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Think Tank: Blame Pension Costs For The 140 Tax Increases On California’s Ballot

When Californians go to vote on November 4, they will find a ballot stuffed with tax hikes. There will be 140 different proposed tax increases on ballots across California. Is there a reason behind the surge?

Mark Bucher, president of the California Policy Center, thinks he knows the reason. In a new column he says voters need look no further than pension costs. From Bucher’s column in the Sacramento Bee:

Tax-weary Californians looking to explain this paradox need look only to former Vernon (population 114) city administrator Bruce Malkenhorst for an answer.

Malkenhorst received a $552,000 pension in 2013, according to just-released 2013 CalPERS pension data on TransparentCalifornia.com.

[…]

Malkenhorst is part of a growing number of 99 California retirees who received at least half-million-dollar pension payouts in 2013, up from four in 2012. Such lucrative pensions mean that in 2014, California will spend approximately $45 billion on pensions, equaling total state and local welfare spending for the first time. And in the zero-sum game of government spending, an extra dollar spent on pensions means one less spent on welfare, infrastructure or safety – or returned to the taxpayer.

Though Malkenhorst and his ilk personify California’s pension profligacy, they do not drive it. That distinction goes to the 40,000 California retirees who took home pensions greater than $100,000 in 2013.

These are the pensions of Susan Kent, a retired Los Angeles city librarian, who took home a $137,000 pension in 2013. And Thomas Place, a retired San Joaquin court reporter, whose pension was $105,000. And, Betty Smith, a retired Alameda nurse, who received $116,000.

Anecdotal evidence aside, more tax dollars than ever are going toward paying pension costs. From Bucher:

Six-figure pensions for mid-level public servants have brought the state to the point where one out of every nine state and local tax dollars goes to pay for pensions. That’s up from one in 16 tax dollars in 1994. Tax increases now do not increase government services, but simply service government pensions.

And these compensation figures do not include five-figure health benefit obligations, which will only increase as the population ages and health care costs inflate. Bankrupt Stockton, where city employees who worked as little as one month receive a lifetime of retiree health benefits (including spousal coverage), is already paying this price.

Barring pension reform, Stockton – where one in five tax dollars will soon go to pensions – is a harbinger of things to come for other California cities that find themselves at some point on Stockton’s adverse pension spiral: Big pension obligations mean fewer tax dollars for services like safety and infrastructure, driving away taxpayers and increasing pension burdens further. Hence the need for yet more tax increases.

But taxpayers are having trouble keeping up: California pension funds are currently only 74 percent funded. And this is an optimistic estimate given that pension funds assume a very high rate of return of about 7.5 percent per year, an ambitious goal in this investment climate. For every 1 percent this projection drops, California taxpayers must contribute $10 billion more per year to maintain the same funding level, according to a recent analysis by the California Policy Center, using investment formulas provided by Moody’s Investors Service.

The entire column can be read here.

Omaha Hit With Credit Downgrade As Pension Liabilities Increase

Moody’s downgraded Omaha’s credit rating from Aa1 to Aa2 on Thursday, citing “pension costs” as a major driver of the downgrade.

Moody’s did give the city a “stable” outlook, but admitted that pension costs are “not expected to moderate in the near future.”

Factors that played a part in the downgrade, according to the Moody’s report:

CHALLENGES

– Large and growing unfunded pension liabilities, persistent underfunding of ARC

– High fixed operating costs arising from pensions, debt service, and OPEB

– Protracted union negotiations likely to require retroactive expenses

Factors that could drive the city’s rating up, or further down, from the report:

WHAT COULD CHANGE THE RATING- UP

-Significant progress to reduce the city’s long-term pension and OPEB liabilities

-Reduction in fixed cost burden to the city’s budget

WHAT COULD CHANGE THE RATING – DOWN

-Failure to achieve significant progress towards reducing long term liabilities

Omaha Mayor Jean Stothert released a statement addressing the downgrade. From WOWT News:

“Omaha’s bond rating is still better than 80% of all US cities,” reads a news release from the Mayor’s Office.

[…]

“This bond rating shows we still have a lot of work to do in reforming our public employee pensions,” says Mayor Jean Stothert. “Our unions must realize the severe consequences of delays, inaction and failure to accept reasonable contract offers.”

Photo credit: “Omaha skyline humid day” by Mawhamba. Licensed under Creative Commons Attribution-Share Alike 2.0 via Wikimedia Commons

CalPERS May Have Approved Special Pay Items Without Doing The Math On Cost

CalPERS recently approved a list of 99 “special pay items”, or bonuses given to workers whose jobs meet certain requirements.

But a report from the Los Angeles Times suggests that CalPERS approved the items without knowing how much they would cost.

From the LA Times:

CalPERS repeatedly told The Times it didn’t know how much the bonuses were adding to the cost of worker pensions even though cities submit detailed pay and bonus information that is used to calculate retirement pay.

Even a small bump in salary can cause a public agency’s pension costs to soar. An increase of $7,850 to a $100,000 salary can amount to an additional $118,000 in retirement if the employee lived to 80, according to an analysis by the San Diego Taxpayers Assn., a watchdog group that scrutinizes city finances.

Fitch, a Wall Street rating firm that weighs in on the financial health of governments, warned that the pension fund’s vote would burden cash-strapped cities.

“Cities and taxpayers will undeniably face higher costs,” said Fitch analyst Stephen Walsh. “Pensions are taking a bigger share of the pie, leaving less money for core services.”

[…]

At The Times’ request, CalPERS analyzed salary and bonus costs for Fountain Valley — one of hundreds of cities and public agencies that award pension-boosting bonuses to workers.

CalPERS found the Fountain Valley perks could hike a worker’s gross pay as much as 17%. About half the city’s workforce received the extra pay that will also increase their pensions, most of them police and fire employees.

CalPERS’ response to the report:

CalPERS executives said they don’t understand the anger caused by the board’s vote. The action simply clarifies the 2012 reform law, which was designed to stem rising pension costs, said Brad Pacheco, a spokesman for the agency.

CalPERS always assumed that new employees would continue to benefit from bonuses just as those hired earlier did, Pacheco said. The reform law is still estimated to save taxpayers $42 billion to $55 billion over the next 30 years, he said.

“It’s far-stretched to say this is a rollback of reform,” Pacheco said. “We implement the law as it was written, not how others wish it were written.”

The special pay items passed a vote from the CalPERS board, but some board members have voiced their displeasure for the rules, according to the LA Times:

State Treasurer Bill Lockyer and state Controller John Chiang both complained about the pension boosters but said they had little choice but to approve them.

“Many of the items on this premium pay list are absolutely objectionable,” said Tom Dresslar, a spokesman for Lockyer. But frustration, he said, “needs to be directed to the proper place, which is the public agencies that negotiated the perks through collective bargaining agreements.”

All of Pension360’s coverage of CalPERS’ special pay items can be read here.

New Jersey Anti-Pay-To-Play Bill Passes Senate

The New Jersey Senate on Thursday approved a recently introduced piece of legislation that would tighten rules regarding political donations made by investment firms vying for business from the state’s pension funds.

The bill, called S-2430, passed by a vote of 25–8.

Kentucky Bill Aims To Increase Transparency, Accountability In Retirement System

Kentucky State Rep. Jim Wayne has introduced legislation that would infuse a ray of transparency into the state’s retirement systems, including KRS, a system oft criticized for its opaque practices.

From the Independent:

The legislation, Bill Request 91, would require state-administered retirement systems to operate under the state procurement laws, which includes making contracts public. It would also prohibit the use of placement agents, intermediaries who have been involved in pay to play scandals in other states.

The legislation also seeks to tighten requirements for KRS board members appointed by the governor to ensure they have appropriate investment expertise. The current low-qualified “investment experts” on the board refused to comment on any investment issues for the Kentucky Center for Investigative Reporting story, Wayne said. He added the two investment experts on the board need to be knowledgeable, independent and willing to be accountable to the public.

[…]

“The current model smacks of the good ol’ boy system,” said Wayne, D-Louisville. “The system is closed. A small group decides behind closed doors who gets to manage billions of dollars in public money and what they’ll get paid for it, no questions allowed. That’s just way to chummy for my tastes.”

The urgency for such legislation was illustrated after two journalism organizations investigating the pension plans during the summer were denied information on fees and even the names of individual managers, Wayne said.

The Lexington Herald-Leader reported June 14 that KRS spent at least $31 million on managers of hedge funds, private equity, real estate and other “alternative investments” that hold just one-fourth of the system’s $15 million in assets and produced its lowest returns.

A July 24 report by the Kentucky Center for Investigative Reporting in Louisville found KRS potentially spent $156 million in mostly undisclosed fees to these “alternative investments.”

Wayne added one more comment:

“The health and well-being of public employee retirement systems should not be shrouded in mystery,” said Wayne. “No one should be required to invest their hard-earned money in a system that is not fully transparent. Not only should public employees know if the systems are financially stable, the taxpayers should also know.”

The Kentucky Retirement Systems holds $16 billion in assets and is about 45 percent funded, although certain parts of the system are unhealthier.

KRS allocates about 35 percent of its assets toward alternative investments, including real estate; the nationwide average is 25 percent, according to data from Cliffwater LLC.

Arizona City On Hook For $16 Million of Additional Pension Payments in 2015, New Calculations Reveal

Tucson’s 2015 payment to its pension systems will likely be much higher than city officials initially thought—new calculations by Arizona pension officials indicate Tucson may be on the hook for an additional $16 million.

The city thought its 2015 payment to the public safety pension system would total around $46 million. But after recent calculations, the payment will likely be upwards of $62 million.

Reported by the Arizona Daily Star:

Tucson could pay up to $16 million more for its police and fire pensions next fiscal year, according to a newly released state pension board report.

The ballooning costs are mostly the result of a recent Arizona Supreme Court decision overturning a 2011 state law intended to keep pension costs down.

The decision means Tucson could pay about $62 million for its public-safety pensions next year.

Back in February, the court ordered the Public Safety Personnel Retirement System to reimburse retirees $40 million for past cost-of-living increases and to shift $335 million to a reserve fund to cover future cost-of-living increases.

After the ruling, the state pension board had to calculate how much of a dent the court order would put in each city’s retirement funds.

It released its calculations earlier this week.

For Tucson, it drops its police and fire pensions under 40 percent funded through the plan’s investments, according to PSPRS documents.

That means taxpayers are on the hook for $763 million in unfunded pension obligations owed to existing and future public safety retirees. The two pensions hovered around 50 percent funded last year.

As a result, Tucson will likely pay over 60 cents on every dollar of salary for police and fire personnel toward pensions.

Tucson’s payments to its pension systems in 2015 are expected to total around $100 million.

Chart: Is The Actuarially Required Contribution A “Joke”?

Yesterday, Pioneer Institute Senior Fellow Iliya Atanasov called the annual required contribution (ARC) the “biggest joke of the costing and funding process”. He said in a column at Public Sector Inc:

The biggest joke of the costing and funding process is the so-called annual required contribution (ARC) that the actuarial valuation is supposed to determine. In reality, there is nothing “required” about the ARC – most jurisdictions can contribute absolutely nothing and face no legal repercussions, at least in the short run. And when state and local governments don’t make the ARC, they rarely look at, let alone disclose, the long-term cost of postponing the payment and how much more expensive the benefits become as a result. Just look at Illinois, New Jersey and Pennsylvania, which owe some $300 billion in unfunded liabilities between them, or at the sad condition of once glorious cities like Philadelphia, Chicago and Detroit, teetering towards or already in bankruptcy.

As the above chart shows, the country’s public pension funds are indeed failing to pay 100 percent of their ARCs. Often, states and municipalities make full payments to smaller systems but fail to make consistent, meaningful contributions to larger systems. Another chart for more context:

Texas Firefighters Fund Sues Tesco Over “Artificially Inflated” Stock Price, Accounting Irregularities

The Irving Firemen’s Relief and Retirement Fund, of Irving, Texas filed a lawsuit on Thursday against retail giant Tesco.

The fund says it suffered heavy losses when Tesco stock fell after the firm admitted it had overstated its profits.

From Bloomberg:

Tesco Plc (TSCO) and its directors misled investors about its financial health, according to a Texas retirement fund that sued the U.K.’s biggest retailer just as it’s facing an onslaught from rival European companies.

[…]

The Irving Firemen’s Relief and Retirement Fund, of Irving, Texas, alleged that it bought Tesco stock at artificially inflated prices. It suffered “significant losses” when Tesco said in September that accounting irregularities caused it to overstate profits, according to the complaint filed yesterday in federal court in Manhattan.

Tesco shares plummeted Sept. 22 after the supermarket chain said some income was booked before being earned and costs were recognized later than incurred. The news prompted investors, including Warren Buffett, to cut their stake. Yesterday, the Cheshunt, England-based company said the accounting caused it to overstate profit by 263 million pounds ($422 million), with more than half of that amount pre-dating this year.

Matt Francis, a spokesman for Tesco, declined to immediately comment on the complaint by the fund, which has 463 members, according to its web site.

[…]

The Irving fund is seeking to represent all Tesco shareholders who purchased the company’s American depositary receipts, each representing one ordinary share, between Feb. 2 and Sept. 22, according to the complaint.

The Irving Firemen’s Relief and Retirement Fund manages $135 million in assets and was 67 percent funded as of February.

Oklahoma PERS Hires Executive Director

The Oklahoma Public Employees Retirement System has tabbed a new executive director: Joseph Fox, who was the fund’s general counsel since 2005 and who had been serving as interim executive director since September.

From an OPERS release:

The board of trustees of the Oklahoma Public Employees Retirement System (OPERS) has selected Joseph A. Fox as its new executive director effective November 1, 2014. The board had previously named Fox as its interim executive director. Mr. Fox fills the vacancy created by the resignation of Tom Spencer who is becoming the executive director of the Oklahoma Teachers’ Retirement System.

“The OPERS Board is very happy with its selection of Joe as executive director,” said OPERS Board Chair DeWayne McAnally. “The search committee met and discussed the possibilities at length, and after many consultations with outside sources and OPERS staff, Joe became the clear choice.”

[…]

McAnally added, “This is a critical time for OPERS as it is focusing on implementing a new defined contribution retirement plan in 2015. The agency needs strong and enduring leadership, and the board feels Joe provides that continuity.”

OPERS oversees $8.5 billion in assets for 81,000 members.

Deutsche Bank: CalPERS’ Hedge Fund Exit “Has No Bearing” On Allocations Of Institutional Investors

The CalPERS Building in West Sacramento, California.

Deutsche Bank says that after a series of meetings this month with institutional investors, they’ve concluded that CalPERS’ hedge fund exit “has no bearing on most investors commitment to the industry.”

From ValueWalk:

Deutsche Bank prime brokerage notes that hedge funds have been engaged in “extreme protection buying in equities” and said that the recent exit from hedge funds by CalPERS “has no bearing on most investors commitment to the industry.”

After speaking with the institutional investor community regarding their commitment to maintain their hedge fund allocations, Deutsche Bank’s Capital Introductions group reports this positive message that it says was bolstered by recent meetings with Canadian pensions and global insurance companies throughout the month, while a trip to Munich indicated an increase in hedge fund exposure from institutions.

[…]

Separate hedge fund observers, meanwhile will be watching numeric asset flow patterns in December and the first quarter of 2015 to determine on an objective basis if there has been a statistical move away from hedge funds.

Even if institutional investors on the whole aren’t moving away from hedge funds, the exit by CalPERS – and the public debate swirling around the investment expenses associated with hedge funds – has forced some hedge funds to reconsider their fee structures. From the Wall Street Journal:

Two titans of the hedge-fund and private-equity world say they are growing more open to reducing fees in the face of rising scrutiny of the compensation paid to managers of so-called alternative investments.

[…]

Mr. [John] Paulson [founder of hedge fund firm Paulson & Co.] said he feels “pressure” to act in the wake of “enormous numbers in compensation” for hedge fund managers. Mr. Paulson, 58, earned a reported $2.3 billion last year, counting both fees and the appreciation of his own personal investment in his funds.

“Institutions are becoming a little more demanding…they are putting pressure on the management fee and the incentive fee,” he said Monday during a panel discussion at New York University’s Stern School of Business.

Joseph Landy, co-CEO of $39 billion buyout shop Warburg Pincus, echoed Mr. Paulson’s experience.

“There are a lot of private-equity managers out there who can make a lot of money before they return a dime to investors,” Mr. Landy said. “Most of the pressure [to reduce fees] has been on the actual annual management fee.”

Neither he nor Mr. Paulson, however, were too concerned about any widespread threats to their businesses.

“We came out relatively unscathed from the crisis. We’re doing pretty much the same things we did as before [with] very little restrictions on how we invest the money,” Mr. Paulson said.

Paulson said he think more hedge funds will start using “hurdles”, a fee structure which prevents managers from collecting performance fees until they’ve met a certain benchmark return.

Photo by Stephen Curtin

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