CalPERS Local Government Employers Rates to Go UP
In March 2012 the CalPERS Board of Administration announced it cannot count on the high returns on investments it previously projected and that it will need hundreds of millions more from state and local governments, meaning that taxpayers will bear hundreds of millions more in costs to fund public employee pensions. Actual CalPERS returns have fluctuated wildly, ranging from 1.1 percent for 2011 to 8.3 percent for the past three years, with a 10-year return of 5.1 percent. Critics argue that assuming unrealistically high investment returns masks the true costs of public employee pensions to the taxpayers, leading to even greater costs in future years. (1)
In March 2012 the California Public Employees’ Retirement System (CalPERS) Board of Administration voted to reduce the discount rate to 7.5 percent, affirming the recommendation made by its Pension and Health Benefits Committee. The discount rate for the Public Employees’ Retirement Fund was last changed 10 years ago when it was lowered to 7.75 percent from 8.25 percent. The discount rate is calculated based on expected price inflation and real rate of return. The discount rate reflects expectations of what the markets will deliver in the future. (2)
Glendale’s pension obligation increased by $735 million dollars from $688 million (2001) to $1.423 Billion (2012). This is because the taxpayers guarantee an annual pension return (discount rate) of 7.5%. Any shortfall in CalPERS investment return below 7.5% results in increased annual pension payments by the City of Glendale. The city’s pension payments are $23 million higher per year and it’s expected to increase significantly in the next few years due to higher salaries, salary perks, and pension spiking that is still allowed. From 2001 to 2012, post employment health benefits increase by $191 million and our annual debt has tripled. (3)
CalPERS reported a 12.5 percent return on investments for the 12 months that ended June 30, 2013, well above the Fund’s discount rate of 7.5 percent, the long-term return required to meet current and future obligations. CalPERS assets at the end of the fiscal year stood at more than $257.8 billion. (4)
Investment returns are based on compounded daily earnings over the year, including continuing member contributions and benefit payments, and do not precisely correspond to one-year changes in CalPERS overall portfolio market value. Employer contribution rates that use CalPERS 2012-13 Fiscal Year investment performance will be calculated based on audited figures and will be reflected in contribution levels for the State of California in Fiscal Year 2014-15, and for contracting cities, counties and special districts in Fiscal Year 2015-16. (4)
Per article dated October 7, 2013, there is a new focus on showing risks as rates go up. CalPERS begins to take a bigger bite of state and local government budgets. A new CalPERS projection shows employer rates for the largest group of state workers increasing 27 percent over the next six years. The goal is make rates more predictable for employers, avoiding future sticker shocks and allowing time to adjust budgets, while also encouraging employers to think about risks that could change the rates. (5)
Local Government Employers need to think not just about their current risk levels, but also how that risk level can change over time,” Alan Milligan, CalPERS chief actuary, said “If they are uncomfortable with the risk level now, and we know that is likely to increase, then that’s something they should be aware of and thinking about.” He previously has said that a rate increase is likely early next year, after a review of economic and demographic forecasts, including new projections that people on average are living longer. (5) In Glendale’s case, it faces exorbitant pension costs due to increased salaries (formula based on highest 12 month period), salary perks, and pension spiking.
As CalPERS pension systems move toward full funding (the goal of new higher CalPERS rates) year-to-year jumps in employer rates are more likely. This is not the time for the Glendale City Council to add to the City’s pension woes by approving cost of living pay increases. With any investment loss, a bigger employer contribution rate increase is needed to fill the gap. With last year’s outstanding investment returns, Milligan said that the board should consider “flexible derisking” resulting in lowering the discount rate, and/or changing the asset allocation mix. (5)
The California Public Employees Retirement System board is expected to review Calpers asset allocations later this year. Milligan said he is likely to recommend lowering risk levels, that would result in another rate increase. In the past, CalPERS adopted a “discount rate” to offset future obligations based on a slightly lower earnings forecast than actually expected, providing some cushion to reduce risk. Milligan said, indicating that he may recommend that they consider adopting a less volatile asset mix, because that may be actually a better way to control risk.” (5)
At the core of CalPERS risk is the need to get about two-thirds of the money to pay future pensions from market-based investment earnings, which are difficult if not impossible to predict with precision. Public pensions in California originally were limited to more predictable investments: bonds. But Proposition 1 in 1966 allowed 25 percent of investments in blue-chip stocks. Proposition 21 in 1984 removed the lid, allowing anything “prudent.”
When a booming stock market in the late 1990s gave CalPERS a surplus, pushing the funding levels past 100 percent, the pension system followed the common practice of spending the “windfall” rather than keeping the money to offset future downturns. Employers were given a contribution “holiday,” dropping the annual state payment from $1.2 billion to $159 million in fiscal 1999-00 and to $157 million the following fiscal year. Pension reform legislation last year bans future contribution holidays. (5)
In 1999, CalPERS sponsored a retroactive pension increase for state workers, SB 400 misleading legislators “superiors” that market-based investment returns would cover the cost. The SB 400 benefit increase, that lowered the retirement age by five years with the same retirement formula rate, accounted for 27 percent of the increase in the annual state CalPERS payment by fiscal 2009-10. The City of Glendale passed similar legislation in 2001. The pension reform signed last year by Gov. Brown, rolled back the SB 400 retirement age for new hires.
With the deep recession in March 2009, the CalPERS investment fund plunged from about $260 billion in the fall of 2007 to $160 billion in March 2009. The CalPERS fund, did not fully recover again until this year, was valued at $270.5 billion last week.
The big loss revealed shortcomings in the 2005 actuarial method that kept rates low. CalPERS in 2009 temporarily lifted actuarial limits for a three-year phase in of the biggest one-year loss, $24 billion. Other problems in an annual risk report said most funds pay less than the annual interest on their debt or “unfunded liability.
CalPERS adopted a new actuarial method last Aprilaimed at getting to full funding by raising rates by 50 percent over the next seven years. CalPERS says it will have about 70 percent of the projected assets needed to pay future pension obligations. (5)
With Glendale’s $1.423 billion unfunded pension debt, coupled with CalPERS plan to raise rates over the next seven years to achieve full funding, and the risk of a market downturn due to a stagnant economy, the City Council needs to substantially reduce employee debt, by restructuring and streamlining each department, eliminating waste and abuse, duplication by consolidating departments and eliminating top heavy management positions, not refilling open positions, outsourcing in lieu of, substantially reducing its overtime policy, eliminating pension spiking and sharing costs, where fiscally prudent, with its tri-city neighbors, Burbank and Pasadena.