in their county to ensure they complied with the law.

Contacts for additional information:

John Moore
(831) 655-4540

David Brown
Marin County Citizens for Sustainable Pensions
(415) 987-1619

Ken Churchill
New Sonoma
(707) 578-3403

CalPERS Spends $50 Million on Investment Advisors, Underperforms Market by 67%

The California Public Employees’ Retirement System (CalPERS) spent nearly $50M on their investment advisors in 2014, despite producing a dismal 2.4% investment return – 67% lower than what the market returned over the same time, as measured by the S&P 500. CalPERS’ 275 investment officers and portfolio managers cost taxpayers $49.27 million, with chief investment officer Theodore H Eliopoulos’ $856,000 compensation package topping the list.

The California State Teachers’ Retirement System (CalSTRS) also missed its 7.5% target, returning only 4.8%, but spent significantly less on their investment advisors in the process. CalSTRS spent roughly $18 million on their 100-plus investment officers and portfolio managers. Their chief investment officer, Christopher J Ailman, received a $674,000 compensation package.

To put these returns in perspective, an index fund that tracks the Dow Jones Industrial Average (DJIA) returned 7.1% and the S&P 500 fund returned 7.4%.


After adjusting the total cost spent on investment advisors against actual investment results, CalPERS’ performance looks even bleaker. CalSTRS spent roughly $3.75 million per percentage point of returns on investment advisors, whereas CalPERS spent nearly six times as much at over $20 million per point. These costs are only for employees of their respective retirement system and do not include the billions of dollars spent on fees for external funds and the unknown carried interest fees associated with CalPERS’ private equity investments.strsvspers

One of the added benefits of utilizing the appropriate, lower discount rate in the 4-5% range is that public pension funds would be able to save billions of dollars on fees. For example, the New York Times reported that CalPERS paid $1.6 billion in fees to external funds managing their global equity portfolio in 2014. By contrast, the comparable fees for investing in the S&P 500 index ETF would have been $154 million, for a savings of nearly $1.5 billion.

Naturally, given the size and current investment objectives of both CalPERS and CalSTRS, investing in a single index fund is implausible. Yet, it does illustrate the degree of savings that would come from using a risk-free discount rate in which long-term AA-rated bonds and a basket of index funds were used in lieu of an aggressive investment strategy and the fees that accompany it.

The argument against such a conservative strategy is that it would reduce the potential for investment gains that a more aggressive strategy would provide. Yet, neither CalPERS nor CalSTRS has been able to beat the market over the past 20 years, despite spending millions of dollars each year on investment advisors, at taxpayer expense.

While both CalPERS and CalSTRS tout their 7.8% returns over the past 20 years as being indicative of their investing prowess, this is significantly less than the 9% achieved via an index fund that tracks the S&P 500. As such, it is hard to justify the millions spent on investment advisors internally, not to mention the billions spent on investment fees externally.

Many defenders of the status quo attempt to impugn the motives of those advocating for pension reform as being de facto lobbyists for big bankers and investment managers on Wall Street, claiming that a shift to defined contribution plans would line the pockets of fund managers on Wall Street. In reality, California’s public pension systems consistently send billions of dollars each and every year in fees to Wall Street.

A shift to a defined contribution plan would give individuals greater access over their own accounts and dramatically reduce the fees being paid to Wall Street, as individual investors are free to choose low-cost mutual funds or exchange-traded funds (ETFs) that have dramatically lower fee structures than what CalPERS and CalSTRS pay, yet have outperformed both pension funds over the past 20 years.

Robert Fellner is the Director of Transparency Research at the California Policy Center.

University of California Hikes Tuition to Fund Soaring Pensions of up to $350,000 a Year

The University of California (UC) is implementing major changes to their retirement system to address its $12.1 billion unfunded liability, which has been cited as the driving factor behind recent tuition hikes.

The proposed changes include a cap on pension benefits and the possibility of offering a 401(k) defined contribution plan to new hires.

Looking at how UC got here is instructive. In 1990, the plan enjoyed a healthy funded ratio of roughly 135%. The decision was then made to stop making any contributions – employee and employer – and rely on investment earnings to keep the fund afloat going forward.

This continued for two decades. UC only resumed contributions in 2010 when over $6 billion in unfunded liabilities had accumulated and the plan was heading towards ruin, should they fail to act.

The fiscal irresponsibility, first in suspending contributions, and then failing to reinstate them until the very last moment, is staggering. As Moody’s declared, “employee and employer contributions are the bedrock of any defined benefit pension plan.” The American Academy of Actuaries (AAA) concurs, noting that contributions “should actually be contributed to the plan by the sponsor on a consistent basis.”

It should be noted that the spectacular decline in the health of UC’s retirement system occurred despite UC realizing an average annual investment return of 9% over those same 20 years, significantly higher than their assumed 7.5% annual return. Clearly, Moody’s and the AAA understand what is needed to keep pension systems in sound financial shape, while public pensions’ emphasis on investment returns over annual contributions is fundamentally flawed.

So why did UC behave so recklessly? Quite simply, public institutions have the exact opposite incentives necessary to manage a defined benefit system appropriately. The decision makers who authorized the funding holiday in 1990 are all long gone, and none of them will bear any of the cost for their actions. In fact, they all directly benefited from their profound mistakes.

UC regents and plan trustees, all being members of the retirement plan themselves, all saw their take home pay immediately rise as a result of their contributions dropping to 0%. Further, UC administrators saw millions of dollars flow back into their general budget, no longer designated for funding the retirement system.

Pete Constant, Senior Fellow at the Reason Foundation, finds that public pension systems are “actually a perverse system in which there is a win for the entire membership when pension board trustees are wrong!”

He notes that, “The risk associated with not meeting actuarial assumptions is borne entirely by the taxpayers…unfunded liabilities are generally amortized over long periods of time, spreading the associated costs across generations.”

This point is driven home by looking at the several recent UC retirees who are collecting base pensions of over $300,000 a year for life. While these former UC employees were fortunate enough to pay nothing, for at least 20 years of their careers, for such lucrative pensions, the cost is now being borne by an entirely new generation of students and taxpayers.

Further, current UC employees have seen their annual contributions rise dramatically, and new hires will be under a substantially reduced pension system themselves. In short, virtually everyone but the employee who received the benefits, or those who received that employee’s services, are now paying the cost.

UC’s decision to consider shifting new hires to a defined contribution plan is long overdue. In addition to the perverse management incentives and issues of intergenerational inequity outlined above, a shift to defined contribution plans would eliminate the long term liability to taxpayers, while offering greater flexibility and portability to employees.

As UC President Janet Napolitano said, “Pension reform needs to happen. It’s the responsible thing to do.”

Robert Fellner is the Director of Transparency Research at the California Policy Center.

Over 8,000 LA County Retirees Made at Least $100K in Pension Pay as Taxpayer Cost Soars

Last year, 8,088 retirees in the Los Angeles County Employees’ Retirement Association (LACERA) received yearly pension and medical benefits packages worth at least $100,000, a more than 11% increase from the previous year, according to Transparent California’s recently published 2014 pension data.

At the same time, the employer’s annual required contribution – the cost borne by taxpayers – hit a record high 20 percent of payroll, more than double the 8.9 percent paid in 2001.

Topping the pension list was former Los Angeles County Sheriff, Leroy Baca, who is collecting a yearly pension and benefits package worth nearly $340,000.

The next three highest compensated members were:

  1. Larry Waldie, retired from the Sheriff’s Department in 2011, received $333,009.
  2. Thomas Tidemanson, retired from Public Works in 1994, received $332,200.
  3. Michael Judge, retired from the Public Defender’s Office in 2010, received $325,078.

The average pension and benefits package for a retiree of the Fire Department with at least 25 years of service was $128,729 and the average for a retiree of the Sheriff’s Department was $106,299. For all other members who had retired with at least 30 years of service, the average pension and benefits package was $74,568.

Current LACERA members are able to include a variety of supplemental pay items as part of their pensionable compensation – which is their highest single year of pay that will be used to calculate their pension benefit. Additionally, LACERA allows employees to sell back any unused vacation, holiday, or sick leave and counts that as part of their pensionable compensation.

While the Pension Reform Act of 2012 sought to ban “abusive practices used to enhance pension payouts” and calculate pension benefits “based on regular, recurring pay” only the practice of selling back unused leave was banned, and only for employees hired after January 1, 2013.

LACERA’s unfunded liability has more than doubled over the past 10 years – rising from $5.6 billion in 2004 to $13.3 billion in 2013, despite having hit their investment target over that same time period.

A Moody’s Investment Services report calculated LACERA’s adjusted net pension liability at nearly $40 billion. They also found that the rules governing public plans inappropriately emphasize investment returns over yearly contributions, resulting in shortfalls even under ideal investment conditions.

Moody’s also cautioned against the increased risk public pension portfolios have taken. When comparing LACERA’s most recent investment portfolio they found a higher allocation of riskier investments such as private equity and hedge funds, as compared to prior years.

This “increases the risk of sharp asset declines” and, consequently, increases the likelihood that taxpayers will be required to pay substantially more to keep the system afloat.

A recent paper published in the Journal of Retirement found that many public pensions will remain underfunded, even if they hit their investment goals, because they rely on flawed actuarial assumptions that understate the true cost of benefits.

Pete Constant, Senior Fellow at the Reason Foundation, observed that there are strong incentives for pension boards to adopt assumptions that are wrong. Doing so directly benefits both the pension system and its member agencies – which now have more tax dollars at their disposal – while the costs are borne by future generations.

To view the complete 2014 pension report in a searchable and downloadable format, visit

Robert Fellner is the Director of Transparency Research at the California Policy Center.