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After Years-Long Battle, Pension Cuts Come To San Jose Firefighters

San Jose firefighters are facing higher retirement ages and lower pension benefits after they came out on the losing side of a long fight between labor unions and the city of San Jose.

Voters approved a ballot measure to cut pension benefits for newly hired public employees almost four years ago, but the firefighters had yet to adopt the changes.

Reported by San Jose Mercury News:

The changes mean newly-hired firefighters can retire at age 60 with a pension of up to 65 percent of their salary. Current firefighters can still retire at age 50 with up to 90 percent of their salary.

[…]

The final arbitration decision, announced this week, will save taxpayers millions of dollars compared to more generous retirement plans previously given to firefighters. It’s a victory for Mayor Chuck Reed, the city’s chief pension reformer, and his fiscal conservative allies that make up a majority of the City Council, who have seen the public costs for employee retirement skyrocket in the last decade.

Retired Judge Catherine Gallagher, the arbitration board chair, made the ruling nearly four years after voters approved a second “tier” of reduced retirement benefits for new employees, and more than two years after voters set limits on those pensions. Gallagher noted in siding with the city that the voter-approved measures prevented her from adopting anything that increased taxpayer costs.

The firefighters are the last of 11 city unions to implement the pension plan changes for new hires, while voter-approved cuts to current employees’ retirement plans remain tied up in court.

Firefighters unions opposed the changes. They argue that it will be harder to hire quality talent if they can’t offer better retirement benefits. As a result, they claim, emergency response times will increase and the quality of the fire department will suffer.

Campaign Ad Puts Pensions In Play In Alaska Senate Race

A new campaign ad has been released in the Alaska’s Senate race between Mark Begich (D) and Dan Sullivan (R).

In the ad (which can be viewed above), Begich claims that Sullivan put Alaska’s general budget at risk when he and the state’s pension fund struck a $500 million settlement with Mercer over allegedly botched actuarial calculations.

Begich says that Sullivan left billions on the table as a result of the settlement, and Alaskan citizens will likely have to pay for it. But is that claim true? FactCheck.org did the legwork and investigated the claim:

A new Begich ad, called “Reprise,” deals largely with the differences between Begich and President Obama. But at one point in the ad, the narrator says Sullivan “let Alaska’s pension fund get ripped off by a New York financial firm, putting the permanent fund at risk.”

Alaska Sen. Mark Begich exaggerates the impact of a $500 million settlement that his Republican opponent, Dan Sullivan, reached as state attorney general in 2010.

The Alaska Retirement Management Board sued its former actuarial firm, Mercer Inc., in December 2007 for erroneous calculations that the board claimed caused the state to underfund its pension system by $2.8 billion. The state sought $2.8 billion in damages and settled in June 2010 for $500 million.

The ad suggests that all residents — not just teachers and public employees — may have to pay for Sullivan’s settlement when it claims that his decision to settle is “putting the permanent fund at risk.” That’s an exaggeration.

Gov. Sean Parnell in June signed legislation that transferred $3 billion from the state’s rainy day fund, known as the Constitution Budget Reserve, into the state’s pension funds. In signing the legislation, Parnell said the infusion of cash will allow the state to reduce future annual pension payments and help preserve the state’s AAA bond rating. Fitch Rating indeed affirmed the state’s AAA rating for its general obligation bonds on Aug. 11.

Parnell notably did not tap the Alaska Permanent Fund. And there was no legislation proposing to take money from the permanent fund to cover pension costs, according to Laura Achee, the director of communications for the Alaska Permanent Fund Corporation.

The conclusion: Alaska’s “Permanent Fund” was not damaged as a result of the Mercer settlement. Begich’s campaign ad, according to FactCheck, is an “exaggeration”.

State Law May Stand In Way of Phoenix Pension Cuts

A Phoenix ballot initiative – titled Proposition 487 – would block off the city’s traditional pension system from all new hires, and instead shift those employees into a new, 401(k)-style plan.

The measure, if passed, would not apply to the city’s police and firefighters. But opponents of the reform are now saying that a legal quirk could end up blocking benefits for all of the city’s 4,000 police officers and firefighters. Reported by the Arizona Republic:

The initiative targets the retirement plan for general city workers hired in the future. Although the measure’s preamble states it’s not intended to affect first responders, attorneys for Phoenix have said the actual language, specifically the amendment to the City Charter, is poorly written and could wind up blocking pension contributions for existing and future police and fire.

However, several areas of state law, including the Arizona Constitution and provisions creating the Public Safety Personnel Retirement System, could prohibit Phoenix from ever withdrawing from the plan or diminishing retirement benefits for existing employees, attorneys said.

[…]

[Attorney Robert] Klausner said the likely result is that the Public Safety Personnel Retirement System would have to sue Phoenix or stop crediting its police and firefighters for additional years of service. Ultimately, he said, the city is in an “impossible conundrum” that it would probably lose.

“No matter what you do, you’re violating the law and welcoming a lawsuit,” Klausner said. “All that does is make lawyers really happy.”

Proponents of the reform measure have accused opponents of “scare-mongering”. From the Arizona Republic:

Scot Mussi, chairman of the group, said it’s clear that the city could not legally stop its payments to the state pension system. He said “scare mongering” Phoenix officials have suggested it could apply to public-safety workers to trick voters.

“That’s just crazy,” Mussi said of the argument regarding police and firefighters. “It would be unconstitutional. It would violate state law, and it goes against what’s expressed in the initiative itself.”

The fight over the measure has been going on for several weeks now. Opponents had earlier claimed that the measure would also unintentionally cut benefits for disabled workers.

CalPERS Is Ramping Up Its Real Estate Portfolio. Why?

Last week marked a big shift in investment strategy for CalPERS, and it goes beyond hedge funds. The pension fund’s hedge fund pullout got all the headlines, of course, but CalPERS also decided to invest an addition $1.3 billion in real estate.

The reasoning behind dropping hedge funds has been made clear. But what about the real estate investments? Over at GlobeSt.com, Erika Morphy explores some of the reasons that could be behind CalPERS’ deep dive into real estate.

From GlobeSt.com:

It’s business as usual

It was just real estate’ turn, says Stephen Culhane, who heads the investment management practice at the law firm Kaye Scholer.

“Institutional investors are always assessing and reassessing their allocations,” he tells GlobeSt.com. “Commercial real estate valuations are strong and it is perceived as a bit as a safe haven particularly for non US and long-term investors.”

It’s a shift in investment philosophy – and not just a change in asset allocation

CalPERS handles over $300 billion for over 1 million current and former state employees. Their investing philosophy is transitioning from a classic hedge fund, 60/40 model, to more of an endowment model, says Jeff Sica, founder and CIO of Circle Squared Alternative Investments.

“CalPERS is aiming to reduce volatility and obtain a more predictable annual return across their portfolio,” Sica tells GlobeSt.com. “Their move into real estate provides them with stability and a quantifiable income stream. With reduced volatility and a stabilized annual return, it will be more beneficial to them in the long run instead of fluctuating with the equity market,” he says.

Hedge funds have lost their appeal.

Despite CalPERS careful explanations, this is the theory of Bill Militello, co-founder and CEO of Militello Capital.

“The increasing trend of moving away from hedge funds is due in part to their lack of transparency and a lack of understanding of the investments—they are intangible,” he tells GlobeSt.com. “Hedge funds are simply public securities in a different wrapper, they are not an asset class, they are a compensation scheme.”

There is also evidence that hedge funds on an overall basis have actually underperformed versus passively managed funds, Chauncey M. Swalwell, partner with Stroock & Stroock & Lavan LLP, tells GlobeSt.com—”making the relatively high fees typically paid to hedge fund managers untenable at CalPERS.”

It is an inflation hedge

This is the flip side of fund’s decision, Militello adds. “Properly purchased real estate in supply constrained markets with built in demand drivers provides access to well-insulated investments that protect against rising interest rates.”

There isn’t space here to list all the potential reasons listed. You can read all seven reasons here.

LACERS also committed an additional $190 million to real estate investments last week.

Advisors Question Hedge Fund Fee Structure

In light of CalPERS’ recent pullback from hedge funds, scores of investment consultants are coming out of the woodwork advocating for changes to the “2 and 20” fee structure traditionally used by hedge funds.

Towers Watson research chief Damien Loveday told the Wall Street Journal yesterday:

“We believe a better way of tackling fees is by assessing the skill managers offer to clients, rather than paying for market-based returns. ‘Two and 20’ should not be the norm.”

Kerrin Rosenberg, an executive at the consulting firm Cardano, shared the sentiment:

“If ever there was a moment to get rid of ‘two and 20’ forever, this is it.” He backed Towers Watson’s initiative, noting that many hedge funds were out to survive, rather than prosper.

Just because consultants think one way doesn’t mean pension funds will think the same. But it’s important to note that these firms frequently advise pension funds on investment decisions—so it’s safe to say the funds are hearing the same anti-fee sentiment that we are.

Last week, a major Dutch pension fund shut out hedge funds and cited one reason: the fees. From the Wall Street Journal:

Last week, PMT, the Dutch pension fund with €56 billion ($71.7 billion) under management, said it would close its €1 billion hedge fund portfolio, adding that although hedge funds were only about 2% of assets, they collected 32% of the investment fees it paid.

A spokeswoman for the fund said: “The hedge fund investments were expensive if you relate the cost to what the funds delivered. We found that we did earn from hedge funds, but we did not earn enough versus the risks and the costs.”

To be fair, it seems hedge funds have budged just a bit from the “2 and 20” scheme. According to Preqin data, fees have fallen to around 1.5 percent of assets and 18.7 percent of performance.

Oregon PERS Reforms: The Supreme Court Will See You Now

Two major reform measures are finally ready for their day in the Oregon Supreme Court.

Public employees are challenging the 2013 reforms –which reduced the state’s unfunded pension liabilities by $5 billion by cutting COLAs and scaling back benefits – on the grounds that the measures broke contracts protected under the state’s constitution.

This week, both sides submitted their written briefings to the Supreme Court. Reported by the Oregonian:

Monday marked the deadline for written briefings to the Oregon Supreme Court, where public employees are challenging the legality of two pension reform bills enacted last year.

The laws reduced retirees’ annual cost of living increases and eliminated a benefit bump-up for out-of-state retirees that don’t pay taxes in Oregon. As such, they helped staunch the precipitous rise in required contributions to the system since the 2008 financial crisis decimated the fund’s investment portfolio and opened up a $16 billion funding gap.

Oral arguments will be held Oct. 14. Each side will have one hour. After that, public employers, the governor, lawmakers, employees and retirees can hold their collective breath, with a decision anticipated during expected in time for the 2015 Legislative session.

A quick breakdown of what we can expect each side to argue, from the Oregonian:

The Legislature referred any challenges to the bills directly to the Supreme Court to expedite the legal decision process. Public employees appealed the changes, arguing in briefs filed earlier this summer that the benefit changes violate the contract clauses of the Oregon and U.S. constitutions and amount to an illegal taking of private property without compensation.

The state and public employers maintain that the cost of living adjustments, contrary to previous decisions by the court, is not an immutable part of the contract. And even if it is, they maintain it can be changed, as the Legislature has done previously.

Likewise, they argue that the extra payments to cover beneficiaries’ state tax liabilities aren’t part of the contract and can be eliminated for out-of-state retirees who don’t pay Oregon taxes.

Legislators briefly weighed enacting another round of pension reforms this year, but they decided against it.

Vermont Fund May Become First To Hit Gas On Fossil Fuel Divestment

Vermont Gov. Peter Shumlin had previously been against the state’s pension fund divesting from fossil fuel companies.

Shumlin talked to the Associated Press about divestment last November:

“I believe that by keeping a seat at the table and by encouraging smart investments, we can make progress towards a cleaner, greener economy while still meeting our obligations to pay for the retirement of [state and municipal employees] in the most responsible way for taxpayers,” Shumlin told the Associated Press…

In other words: they can do more to effect change as a shareholder of fossil fuel companies. His argument against divestment echoes what we’ve heard from other pension funds around the country.

But Vermont’s view might be changing. Last week, Shumlin went so far as to call divestment from fossil fuels a “good idea”. Reported by Seven Days:

“I actually think it’s an intriguing idea,” Shumlin said. “And, you know, I think that, over time, we’ll find ways that we can be more active in that effort. I would like us to be. As you probably know, we have a fiduciary responsibility to the taxpayers to ensure that, you know, we’re getting a good return on our investments. So it’s going to take some time to make the transformation, but I think it’s a good idea.”

[…]

“I think it’s great,” [environmentalist and scholar Bill] McKibben told Seven Days by email, referring to Shumlin’s shift. “He’s been talking about climate change in powerful ways since [Tropical Storm] Irene, and this (assuming he actually follows through, and soon) is an obvious and easy move (Vt. led the way in divestment from apartheid, after all).”

“And it’s hardly revolutionary,” McKibben added, noting that the Rockefeller Brothers Fund, whose $860 million comes from Standard Oil money, committed to divestment on Sunday. “If the heirs to the world’s greatest oil fortune think it’s unwise and immoral to invest in fossil fuel, what the hell excuse do any of the rest of us have?”

More and more, pension funds are thinking about this issue. CalSTRS and other major institutional investors announced last week they are helping to fund a study on the effect climate change would have on markets.

Photo: Paul Falardeau via Flickr CC License

Can Insurance Companies Save Public Pensions?

Last week, Pension360 covered a question asked by the Washington Post’s Wonkblog:

Does it make sense for local governments to turn over the assets of their employee pension plans to insurance companies, who would in turn make monthly payments to retirees?

This week, Mary Pat Campbell (who runs the STUMP blog) has given an in-depth answer to the above question:

Here is the problem: for all of my posts about alternative assets in public pensions (though those are troubling when they are a huge portion of the portfolio), it’s not the financial risks per se, or even the longevity risk, that has been killing public pensions, though those do contribute.

It’s that governments are great at promising, but not so great at putting money by to pay for those promises.

[…]

Insurers are willing to write group annuities to back pension promises — they did this with GM and Verizon pensions — but you have to give them all the assets they require to back that business. A “fair price” would be less than what is statutorily required, probably, because statutory requirements tend to be very conservative in valuing the liabilities, in order to protect policyholders/annuitants. This is called surplus strain.

But the thing is, even with the “fair price”, governments would have to pay amounts way beyond what they’re paying now, just to meet the pension promises made for past service, forget about any future service accruals.

The main problem is that not enough money has been put by. The risk is not so much that public pensions across the country have been investing too riskily or anything like that (but overly risky investing can make the bad situation worse.)

Now, not all pensions are underfunded as grossly as New Jersey or Illinois. But you don’t get to a 72% overall funded ratio just from those two states.

While insurers might be able to reduce the worry about longevity risk and financial risk for fully-funded plans, they cannot help politicians trying to lowball pension costs.

Her answer, in other words: “No”.

Photo by www.stockmonkeys.com

Public Pension Funds Drive Venture Capital Boom, But Performance Is An Issue

The venture capital industry is becoming a major force again, and pension funds are the major driver of the resurgence. From Businessweek:

Public pension funds—the state-run investment pools responsible for the retirement benefits of nearly 20 million Americans—have quietly been funding the recent boom in venture capital. The investment pools are made up of tax dollars and contributions from state employees. For the last few years, they have made up the biggest single source of funds flowing to venture capital, according to the most recent Dow Jones Private Equity Analyst Sources of Capital survey. In 2014, they contributed 20 percent of the sector’s overall haul, down slightly from a 25 percent contribution in 2013.

Indiana’s Public Retirement System allocates (PDF) 1.6 percent ($363 million) to venture capital, which is on the higher end as a percentage of assets; the California Public Employees’ Retirement System (CalPERS) allocates a more typical half percent of assets, although the fund is so big that this meager fraction totaled $1.8 billion in 2013. The amounts are small enough that if pension funds’ entire venture capital investments were to evaporate, pensioners would still be all right. In most states, pension obligations are guaranteed by state constitutions. If the investments—in venture capital or anything else—don’t pay off, taxpayers are on the hook for the shortfall.

But there’s a problem: some of the best venture capital funds don’t want to do business with public pension funds. From Businessweek:

Because public pensions must be transparent about their investments, which are subject to the Freedom of Information Act, many top-performing venture capital funds won’t accept pension money; they don’t want to publicly disclose their portfolios. This makes public pensions pick from other—often lesser-performing—funds.

Like hedge funds and other kinds of private equity, venture capital funds charge an annual management fee of 2 percent, plus 20 percent of profits. Performance is an open question. Many funds fail to perform (PDF) as well as an Standard & Poor’s 500-stock index fund. Diane Mulcahy,senior fellow at the Kaufmann Foundation, has observed that many venture capital funds aren’t profitable and that steady fee income diminishes the funds’ incentive to find profitable investments.

Other institutional investors are funding the VC resurgence, as well. Endowment funds provided the VC industry with 17 percent of its capital in 2014, according to the Dow Jones survey. Corporate pension funds accounted for 7 percent, while union pension funds accounted for 2 percent.

Photo by c_ambler via Flickr CC License

Linking Benefits to Investment Performance in US Pension Systems

Some countries, such as Norway, have incorporated a pension model called “risk-sharing”—a model where COLAs (and sometimes even benefit amounts) are contingent on investment performance. In other words, plan participants bear much more investment risk than participants in traditional DB plans.

What if that policy were extended to every public pension system in the United States? What effect would it have on liabilities?

Robert Novy-Marx and Joshua D. Rauh published a paper on the topic in the Journal of Public Economics last month.

From the paper:

Replacing COLAs across the US with PLAAs [performance-linked annuity adjustments] with a 5% hurdle and a guarantee that benefits would not fall below their initial level at retirement reduces the present value of legacy liabilities by $575 billion (or 12%) and the unfunded legacy liability by around 25%. Without minimum benefit guarantees, the legacy liability falls by $1.2 trillion (or 26%) and the unfunded legacy liability falls by 53%.

These reforms would also lower the annual required revenue increases to fund state plans within 30 years. These required increases stand at $1147 per household per year under current plan rules. They fall to $770 per household per year with PLAAs if benefits are not guaranteed to remain above a minimum level, but to only $1016 per year if benefits are guar-anteed not to fall below the initial level at retirement.

Of course, those numbers would come at a price for retirees: they’d bear extra risk during retirement under this policy. From the paper:

The PLAA arrangement leaves participants bearing risk only during retirement, not during the time they are working. Standard intuition from the lifecycle portfolio literature suggests that given a choice, individuals prefer to bear risk during the earlier years of their lives instead of the later years.

[…]

In a utility framework, we find that depending on the parameters, PLAAs with the hurdle rates and floors that we study in this paper can have either gains or losses relative to a COLA in terms of expected utility. Of course, the PLAAs we compare to COLAs here are generally substantially cheaper to provide, particularly with 5% hurdle rates and above. Even where expected utility is reduced, there are points of the distribution where the utility outcomes from the PLAAs surpass those of the COLAs, due to the benefits of equity exposure to CRRA utility agents with relatively modest degrees of risk aversion.

The rest of the paper can be read here.

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