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Coping With the Pension Albatross

Instead of the cross, the albatross
About my neck was hung.
–  Samuel Taylor Coleridge, The Rime of the Ancient Mariner, 1798

In Coleridge’s famous poem, a sailor who killed an albatross has it hung around his neck as punishment. Since then, the albatross, which sailors used to consider good luck, has come to symbolize an oppressive burden. When it comes to ensuring the financial sustainability of California’s cities and counties, few burdens have become more oppressive than funding employee pensions.

A study issued earlier this month entitled “Pension Math: Public Pension Spending and Service Crowd Out in California, 2003-2030,” by the Stanford Institute for Economic Policy Research, offers comprehensive and visceral proof of just how big the pension albatross has become around the fiscal necks of California’s cities and counties, and how much bigger it’s likely to grow. Recent articles by pension expert Ed Mendel and political watchdog Steve Greenhut provide excellent summaries. To distill the “Pension Math” study to a few ominous and definitive quotations, here are two that describe how dramatically pension costs have eaten into California’s civic budgets:

“Employer pension contributions from 2002-03 to 2017-18 have increased at a much faster rate than operating expenditures. As noted, pension contributions increased an average of 400%; operating expenditures grew 46%. As a result, pension contributions now consume on average 11.4% of all operating expenditures, more than three times their 3.9% share in 2002-03.”

And the fun is just beginning:

“The pension share of operating expenditures is projected to increase further by 2029-30: to 14.0% under the baseline projection—that is, even if all system assumptions, including assumed investment rates of return, are met—or to 17.5% under the alternative projection.”

Back in 2016, the California Policy Center produced a study entitled “The Coming Public Pension Apocalypse, and What to Do About It.” In that study (ref. Table 2-C), the implications of adopting responsible paydowns of the unfunded liability (20 year straight-line amortization which CalPERS is now recommending), are explored, along with various rate-of-return assumptions. Quote:

“A city that pays 10% of their total revenues into the pension funds, and there are plenty of them, at an ROI of 7.5% and an honest repayment plan for the unfunded liability, should be paying 17% of their revenues into the pension systems. At a ROI of 6.5%, these cities would pay 24% of their revenue to pensions. At 5.5%, 32%.”

These are staggering conclusions. Only a few years ago, opponents of pension reform disparaged reformers by repeatedly asserting that pension costs only consumed 3% of total operating expenses. Now those costs have tripled and quadrupled, and there is no end in sight. What can local elected officials do?

The short answer is not much. At least not yet. The city of Irvine provides a cautionary example of how a city did everything right, and still lost ground. In 2013, Irvine’s city council resolved to eliminate their unfunded pension liability in 10 years by making massive extra annual payments out of their reserve fund. As reported in detail last week in the article “How Fraudulently Low “Normal Contributions” Wreak Havoc on Civic Finances,” here is the upshot of what happened in Irvine between 2013 and 2017:

“While the stock market roared, and while Irvine massively overpaid on their unfunded liability, that unfunded liability still managed to increase by 51%.”

There are plenty of ways for California’s cities and counties to get the pension albatross off their fiscal necks, except for one thing. The people who receive these generous pensions (the average pension for a full-career retired public employee in California, not including benefits, was $68,673 in 2015) are the same people who, through their unions, exercise almost absolute control over California’s cities and counties.

Spokespersons for public sector unions scoff at this assertion. “Politicians are mismanaging our cities and counties,” they allege, “blame the politicians.” And of course they’re right. Politicians do run our cities and counties. But these politicians have their campaigns funded by the public sector unions. Even when a majority of city council or county supervisor seats are won by politicians willing to refuse campaign contributions from public sector unions, any reforms they enact are reversed as soon as the unions can reestablish a majority. And if reformers can stay in control of a city or county through multiple election cycles, any reforms they enact are relentlessly fought in court by the unions. Meanwhile, California’s union controlled state legislature enacts law after law designed to prohibit meaningful reform.

This is the reality we live in. Californians pay taxes in order to pay state and local government employees a wage and benefit package that averages twice what private sector workers earn.

Here’s what can be done:

(1) Convince citizens to always vote against any candidate supported by a public sector union.

(2) Convince public sector union officials that the pension crisis is real so at least they will agree to minor reforms. The recent Stanford study, along with the recently introduced CalPERS agency summaries, should provide convincing leverage.

(3) Continue to implement incremental reform either through council action, local ballot measures, or in contract negotiations. They may include:
– lower pension formulas for new employees
– lower base pay in order to lower final pension calculations
– eliminating binding arbitration
For more ideas, refer to Pension Reform – The San Jose Model, Pension Reform – The San Diego Model, and Reforming Binding Arbitration.

(4) Support policies designed to lower the cost-of-living. California’s union controlled legislature has created artificial scarcity in almost all sectors of the economy, driving prices up and providing the justification for public employees to demand wages and benefits that allow them to exempt themselves (but not the rest of us) from the consequences of those policies.

(5) Wait for resolution of two critical court cases. The first is the case Janus vs. AFSCME, challenging the right of government unions to charge “agency fees” to members who opt out of membership. That case is set to be heard by the U.S. Supreme Court in 2018. The second is the ongoing court challenges to the “California Rule.” Attorneys representing California’s government unions claim the California Rule prohibits changing the formulas governing pension benefit accruals even for work not yet performed. California’s Supreme Court is set to hear this case after an appeals court rules on three cases – from Alameda, Contra Costa, and Merced counties. Both of these cases should be resolved sometime in 2018.

The Janus case could decisively lower the amount of money public sector unions currently manage to extract from dues paying public employees, which in California alone is estimated to exceed $1.0 billion per year. A successful challenge to the California Rule would pave the way for real pension reform. Current legal interpretations of the California Constitution bar reductions to pension formulas, even for work that has not yet been performed. This is the so-called “California Rule.” If that interpretation were overturned, pension benefit accruals for future work done by existing employees could be lowered to financially sustainable levels.

All in all, today the pension albatross weighs heavy on the fiscal necks of California’s public agencies, and it’s getting worse, not better. If there were easy answers, the problem would have been solved long ago.

REFERENCES

Pension Math: Public Pension Spending and Service Crowd Out in California, 2003-2030
https://siepr.stanford.edu/sites/default/files/publications/17-023.pdf

How pension costs reduce government services, Ed Mendel, CalPensions, 10/09/2017
https://calpensions.com/2017/10/09/how-pension-costs-reduce-government-services/

Forget the scary pension future; study confirms the crisis is hitting now, Steve Greenhut, California Policy Center, 10/10/2017
http://californiapolicycenter.org/forget-scary-pension-future-study-confirms-crisis-hitting-now/

The Coming Public Pension Apocalypse, and What to Do About It
http://californiapolicycenter.org/the-coming-public-pension-apocalypse/

How Fraudulently Low “Normal Contributions” Wreak Havoc on Civic Finances
https://calocalelectedofficials.org/fraudulently-low-normal-contributions-wreak-havoc-civic-finances/

What is the Average Pension for a Retired Government Worker in California?
http://californiapolicycenter.org/what-is-the-average-pension-for-a-retired-government-worker-in-california/

California’s Public Sector Compensation Trends
http://californiapolicycenter.org/californias-public-sector-compensation-trends/

Average Full Career Pension by City (all CalPERS employers), Transparent California
http://transparentcalifornia.com/pensions/2016/calpers/employers/?s=-average

Public Agency Actuarial Valuation Reports by CalPERS Agency
https://www.calpers.ca.gov/page/employers/actuarial-services/employer-contributions/public-agency-actuarial-valuation-reports

Pension Reform – The San Jose Model
https://calocalelectedofficials.org/pension-reform-san-jose-model/

Pension Reform – The San Diego Model
https://calocalelectedofficials.org/pension-reform-the-san-diego-model/

Reforming Binding Arbitration
https://calocalelectedofficials.org/reforming-binding-arbitration/

The Bell Syndrome Afflicts More Cities Than Just Bell

Remember Bell, California? Back in 2010 the Los Angeles Times reported that Bell city officials were receiving unusually large salaries, perhaps the highest in the United States. For example, Robert Rizzo, the City manager, had received $787,637. By September of that year, as reported on CNN, the California Attorney General filed charges against eight former and current city officials. The public was outraged.

Not generally known however was the process whereby the City of Bell employees managed to pay themselves so much money. Earlier that summer the Los Angeles Times covered this part of the story, reporting “The highly paid members of the Bell City Council were able to exempt themselves from state salary limits by placing a city charter on the ballot in a little-noticed special election that attracted fewer than 400 voters.”

This use of barely legal maneuvers to extract ridiculously generous salaries and benefits from taxpayers is not restricted to Bell, however. The Bell Syndrome existed before any of us had ever heard of Bell, and even now, in this sanitizing age of transparency, it lingers, continuing to infect our public institutions.

Two cases of the Bell Syndrome are featured in an investigative report just published on UnionWatch entitled “The Pension Scandals in Sonoma and Marin Counties,” written by John Moore, a retired attorney living in Pacific Grove.

Back in the period between 2002 and 2008, Sonoma and Marin counties were, just like virtually every other city and county in California, in the process of granting pension benefit enhancements to their employees. But did they follow due process? Moore writes:

This article deals with pension abuses by two separate CERL agencies, the counties of Sonoma and Marin. Each has its own retirement board. In each county, the civil grand jury found serious procedural violations that were preconditions to the adoption of retirement increases:

Grand Jury Report – Marin County
Grand Jury Report – Sonoma County

Each grand jury report documented the grant of pension increases from 2002 through 2008 without providing the board of supervisors and citizens mandated actuarial reports estimating the “annual” cost of each enhancement.

There are 21 counties in California with independent pension systems. In all, taking into account cities with their own pension systems, along with CalPERS and CalSTRS, there are 81 independent state and local government worker pension systems in California. And most if not all of them adopted pension enhancements between 1999 and 2008, awarding the benefit enhancements retroactively.

Anyone who thinks there aren’t legal grounds on which to question the retroactive pension benefit enhancements that have mired California’s public sector in a swamp of overwhelming debt should carefully read Moore’s article. Improper notice. Poor estimates of “annual costs.” Lack of independent financial review. But the consequences of these improprieties are plain to see.

In Marin County the most recent financial report shows their pension system, as of June 30, 2015, was funded at a ratio of 84.3%. If we were at the bottom of the market instead of on the plateau of a market that has roared for the past seven years, that would be reassuring. But we’re not. Since June 30, 2015, the S&P 500 has risen from 2076 to 2091. That’s less than one percent during a ten month period when – at 7.25% per year – this index should have gained 6.0%. The DJIA for the same period? Up 1.5%. The NASDAQ? Down 2.4%.

On page 27 of Marin County’s most recent pension fund financial report is a table entitled “Sensitivity of the net pension liability to changes in the discount rate.” That table shows the system, as noted, 84.3% funded when assuming – as they do – a “risk-free” rate of return, year after year, of 7.25%. On the same table, the lowest assumption they calculate is at a return of 6.25%, which lowers the funded ratio to 74.4%.

Abstruse Gobbledygook

It’s too bad this is all abstruse gobbledygook to most voters and most politicians, because this is real money. Also shown on page 27 of Marin County’s 6/30/2015 financial report is the amount of the unfunded liability for Marin County’s pension system. If those investments keep on earning 7.25% per year, that liability is $387 million. If those investments only earn 6.25% per year, the liability nearly doubles, to $717 million.

Along with asking questions as to the legality of shoving these pension benefit enhancements through county boards of supervisors and city councils with minimal due process or quality independent financial analysis, one may ask how these pension systems get away with claiming 7.25%, or 6.25% for that matter, is a “risk free” rate of return. When is the last time you went to a bank and bought a CD, or went to a brokerage and bought a treasury bill, and saw a return north of 3.0%? So how much would Marin County’s pension liability be if their investments only earned 3.0% per year?

Using formulas developed by Moody’s Investor Services for this purpose, as explained in the California Policy Center study “A Method to Estimate the Pension Contribution and Pension Liability for Your City or County,” if Marin County’s pension system were to earn a risk free 3.0% return per year, their unfunded pension liability – that’s “debt to taxpayers” in plain English – would be $2.1 billion.

Two-point-one-billion. Billion with a “B”.

When pension benefits were enhanced by one local government after another between 1999 and 2008, the means by which they were approved were barely legal, if they were legal at all. The chicanery and insider-dealings that constituted these decision making processes rival the scandal in the City of Bell. The syndrome is the same – financial corruption that enriches the government while disenfranchising and diminishing private citizens. But the sheer scale of the financial consequences of these retroactive pension enhancements, the literally hundreds of billions of debt that these shady machinations imposed on California’s taxpayers – that dwarfs the scandal in Bell like a whale dwarfs a minnow.

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Ed Ring is the president of the California Policy Center.

Why Investment Realities Will Compel Pension Reform

“For the first time in the pension fund’s history, we paid out more in retirement benefits than we took in contributions.”
–  Anne Stausboll, Chief Executive Officer, CalPERS, 2014-2015 Comprehensive Annual Financial Report

There are few examples of a seemingly innocuous statement with more significance than Stausboll’s admission, buried within her “CEO’s Letter of Transmittal,” summarizing the performance of CalPERS, the largest public employee retirement system in the United States. Because what’s happening at CalPERS – they now pay more in benefits than they collect in contributions – is happening everywhere.

For the first time in history, America’s public employee pension funds, managing well over $4.0 trillion in assets, are becoming net sellers, not buyers. And as any attentive student of economics will tell you, when there are more sellers than buyers, prices drop. Behind this mega economic trend is a mega demographic trend – across the developed world, certainly including the United States, a relentlessly increasing percentage of the population is retired. The result? An increasing proportion of people who are retired and slowly liquidating their lifetime savings – also driving down asset values and investment returns.

Last week’s sell-off in the markets has immediate causes that get most of the attention. Turmoil in the middle east. A long overdue slowdown to China’s overheated economy. Depressed energy prices. But there are two long-term trends that will keep investment returns down. Demographics is one of them: The more retirees, the more sellers in the market. The other mega-trend, equally troubling to investors, is that debt accumulation, which stimulates spending, has reached its limit. We are at the end of a long-term, decades long credit cycle. The next three charts will illustrate the relationship between interest rates, debt formation, and the stock market during two critical periods – the first one following the stock market peak in December 1999, and the second following the stock market peak in September 2007.

The first chart shows the federal funds rate over the past 30 years. As can be seen, when the stock market peaked in December 1999, the federal funds rate was 6.5%. Within three years, in order to stimulate borrowing which would put cash into the economy, that rate was dropped to 1.0%. Similarly, once the stock market recovered, the rate went back up to 4.25% until the stock market peaked again in the summer of 2007. Then as the market declined precipitously for the next 18 months through February of 2009, the federal funds rate was lowered to 0.15% and has stayed near that low ever since. The point? As the stock market recovered since February of 2009 to the present, unlike during the earlier recoveries, the federal funds rate was never raised. This time, there’s no elbow room left.

Effective Federal Funds Rate – 1985 to 2015
20160111-UW-ER-fedrate

To put these low interest rates in context requires the next chart which shows total U.S. credit market debt as a percent of GDP over the past 30 years. Consumer debt, commercial debt, financial debt, state and federal debt (not including unfunded liabilities, by the way), is now estimated at 340% of U.S. GDP. The last time it was this high was 1929, and we know how that ended. As it is, even though interest rates have stayed at nearly zero for just over seven years, total debt accumulation topped out at 366.5% of GDP in February of 2009 and has slightly declined since then. The point here? Low interest rates, this time at or near zero, no longer stimulate a net increase in total borrowing, which in turn puts cash into the economy.

Total U.S. Credit Market Debt – 1985 to 2015
20160111-UW-ER-debtGDP

Which brings us to the Dow Jones Industrial Average, a stock index that tracks nearly in lockstep with the S&P 500 and the Nasdaq, and is therefore an accurate representation of the historical performance of U.S. equities over the past 30 years. As can be seen from this graph and the preceding graphs, the market downturn between December 1999 and September of 2002 was countered by lowering the federal funds rate from 6.5% to 1.0%. Later in the aughts, the market downturn between September 2007 to February 2009 was countered by lowering the federal funds rate from 5.25% to 0.15%. But during the sustained market rise for the seven years since then, the federal funds lending rate has remained at near zero, and total market debt as a percent of GDP has actually declined slightly.

Dow Jones Industrial Average – 1985 to 2015
20160111-UW-ER-DJIA

It doesn’t take a trained economist to understand that the investment landscape has fundamentally changed. The trend is clear. Over the past thirty years debt as a percent of GDP has doubled from 150% to over 350%, then remained flat for the past seven years. At the same time, over the past thirty years the federal lending rate has dropped from high single digits in the 1980’s to pretty much zero by early 2009, and has remained there ever since. The conclusion? Interest rates can no longer be used as a tool to stimulate the economy or the stock market, and the capacity of the American economy to grow through debt accumulation has reached its limit.

For these reasons, achieving annual investment returns of 7.5%, or even 6.5%, for the next several years or more, is much harder, if not impossible. Conditions that stock market growth has relied on over the past 30 years no longer apply. Public employee pension funds, starting with CalPERS, need to face this new reality. Debt and demographics create headwinds that have changed the big picture.

In the case of CalPERS, of course, it isn’t mere demographics that has turned them into a net seller in a market that’s just given up two years of appreciation. It’s the fact that their retiree population is increasingly comprised of people who are retiring with benefits that have been enhanced in the past 10-15 years. This fact accelerates and augments the demographically driven disparity between collections and disbursements. Take a look at the past three years of CalPERS collections and disbursements:

CalPERS Cash Flow (not including investment returns)
2013 to 2015, $=Billions
20160111-UW-ER-CalPERS

These figures, drawn from CalPERS 6-30-2015 CAFR (page 26) and CalPERS 6-30-2014 CAFR (page 24), show the system to be a net seller at a rate of about $5.0 billion per year for the past three years. Interestingly, during that time, employee contributions to CalPERS have actually declined by 4.6%, at the same time as the employer, or taxpayer, contributions have risen by 24.1%.

The idea that CalPERS cannot lobby for equitably reduced pension benefits is a fallacy. Because the financial problems with pensions began when Prop. 21 was narrowly passed in 1984, deleting constitutional restrictions and limitations on the purchase of corporate stock by public retirement systems. The financial problems got worse when California’s legislature passed SB 400 in 1999, which set the precedent for retroactive pension benefit increases. And in both cases, CalPERS was there, lobbying for passage of what were ultimately ruinous decisions.

Now that an aging population delivers millions of sellers into a market already challenged by epic deleveraging, CalPERS can do the right thing, and lobby for meaningful pension reform. They can start by supporting policies that reverse the impact of Prop. 21 and SB 400. If they do this sooner rather than later, they may be able to save the defined benefit. Anne Stausboll, are you prepared to stand up to your union controlled board of directors, and tell them the hard truth?

 *   *   *

Ed Ring is the executive director of the California Policy Center.

Eureka Faces Pension Headwinds – Just Like Every Other California City

The city of Eureka on the far north coast of our state is part of a fabled land, far removed from the rest of drought stricken California. The winds that the ridiculously resilient ridge of high pressure push north find welcoming mountains and canyons in and around Eureka, drenching them with rain, nourishing endless groves of the tallest trees on earth, the magnificent coast redwoods. Gushing rivers run through thick green forests scented with maritime air. Downtown, the mansions of the 19th century lumber barons defy time, marvelous, intricate, stunning. And on postcard perfect shorelines, the rugged Pacific surf surges against the rocks. It’s hard to imagine a more beautiful place.

But when it comes to government unions making sure their compensation crowds out any hope of fiscal sanity, Eureka is as ordinary, and as challenged, as every other city in California.

A few weeks ago the California Policy Center released a study “California City Pension Burdens” that compiled key financial indicators for every city in California. When it came to pension contributions as a percent of general fund revenue, the city of Eureka made the top ten. That is, in 2015, Eureka will send 11.3% of its entire incoming revenue from taxes and fees to the giant pension fund, CalPERS.

These findings, covered in the Eureka Times-Standard, earned this rebuke in a guest editorial submitted by Eureka City Councilmember Linda Atkins on March 17th:

“… the California Policy Center, a renowned conservative pressure group disguised as a “think tank” that’s out to push the California public into believing that they deserve government services for free and that a secure retirement is only for those with enough income to provide it for themselves. Their hope is to dismantle all reliable retirement systems, including Social Security, so that you and I will live a frightening old age in poverty, while the execs and corporations rake in the billions.”

One may attack the messenger, or face facts. The city of Eureka has an officially recognized unfunded pension liability of $53 million, which equates to $4,529 per household. That number, of course, does not include the additional liability facing local taxpayers for Humboldt County’s pension liabilities, or local school districts, or state agencies. And if there is another market downturn, these unfunded liabilities and the city’s required annual contribution will go way up.

No reasonable person expects government services to be free. But in Eureka during 2013 the average full time police officer collected pay and benefits – including the city’s contribution to CalPERS – of $110,280; the average full-time firefighter, $120,243 (download spreadsheet). The average pension collected in 2013 by retired city employees with 30+ years of service, public safety and miscellaneous combined, was $58,397. All of this in a town with a median household income of $36,393 and an unemployment rate of 9.7%. It should be possible to question these rates of pay and pensions for Eureka’s city employees while still respecting and appreciating the work they do.

To set Ms. Atkins’ mind at rest, on the topic of retirement security, here are just two of the California Policy Center’s well-documented recommendations for rescuing the finances of cities and counties in California, including Eureka:

(1) Preserve Social Security by enrolling every government employee in the program, subject to the same rules and benefit formulas that apply to current participants. In terms of return on investment, Social Security pays high income individuals far less in retirement compared to low income individuals. Therefore, because government workers make so much more than private sector workers, enrolling America’s millions of highly compensated government workers in Social Security would significantly reduce any eventual financial challenges the system will face.

(2) Preserve defined benefit pensions for government employees by changing the benefit formulas, retroactively, to the precise annual multipliers and retirement ages that were in effect prior to 1999, when pension bankers and unions began pressuring politicians into enhancing these benefits, retroactively, to levels far beyond what is fair to taxpayers or financially sustainable. Alternatively, simply suspend pension cost-of-living increases, change benefit formulas prospectively, and raise employee contribution rates, until the systems are 100% funded.

We invite Ms. Atkins to identify any “right wing pressure group,” anywhere, that supports either of these recommendations.

Atkins is at her most thoughtful when she describes the crash of 2008. She writes:

“Then came the criminal actions from Wall Street that caused the Great Recession, where risky mortgages were “bundled” into investment instruments that were sold to many retirement funds as “safe” investments. Investing in Americans’ mortgages used to be very safe; people were vetted very well before they were given the opportunity to buy a home. Then came Wall Street with “sub-prime” mortgages, giving loans to people who never had a chance of being able to pay them back. The banks then bundled these loans and offered them as stable investments. Then came the crash of 2008. Who got hurt? All the pension fund investors who purchased the bogus “bundles” and of course the rest of America who lost jobs, homes and futures because of the greed and avarice of those Wall Street bankers.”

All true. But what Atkins doesn’t care to admit is that public sector pensions are the last, best con job of the most corrupt among these “Wall Street bankers.” Just as people bought overpriced homes who could never afford to pay them back, pension funds – who are the biggest players on Wall Street – are pretending they can earn high-returns forever. And just like the big bankers, the pension funds expect taxpayers to bail them out.

There is a hypocrisy involved in lumping advocates for pension and contribution reform in with “execs and corporations” who “rake in billions.” Because the high returns pension funds currently earn depend on a rising stock market, jacked up by debt fueled, unsustainable consumer spending. Without corporate profits, corporate stocks don’t appreciate, and pension funds go broke. No profits, no pensions.

The hypocrisy doesn’t end there. When pension funds struggle financially – which they will more than ever when we return to sustainable rates of asset appreciation – the government unions and their supporters call on us to “tax the rich.” But those taxes aren’t for us. Those taxes are to pay government employees twice as much, or more, as ordinary private citizens.

But all of this is far too big to constitute a “sound bite,” so none of it can possibly be true, right Councilmember Atkins? It’s easier to suggest that any criticism of pension excess must emanate from a “right wing pressure group.”

*   *   *

Ed Ring is the executive director of the California Policy Center.

REFERENCES

Transparent California listing of CalPERS participating employers
(includes average pension for 30+ year participants)

Transparent California listing of city of Eureka individual retiree pension recipients

Transparent California listing of Eureka active employees

Estimating America's Total Unfunded State and Local Government Pension Liability

Summary:  The total state and local government pensions in the United States at the end of 2013 had an estimated $3.6 trillion in assets. They were 74% funded, with liabilities totaling an estimated $4.86 trillion, and an unfunded liability of $1.26 trillion. These funds, in aggregate, project annual returns of 7.75%. If you apply a 6.2% average annual return to recalculate the liability, using formulas provided by Moody’s Investor Services, the liability increases to $5.87 trillion and the unfunded liability increases to $2.27 trillion. Using the 4.33% discount rate recommended by Moody’s for valuing pension liabilities, the Citibank Pension Liability Index for July 2014, increases the estimated liability to $7.39 trillion and the unfunded liability to $3.79 trillion. That is, if America’s state and local pension funds were to no longer make aggressive market investments but were to return to relatively risk free investments, the payment required just to return these funds to solvency would be more than $12,000 per American.

This study concludes with four recommendations to ensure the ongoing solvency of public sector pensions. Based on the principals governing Social Security benefits, they are (1) Increase employee contributions, (2) Lower benefit formulas, (3) Increase the age of eligibility, (4) Calculate the benefit based on lifetime average earnings instead of the final few years, and (5) Structure progressive formulas so the more participants make, the lower their actual return on investment is in the form of a pension benefit. Finally, the study recommends all active public employees immediately be enrolled in Social Security, which would not only improve the financial health of the Social Security System, but would begin to realign public and private workers so they share the same sets of incentives and formulas when earning government administered retirement benefits.

*   *   *

Introduction and Methodology:

This study relies on the most recent data compiled by the U.S. Census Bureau, combined with recent analysis performed by Wilshire Associates, an investment advisory firm, to estimate America’s total state and local government pension fund assets, liabilities, earnings, contributions and payments to retirees. This study then applies formulas provided by Moody’s Investor Services to estimate how much the unfunded liability deviates from the Census Bureau’s estimate, based on using lower rate of return projections. This study is limited to state and local government pension funds and does not include analysis of the federal retirement pension systems. In most cases, instead of footnotes, citations and links to sources are included within the text. This report concludes with some recommendations intended to stimulate discussion and debate.

*   *   *

Total Assets – All U.S. State and Local Government Pension Systems:

The most recent compilation of total assets, contributions and payments for America’s state and local government pension funds is the “Summary of the Quarterly Survey of Public Pensions for 2014: Q1,” released on June 26, 2014 by the U.S. Census Bureau. It provides data for the quarter ended March 31, 2014.

In the introduction, the report states “total holdings and investments of major public pension systems increased to over $3.2 trillion, reaching the highest level since the survey began in 1968.” In the footnotes, the report provides clarification that they are only referring to state and local pension systems. They also estimate these “major public pension systems” to only represent 89.4% of all state/local pension system assets, which allows the means to reasonably extrapolate an estimate representing 100% of the total state/local pension system assets, contributions, and payments. They write:

“This summary is based on the Quarterly Survey of Public Pensions, which consists of a panel of the 100 largest state and local government pension systems, as determined by their total cash and security holdings reported in the 2007 Census of Governments. These 100 systems comprised 89.4% of financial activity among such entities, based on the 2007 Census of Governments.”

In table 1, below, the total pension assets are determined by taking the Census Bureau’s reported $3.218 trillion representing the 100 largest state/local pension funds, and dividing by 89.4%, yielding an estimated total assets for all state/local pension systems in the United States of $3.6 trillion.

Similarly, in table 1, using Census Bureau data, the most recent reported quarterly total employer and employee contributions for the 100 largest state/local pension funds are multiplied by four, with the product then divided by 89.4%. The resulting estimates are that during the 12 month period through March 31, 2014, $163.8 billion was contributed into these funds by employers and employees, and $251.6 billion was paid out to state and local government retirees. Presumably the cash flow deficit, $87.8 billion, was covered by investment returns.

Table 1 – State/Local Pension Systems as of 3-31-2014
Estimated Assets, Contributions, and Payments ($=B)
20140910_Ring_Pensions-T1b

*   *   *

Official Funding Status  – All U.S. State and Local Government Pension Systems:

At face value, it would appear that the funding status of these pension systems is quite healthy, since the deficit implied by payments to retirees exceeding contributions by employers and employees, $87.8 billion, represents only 2.4% of the estimated $3.6 trillion in assets. It isn’t nearly so simple, however.

The funding status of a pension system is determined by comparing the value of the invested assets to the present value of the estimated future payments to retirees. These future payments include estimates for people who have not yet retired. Since most state and local government employee participants in their pension systems are still working, the fact that current investment returns easily cover the deficit between contributions and payments to retirees is irrelevant. For a pension system to be 100% funded, payments into the fund, combined with investment returns earned by the fund, need to ensure that the total assets invested by the fund are equal to the present value of the liability. More on this later.

Wilshire Associates, a global investment advisory firm, performs in-depth analysis of America’s public employee pension systems through research papers that are updated annually. Their most recent reports are a “2014 Report on State Retirement Systems,” which primarily discusses data for the fiscal year ended 6-30-2013, and a “2013 Report on City and County Retirement Systems,” which primarily discusses data for the fiscal year ended 6-30-2012. Taking into account the improvement in the investment markets between June 2012 and June 2013, the weighted average funding ratio of the state and city/county pension systems combined, in accordance with the estimates provided by Wilshire Associates, at the end of June 2013 was 74%.

As previously discussed, the estimated total assets for all state/local pension systems in the United States is $3.6 trillion. Assuming that $3.6 trillion in assets represents 74% of the total pension liability carried by these same pension systems, then the estimated total liabilities for all state/local pension systems in the United States is $4.86 trillion. This means the total unfunded liability for these systems is estimated to be $1.26 trillion.

Table 2 – State/Local Pension Systems as of 3-31-2014
Estimated Assets, Liabilities, and Unfunded Liability ($=B)
20140910_Ring_Pensions-T2b

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Funding Status Scenarios – All U.S. State and Local Government Pension Systems:

As part of their analysis of America’s state/local pension systems, Wilshire Associates compiles a “median actuarial interest rate assumption,” representing both the average annual rate of return these systems expect to earn over the next 20-30 years, as well as the discount rate they use to derive a present value for the estimated stream of payments they expect to make to current and future retirees. For both state and local systems, in their “Summary of Findings” in both of their reports, Wilshire Associates estimates this median interest rate assumption to be 7.75%.

As alluded to earlier, to be 100% funded, a pension plan must have invested assets equal to the present value of all future pension payments. For every participating employee, whether they are active or retired, actuaries estimate their salary growth, their year of retirement, their initial pension, their subsequent pension payouts based on COLAs, and their life expectancy. The present value of all these future payments is how much a fully funded pension plan’s assets must be worth.

The rate at which these future payments are discounted per year must be equivalent to whatever rate the pension fund managers believe they will earn interest, on average, over the life of the fund. The theory is that if no future work were performed, and therefore no additional future pension benefits were earned and no additional money was contributed to the fund, the assets currently invested in a fully funded plan would earn enough interest to support every future pension payment until the last participant died of old age.

Since the amount of assets in a pension plan is a known, objective quantity, the debate over how much unfunded liability a plan may have centers on what assumptions are used to estimate the present value of the future payments, i.e., the “Actuarial accrued liability (AAL),” which, as discussed and noted on table 2, is estimated as of 6-30-2013 at $4.86 trillion. In order to assess whether or not that amount is overstated or understated, we can use a short-cut formulated by Moody’s Investor Services in their July 2012 proposal, “Moody’s Adjustments to US State and Local Government Reported Pension Data.”

In order to revalue a pension fund’s liabilities without having access to every actuarial calculation from every fund, what Moody’s does is estimate the midpoint of the future payments stream. They select 13 years into the future, which is quite conservative. Using a longer duration than 13 years will greatly increase the sensitivity of the liability to changes in the projected rate-of-return. As discussed in their July 2012 proposal, here is their rationale:

“To implement the discount rate adjustment, we propose using a common 13-year duration estimate for all plans. This is a measure of the time-weighted average life of benefit payments. Each plan’s reported actuarial accrued liability (“AAL”) is projected forward for 13 years at the plan’s reported discount rate, and then discounted back at 5.5%. This calculation results in an increase in AAL of roughly 13% for each one percentage point difference between 5.5% and the plan’s discount rate. For example, a plan with a $10 billion reported AAL based on a discount rate of 8% would have an adjusted AAL of $13.56 billion, or 35.6% greater than reported.

We recognize this duration estimate may be higher than warranted for some plans and lower than warranted for others. Each pension plan has a unique benefit structure and demographic profile that affects the time-weighted profile (duration) of future benefit payment liabilities. However, plan durations are not reported, and calculating duration individually for each plan is not feasible. Our proposed 13-year duration is the median calculated from a sample of pension plans whose durations ranged from about 10 to 17 years. Plans with shorter durations usually are closed or have a preponderance of older or retired members.”

Here is the formula that governs this recalculation of the present value of the liability (“PV”):

Adj PV = [ PV x ( 1 + official %i ) ^ years ] / ( 1 + adjusted %i ) ^ years

As made explicit in the above formula, along with duration (years), the other key variable in order to use Moody’s formula to evaluate funding status scenarios, of course, is the “%i,” the discount rate, which is also the rate of return projection. It is worth noting that the discount rate and the rate of return projection don’t have to be the same number. In private sector pension plans, the discount rate is required to differ from the rate of return projection. Private sector pension plans are required to use a lower, more conservative discount rate in order to calculate the present value of their future liabilities in order to avoid understating the present value of the liability. Public sector pension plans have not yet been subjected to this reform regulation, and the rate used to project interest is invariably the same as the rate used to discount future liabilities. This puts enormous pressure on these funds to adopt an aggressively high rate of return projection.

Here are explanations for the various alternative rate of return projections applied in Table 3.

Case 1, 6.2%  –  here is the rationale for this rate-of-return, excerpted from the report “Pension Math: How California’s Retirement Spending is Squeezing The State Budget” authored by Joe Nation, a Ph.D., Stanford Institute for Economic Policy Research, and former California Democratic assemblyman: “This 6.0 to 6.5 percent figure is based on the performance of a hypothetical fund containing 80 percent equity and 20 percent income instruments between 1900 and 1999. It assumes an equity rate based on the 20th-century Dow Jones industrial annual average of 5.3 percent, plus 2 percent in dividends, less 0.5 percent in fees. Combined with income instruments with a net rate of return of 4.5 percent, this hypothetical fund would have earned an average annual rate of 6.2 percent.”

Case 2, 4.33%  –  the rationale for this rate-of-return comes from Moody’s Investor Services “Moody’s Revised New Approach to Adjusting Reported State and Local Government Pension Data,” released in April 2013: “For adjustments to pension data, Moody’s will use the Citibank Pension Liability Index (Index) posted on the date of the valuation instead of its original proposal to apply a single rate for all plans each year.” Citigroup Pension Discount rate as posted by the Society of Actuaries in July 2014 was 4.33%.

Table 3, below, shows how much the unfunded liability for all of America’s state/local pension systems will increase based on various alternative rate-of-return projections, all of which are lower than the official composite rate of 7.75% currently used by America’s state/local pension funds. As can be seen, if a rate of 6.20% is used, reflecting the historical performance of U.S. equities, the total liability for America’s state/local pension systems rises from $4.86 trillion to $5.87 trillion; the unfunded liability rises from $1.26 trillion to $2.27 trillion; the funding status declines from 74% to 61%.

If the relatively risk-free rate of 4.33% is used, reflecting Moody’s recommendation to adhere to the Citibank pension liability index rate, the total liability for America’s state/local pension systems rises from $4.86 trillion to $7.39 trillion; the unfunded liability rises from $1.26 trillion to $3.79 trillion; the funding status declines from 74% to 49%.

Table 3 – State/Local Pension Systems as of 3-31-2014
Estimated Unfunded Liability Using Various Discount Rate Projections ($=T)
20140910_Ring_Pensions-T3c

Please note the above table can be downloaded here [1]. It is a useful tool for quickly estimating how much the unfunded liability may increase for any pension fund if the projected rate of return is lowered from the official rate. In this table, and on the spreadsheet, the yellow highlighted cells represent assumptions, and require input from the user. The green highlighted cells depict key results from the calculations.

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Observations and Recommendations

The data gathered for this study, combined with reasonable assumptions, allows one to estimate the pension fund assets for the total state and local government pension systems, combined, to equal $3.6 trillion, with an attendant liability of $4.86 trillion. In turn this means the total unfunded liability for these pension systems is estimated at $1.26 trillion. Using formulas provided by Moody’s investor services, one may apply lower rate-of-return assumptions to the official total liability estimate, and calculate how much the liability – and unfunded liability – will increase based on lower projected returns. While none of these various estimates can be considered precise and indisputable, the credibility of the source data and formulas strongly suggest they are reasonably accurate.

Not beyond serious debate, however, are financial questions and policy issues relating to pensions that are of critical importance to the solvency of America’s state and local governments. For example, even if the 74% funded ratio is accurate, it is a best case scenario that still raises troubling questions. Because the $183 billion in reported annual contributions must include not only the “normal contribution,” representing the present value of future pensions earned by workers in the most recent fiscal year, but also the “unfunded contribution,” the catch-up payment designed to pay down the unfunded liability. Even if the total unfunded liability for all of America’s state/local government pension systems is only $1.26 trillion, to eliminate the underfunding over 20 years at 7.75% interest would require annual payments of $126 billion per year. That would leave only $63 billion to cover the normal payment.

Although consolidated contribution data that breaks out the normal and unfunded contributions separately is not readily available for America’s state/local government pension systems, it is possible to impute the normal contribution – an exercise that leaves wide latitude for interpretation. Nonetheless, in a 2013 study, “A Method to Estimate the Pension Contribution and Pension Liability for Your City or County,” the California Policy Center did just that. The worksheet showing the assumptions and formulas can be downloaded here, ref. the tab “normal contribution (imputed).” As it is, assuming 16 million full-time equivalent active state/local government workers, accruing pension benefits at an aggregate rate of 2.0% of final payroll per year worked – keeping the rate-of-return assumption at 20 years, the imputed normal contribution is $120 billion per year. [2] By this logic, the total contribution of $183 billion is inadequate. The normal contribution of $120 billion plus the unfunded contribution of $126 billion suggests an adequate contribution should be $246 billion per year.

To summarize the immediately preceding paragraphs, if one continues to assume these funds will earn 7.75% per year, annual contributions were $67 billion short of the $246 billion total necessary to pay not only the normal contribution, but enough of a catch-up “unfunded contribution” to restore 100% funded status within 20 years. Aspiring to at least do this much is crucial, because the 7.75% rate-of-return projection may not be achieved. As already shown, the amount of a pension system’s liability is highly sensitive to the assumed rate of return. So are the normal and unfunded contributions. Here is the impact of lower rates of return on those payment estimates:

On Table 3, above, the impact of a 6.2% rate-of-return projection is shown to increase the unfunded liability from $1.26 trillion to $2.27 trillion, and lower the funded ratio from 74% to 61%. Using the tools and assumptions summarized in the preceding paragraphs, the impact of a 6.2% rate of return – representing the historical performance of U.S. equities over the past 60 years – on the unfunded contribution is to increase it from $126 billion to $201 billion; the normal contribution increases from $120 billion to $176 billion. Put another way, if realistic repayment terms are adopted for the unfunded liability, at a rate-of-return of 6.2% the total required contribution for America’s state/local government pension systems could rise from the current $183 billion to $377 billion.

Similarly, at a hopefully risk-free rate-of-return of 4.33% (the July 2014 Citibank Pension Liability Index Rate recommended by Moody’s), the normal contribution estimate rises to $281 billion and the unfunded contribution estimate rises to $287 billion – a total of $586 billion vs. $183 billion being actually contributed today.

These figures are not outlandishly inflated. They merely indicate how extraordinarily sensitive pension fund solvency is to rate-of-return projections, and how perilously dependent pension funds are on investment returns.

This, again, brings up the most salient question of all: What rate of return is truly achievable over the next 2-3 decades?

To at least recap this economic debate is necessary because this one assumption is central to policy decisions of extraordinary significance. If the optimists are right, rates-of-return will rise into the high single-digits and stay there, rendering pensions financially sustainable. The states and locales who offer them can therefore keep their contributions flat and allow a few more good years in the market to wipe out their unfunded liabilities. If the pessimists are correct, rates-of-return are going to shrink into the low single digits and stay there, making aggressive paydowns of a swollen unfunded liability a mandatory proposition. Required contributions will rise to untenable levels, crowding out other government services, causing taxpayer revolts, union lawsuits, and a string of bankruptcies.

The case for pessimism – or realism – is strong. Economic growth over the past 30 years has been fueled by debt accumulation; economic growth creates profits, profits create stock appreciation. Debt accumulation stimulates consumption, low interest rates stimulate purchases of real estate and durable goods, driving prices up. Debt accumulation and easy credit causes an asset bubble, and asset bubbles create collateral for additional debt. Total market debt in the U.S. is now higher than it was in 1929, immediately before the great depression. We are at the point now where there is no precedent in economic history that enables us to assume we can continue to use debt to stimulate economic growth.

The other economic headwind facing investments is the aging population. In 1980, 11% of the U.S. population was over 65. By 2030, over 22% of the U.S. population will be over 65. This means that compared to 1980, when America’s current era of of debt accumulation began, by 2030 there will be twice as many people, as a percentage of the U.S. population, selling assets to finance their retirements. The impact of so many sellers in the markets, combined with interest rates having now fallen to near zero – meaning a primary method to stimulate debt formation has been exhausted – will at the very least take the growth out of asset bubbles, if not cause their collapse. The state/local pension funds, based on current data as presented here, are already net sellers in the markets. All of this augers poorly for returns-on-investment. And while, as noted in the next paragraph, America’s economy remains extraordinarily resilient, especially compared to the rest of the world, a collapse of collateral values would trigger a global financial meltdown, and that would take America down with it.

The case for optimism is not unfounded. To stave off recession, or worse, the U.S. has pursued a policy in recent years of injecting trillions of dollars of new money into the system through massive Federal Reserve Bank intervention. But the only way this impetuous gambit can backfire is via a global loss of confidence in the U.S. currency. Despite wails of panic from predictable quarters, that isn’t likely, since every other central bank in the world is playing the same game, with less success. The largest currency group apart from the U.S. dollar is the Euro, and the Eurozone, unlike the U.S., faces a demographic crisis that is genuinely alarming, and their debt burden combined with their level of structural entitlements is much worse than in the U.S. China’s economy is far more dependent on trade, they face a demographic crisis similar to Europe’s, their society is the most likely among the major economies to experience social upheaval in the future, their real estate bubble is worse than in the U.S., and despite the opacity of their banking system, their debt burden is quite likely more severe than in the U.S. Japan is still reeling from a generation of deflation and crippling debt. No other currencies are supported by economies that are big enough to matter. Especially since the energy boom began in the U.S., no other country has anywhere near America’s capacity to domestically source raw materials and manufactured goods for export. The U.S. is basically daring the world to depreciate the dollar, because currency depreciation might actually help the U.S. economy more than it would hurt.

And so the debate over realistic rates of return rages on.

There is another question, however, which considers not the economic issues, but the issue of equity and fairness. A recently published book “Capital in the Twenty-First Century,” by Thomas Piketty, has become a favorite among leftist intellectuals who provide thought leadership for, among others, the public sector unions who control most public sector pension fund boards and who advocate tenaciously for keeping pension benefits as they are. Piketty makes the following claim:

“The rate of capital return in developed countries is persistently greater than the rate of economic growth, and that this will cause wealth inequality to increase in the future.”

Piketty is certainly correct that the rate of capital return exceeds the rate of economic growth. But his moral arguments fail when it comes to public sector pensions. Because public sector pensions have provided the means whereby public sector employees are granted immunity from the very forces that Piketty is arguing have empowered the oligarchy at the expense of ordinary workers. Public sector pensions have essentially creating a common cause between government workers and the oligarchy they allege is exploiting ordinary workers. This point cannot be emphasized enough. Government workers, through their pension funds, benefit from all policies designed to elevate asset values, including bubble levels of asset appreciation, because that is essential to the solvency of their funds. Their interests are aligned with those of central bankers, international corporations, and individual billionaires, whose self-interests impel them to support policies to keep interest rates artificially low, heap additional levels of debt onto the economy despite diminishing returns, and push asset values to even higher, more unsustainable levels. Because to stop doing that will crash these pension funds.

Is it equitable for government sponsored investment entities to control over $3.6 trillion in market investments, investments made in an economic environment which, if successful, perpetuates the gains of productivity flowing disproportionately to the wealthy elite, yet which, when unsuccessful, hits up taxpayers to cover the losses?

When considering solutions to both the financial challenges and issues of equity and fairness surrounding public sector pensions, it is important to understand that even if these systems are able to recover fully funded status based on surprisingly good and sustained market performance, it does not follow that their performance is something that can be extended to the entire population, because if so, instead of 20% of the retired population funding their retirement income through selling assets on the markets, 100% of the retirement population would be doing so, exerting far more downward pressure on asset values.

A relevant question to ask is therefore whether or not pension systems that are funded by taxpayers and bailed out by taxpayers should be investing in the market at all – why aren’t government employee pensions funded through a combination of low risk investments such as T-Bills and contributions from current workers?

The example of Social Security provides several instructive points which should be considered in any discussions of pension reform, or the larger question of what the government’s role should be in providing financially sustainable retirement security to Americans. Social Security, unlike state/local government worker pensions, has a positive cash flow. As seen here from this table on their website “Fiscal Year Trust Fund Operations,” during 2013 Social Security collected $851 billion from active workers and paid out $813 billion, primarily to retirees. The so-called Social Security “Trust Fund” had a balance at the end of 2013 of $2.76 billion.

If public sector pensions are indeed facing serious, potentially fatal financial challenges, they should consider adopting five elements from Social Security:

(1) Make it possible to increase employee contributions – Social Security withholding can be increased or decreased at the option of the federal government. If collections into public employee pension funds are inadequate, increase the withholding from employee paychecks – not only for the normal contribution, but also to help pay the unfunded contribution.

(2) Make it possible to decrease benefits – nothing in Social Security is guaranteed. Benefits can be cut at any time to preserve solvency. Decreasing benefits may be the only way to preserve defined benefit pensions. Equitable ways to do this must be spread over as many participant classes as possible. For example, the reform passed by voters in San Jose (tied up in court by the unions) called for suspending cost-of-living increases for retirees, and prospectively lowering the annual rates of benefit accruals for existing workers.

(3) Increase the retirement age. This has already been done several times with Social Security. Pension reforms to-date have also increased the age of eligibility for benefits.

(4) Calculate benefits based on lifetime earnings. Social Security calculates a participant’s benefit based on the 35 years during which they made the most. Public sector pensions, inexplicably, apply benefit formulas to the final year of earnings, or the final few years. These pension benefits should be calculated based on lifetime earnings.

(5) Make the benefit progressive. The more you make and contribute into Social Security, the less you get back. At the least, applying a ceiling to pension benefits should be considered. But it would serve both the goals of solvency and social justice to implement a comprehensive system of tiers whereby highly compensated public servants, who make enough to save themselves for retirement, get progressively less back in the form of a pension depending on how much they make.

These suggested reforms are meant to be taken to evolve defined benefit pensions into a plan that provides a minimal level of retirement security. The government should not be in the business of providing retirement benefits to anyone, private or within government, that go beyond providing a minimal safety net. The government certainly shouldn’t be in the business of providing pensions to government employees that are many times better than what they provide to private citizens in the form of Social Security. And the government, or government employees through their union controlled pension funds, should not be playing the market with $3.6 trillion of taxpayer sourced dollars, then forcing taxpayers to bail out these funds when they don’t meet projections.

A unique and elegant way to provide equitable, minimal, government administered and financially sustainable retirement security to all American’s would be to immediately require all active government workers to join Social Security. These workers, and retirees, would keep whatever pension benefits they’d qualified for so far, subject to reductions per the five options just noted in order to preserve solvency for the fund. They would begin to pay into the Social Security system, with the employer contribution into their pension funds proportionally reduced to make it an expense-neutral proposition. Since government workers are relatively highly compensated compared to private sector workers, the participation, for example, of 16 million active state/local government workers would immediately improve the solvency of the Social Security Fund. The five options available to preserve Social Security, as noted above, would be far less onerous in their implementation over the coming decades if tens of millions of highly compensated government workers were to participate. And since their unions purportedly speak for the common man, they should have no objection to the highly compensated among them getting less back in retirement than those less fortunate.

Who knows, maybe the much vaunted, potentially real Social Security “Trust Fund” assets could be used to purchase Treasury Bills. Such a policy would have the twin virtues of taking pressure off the federal reserve, and augmenting Social Security collections with modest investment returns.

Ed Ring is the executive director of the California Policy Center.

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FOOTNOTES

(1) The tables in this study are all found on this spreadsheet, State-and-Local-Pension-Liability.xlsx. The spreadsheet also contains additional notes on the assumptions used, as well as links to the source data.

(2)  To estimate a fund’s required normal pension contribution using the Impact-of-Returns-and-Amortization-Assumptions-on-Pension-Contributions.xlsx spreadsheet, “normal contribution (imputed)” spreadsheet, the assumptions used and referenced above were as follows:
–  Average Salary = $70,000
–  % cola growth/yr = 2.0%
–  % merit growth/yr = 1.0%
–  avg years till retire = 17
–  proj % discount (fund’s assumed annual rate of return) = 7.75%
–  base year 2000+ = 11
–  avg years retired = 20
–  pension formula/yr = 2.00%
–  pension cola % = 2.0%
–  elig # workers = 16,000,000
Please note this spreadsheet does not default to these values. They have to be entered in the yellow highlighted input cells. The spreadsheet is designed to calculate results for whatever set of assumptions the user wishes to enter. This spreadsheet also contains tabs, similarly highlighted with yellow to denote cells to input user assumptions, to recalculate estimates for the unfunded liability and the unfunded contribution. On this spreadsheet, as noted above, there are tools to recalculate the normal contribution based on having that information, or imputing it if that information is not available.

Secret Sheriff Union Negotiations Endanger Orange County’s Financial Future

The Orange County Board of Supervisors has tentatively approved a transparency ordinance, known as COIN (for Civic Openness In Negotiations) that would require negotiations with government employee unions to be open to the public. Boy, do they need it.

The current negotiations between the sheriffs’ union and the Orange County Board of Supervisors are a perfect example of why COIN is needed. On Friday, after two years of secret negotiations with the Sheriffs’ union, the proposed terms of the contract being offered by the union were revealed to the public for the first time. And now the Board proposes to take a final vote this Tuesday!

That’s right, fellow taxpayers. We get one business day to review the complex business deal that will bind our County for years to come, and then our elected officials will vote.

This not nearly enough time for the taxpayers, who are going to be on the hook for these salaries and pensions, to understand the costs of what is being offered or fully weigh in. Which is, of course, the point of keeping the details secret until the last minute. Secret negotiations, followed by sudden and final votes, is how business has always been done in Orange County and throughout California’s cities and counties. So we should not be surprised that our County again faces grave financial challenges.

The unions do not want those of us who pay the bill to have the time to calculate how much this new contract will add to the current average full time compensation, including benefits, of $186,682 per year for sworn sheriffs, compared to the average Orange County household income, with two wage earners in many households, of $75,566 (ref. U.S. Census).

And the last thing the unions want the public to fully digest is how this deal may affect Orange County’s unfunded pension liability. The officially recognized amount of this debt – that must be paid by taxpayers – is over $5 billion dollars, but it grows to almost $8 billion if you assume a more reasonable 6.2% return on investments rather than the highly optimistic 7.25%. It might have been an impediment to their negotiations, after all, if more people understood how much needs to be paid in order to eventually eliminate this debt. To pay it off in twenty years requires annual payments estimated between $500 million and $800 million, which equates to a $500 to $800 per year payment for each of Orange County’s roughly 1.0 million households.

Pension costs constitute a mortal threat to Orange County’s financial health. The county has already been bankrupt once because of a lack of transparency regarding its finances. The public should have more than a long weekend and contract bullet points to consider so that everyone knows how much our children and grandchildren are going to have to pay to fund this contract.

Here are a few things we know about this proposal thanks to an email from Supervisor Moorlach sent on Friday:

“It adds two new steps to the salary schedule, a thirteenth and a fourteenth. This creates two problems. The first is that it benefits all of those who are at the top of their pay scale (step 12), which represents some 77 percent of the workforce in this union. The second is that the pay increases to these impacted employees would be effective immediately, which is a pay raise, but not implemented until the following year.

The retiree medical strategy for AOCDS [Association of Orange County Deputy Sheriffs] is different than that of the other bargaining units. The County’s assumption of the employees’ portion, the Annual Required Contribution (ARC), assumes that this annual commitment of 3.6 percent will remain flat. That is not the case, as it will most likely continue to increase over time, based on actuarial studies. By the County assuming 2 percent of the cost (more than half), another pay raise, there is a blurring effect that, in future negotiations, could have the County picking up all of the costs. This may subject the taxpayers to an ever-increasing cost that this Board may initiate in perpetuity for subsequent Boards.

Now the costs of the “3% @ 50” pension enhancement have come home to roost and it must be addressed. Consequently, all employees should at least pick up the employee portion that the employer had previously, and generously, subsidized. In 2001, AOCDS determined that a pension increase, retroactive to the date of hire, was more important than salaries. Therefore, dealing with this growing fiscal tumor will require an impact on wages. Every other bargaining unit has stepped up to the plate. This proposal provides an almost full offset for this maneuver, a point that may not settle well with the other bargaining units in future deliberations.”

And it is not just private citizens who should be allowed to digest the agreement. The county only has a limited amount of money, so what is negotiated with the sheriffs union will impact other county employees and vital services. Supervisor Moorlach said it best “This is not an equitable proposal. Someone has to sacrifice to pay the Sheriff Department’s employees, and it would be the employees of all the other County departments.”

Moorlach also made this observation: “The contract cities will have to budget for this proposal. I hope that they have an opportunity to weigh in and provide their counsel before the Board of Supervisors votes on this matter.”

The reality, of course, is that the cities, county employees, and the public will not have an adequate opportunity to understand this proposal and have their voices heard. The vote is tomorrow. The consequences will last for decades.

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Mark Bucher is the President of the California Policy Center.