CalPERS | Pension360

Could Detroit-Style Cuts Come to California?

Pension benefits, once thought safe, now stand on shakier footing than they ever have. Detroit’s citizens live in a state where pensions are protected by the Constitution, but that didn’t matter when a bankruptcy judge ruled that the city could cut worker pensions as part of its bankruptcy restructuring plan.

California workers are now wondering what this all means for them—particularly the workers in the bankrupt cities of Stockton and San Bernardino. The state heavily protects its pension benefits, present and future.

Still, the question on everyone’s mind is: Could Detroit-style pension cuts come to California? Ed Mendel explored that question in a post today on CalPensions:

U.S. Bankruptcy Judge Steven Rhodes, acting earlier than expected, ruled last December that Detroit pensions can be cut, even though the Michigan constitution says pensions are a “contractual obligation” that can’t be “diminished or impaired.”

The ruling that federal bankruptcy law allowing contract impairment overrides state law was appealed by unions. But the early ruling, along with potential loss of “grand bargain” financial aid, may have added to fear of deep pension cuts, influencing the vote.

A cut of 4.5 percent in active and retired general worker pensions and the elimination of cost-of-living adjustments was approved by 73 percent of voters. Leaving police and firefighter pensions intact but trimming their COLAs from 2.25 to 1 percent was approved by 82 percent.

In a brief supporting the appeal of Judge Rhodes’ ruling, CalPERS argued, among other things, that Detroit has a city-run plan and that an “arm of the state” like CalPERS cannot under federal bankruptcy law be impaired in a municipal bankruptcy.

The judge handling the Stockton case, U.S. Bankruptcy Judge Christopher Klein, has said one of his options is ruling on the general issue of whether CalPERS pensions can be cut without necessarily finding that Stockton pensions should be cut.

CalPERS filed the brief in question shortly after the Detroit ruling. The premise of CalPERS argument was that the Detroit ruling didn’t apply to them because Detroit is a city, while CalPERS operates on the state level.

But as Mendel points out, there are a few key similarities between Detroit‘s bankruptcy and those of California. From CalPensions:

Although differing on pensions, the Detroit and Stockton plans to exit bankruptcy are similar on retiree health care. Detroit announced last week that a 90 percent cut in retiree health care was approved by 88 percent of voters.

Judge Klein ruled in 2012 that retiree health care can be cut in bankruptcy, acknowledging the result may be “tragic hardships” for some. A Stockton retiree health care debt of $544 million was reduced to a one-time payment of $5.1 million.

Another similarity is that the Detroit and Stockton “plans of adjustment” to cut debt and exit bankruptcy face challenges from bondholders. Making little or no reduction in massive pension debt, but deep cuts in bond payments, is said to be unfair.

What happens in California will have a ripple effect across the country as cities nationwide are increasingly weighing the prospect of going through municipal bankruptcy proceedings. The judges presiding over these cases will be wading in uncharted waters—and their word will be law. Pension360 will be following subsequent developments closely.

CalSTRS Fighting For Changes At PepsiCo After Underwhelming Performance

The California State Teacher’s Retirement System (CalSTRS) owns a $250 million dollar stake in PepsiCo. That makes the fund one of the corporation’s 60 largest shareholders, and it means that the fund’s opinions hold a certain power with PepsiCo—a power that they are now attempting to use after becoming dissatisfied with PepsiCo’s performance of late.

From the Financial Times:

One of the US’s largest pension funds has asked Pepsi to give activist investor Nelson Peltz a seat on the board, after becoming disillusioned with the soft drinks maker’s performance.

Although Mr Peltz’s investment firm, Trian Partners, has made little headway in its year-long battle to persuade Pepsi to split off its snacks business, his meetings with scores of shareholders have persuaded some that his voice should at least be heard in the boardroom.

Calstrs is not backing the break-up call, but wrote in a letter dated June 30 that Trian could help Pepsi address its operational performance and open management to new ideas.

“Trian has a long history of doing very well at these food and beverage companies,” said Aiesha Mastagni, investment officer at Calstrs, who wrote the letter, citing its previous activist positions at Heinz, Snapple and Kraft.

CalSTRS isn’t the only major shareholder looking for change. A few other major players have come forward in favor of change, albeit anonymously. From FT:

[CalSTRS’] concerns were echoed by top 10 shareholders who did not want to be identified.

One said: “They are good shareholders and they have ideas worth looking at, so we are hoping everybody comes together.”

Another top 10 investor explicitly backed the idea of a board seat for Trian, saying Pepsi could learn from the investor’s industry experience while Mr Peltz could learn more about the business before continuing his campaign to split it in two.

“The bigger issue is leadership,” this shareholder said. “The CEO does not have the respect of the investor community. If Trian were on the board, maybe she would listen. I would like to think she is still flexible enough to adapt.”

CalPERS is also a major PepsiCo shareholder. But the fund has stayed on the sidelines during this ordeal and has no plans to join CalSTRS’ corner.

Jerry Brown Sends CalPERS Board Back to School

California Gov. Jerry Brown wanted to make sure that the members of the CalPERS board knew what they are doing when making decisions regarding the fund’s nearly $300 billion investment portfolio. Now, Brown can rest assured that the members have spent some time in the classroom, studying up on the topics that are relevant to the governance of the country’s largest public pension fund. That’s because he just signed a bill requiring all board members to receive 24 hours of education on a variety of investment issues every two years.

From the Associated Press:

AB1163 by Assemblyman Marc Levine, D-San Rafael, originally was introduced as a way to meet Brown’s request to “bring financial sophistication” to the California Public Employees’ Retirement System’s 13-member board, which is dominated by public employees and labor union representatives.

Its original language required adding two board members who had financial expertise and did not have a financial interest in the pension system. It also proposed replacing the State Personnel Board representative with the state Director of Finance.

The bill was changed to give board members 24 hours of education every two years, require records of board members’ compliance with education requirements, and provide an annual report on CalPERS’ website.

The topics of the training are varied, but they include fiduciary responsibilities, ethics, pension funding, benefits administration, investment management, actuarial matters, and governance. All great things to learn about when you govern one of the largest pension funds on the planet.

You can read the entire bill here.

Photo by Eric James Sarmiento via Flickr CC License

California Cities Are Lining Up To Divest From Fossil Fuels, but CalPERS Isn’t Following

A movement is taking hold in California that encourages state and local governments to divest in companies that hold the largest reserves of oil, natural gas and coal.

Over two-dozen California cities—Oakland, Richmond, Berkeley, San Francisco and Santa Monica among them—have already made plans to divest from such companies. Now, the mayors of Berkeley, Oakland and Richmond are publicly asking CalPERS to follow them. From an Op-Ed published by the mayors in the Sacramento Bee:

As elected officials, we believe our investments should instead support a future where residents can live healthy lives without the negative impacts of climate change and dirty air. It’s time for CalPERS to take our public pension dollars out of dirty fossil fuels and reinvest in building a clean energy future, for the sake of our health, our environment and our children.

In actuality, there are more than morals at play here. The value of fossil fuel investments, and by extension CalPERS’ portfolio, may be at risk as well. From the Sacramento Bee:

The International Energy Agency has concluded that “no more than one-third of proven reserves of fossil fuel can be consumed prior to 2050” if the world is to limit global warming to 2 degrees Celsius. That goal “offers the best chance of avoiding runaway climate disruption.”

That means if the world’s governments take responsible action to prevent climate catastrophe, fossil fuel companies will have to leave some 75 percent of their reserves in the ground. These companies are valued by Wall Street analysts on the basis of their reserves. Meanwhile, fossil fuel companies continue to spend hundreds of billions of dollars on exploration for new reserves. A growing “carbon bubble” – overvalued companies, wasted capital and stranded assets – poses a huge risk to investments in fossil fuels.

CalPERS holds almost $10 billion in major fossil fuel company stocks and recognizes this financial risk. It recently adopted “investment beliefs” that include consideration of “risk factors, for example climate change and natural resource availability, that emerge slowly over long time periods, but could have material impact on company or portfolio returns.”

There’s actually precedent for pension funds following social movements and divesting in certain companies. In the 1980’s many funds divesting from companies doing business in South Africa as a way of protesting Apartheid—in that instance, California funds pulled nearly $10 billion worth of investments.

And it happened again last year, when numerous funds (including CalSTRS) divested from gun manufacturers in the wake of several school shootings.

But this time, CalPERS doesn’t appear to be interested in divesting from fossil fuel companies. The fund’s senior portfolio manager Anne Simpson addressed the issue in an editorial in the Sacramento Bee:

We all have a shared concern with climate risk, but our view is that the solution lies in engaging energy companies in a process focused on finding solutions, rather than walking away.

We at CalPERS talk to more than 100 companies on an annual basis to ensure the high standards of corporate governance that underpin effective climate change risk management, and we invest in climate change solutions across our global equity, private equity and real estate portfolios.

CalPERS was a founding member of the Investor Network on Climate Risk, a leading group of 100 institutional investors representing more than $10 trillion in assets, addressing a policy agenda that calls on governments and regulators to introduce carbon pricing and disclosure, so that risks can be tackled effectively.

CalPERS is also actively collaborating in the Carbon Asset Risk Initiative, led by the nonprofit Ceres, which draws together 70 global investors managing more than $3 trillion in assets. The initiative asks 45 large oil and gas, coal and electric power companies – including ExxonMobil, Royal Dutch shell, BHP Billiton, Rio Tinto and Vale – to assess the financial risks climate change poses to corporate business plans.

Of course, there is some evidence that divesting doesn’t actually accomplish the social goals these funds have in mind when they pull their money from companies. Liz Farmer at Governing explains:

There’s no proof that divesting actually effects change. In fact, a 1999 study concluded that apartheid-related pension divestments had no significant financial impact on companies doing business in South Africa.

What’s worse, targeting investments based on social causes has proven to be dangerous for pension plans. In 1983, a study found that 10 states that had targeted investments in mortgage-backed securities as a way of encouraging homeownership either inadvertently or deliberately sacrificed returns. In some cases, they gave up as much as 2 percent in returns all for the goal of making homeownership more accessible. In 1990, Connecticut’s pension fund bought a 47 percent interest in Colt Industries in an attempt to protect Connecticut jobs. The firm went bankrupt two years later and the fund lost $25 million.

This will be an interesting story to watch play out. CalPERS will likely come under scrutiny no matter what they decide to do. In any case, any investment decision that results from this campaign should be transparent and financially sound. Pension360 will keep you updated on future developments.

CalPERS and CalSTRS Rake in Big Returns, But Much Work Left To Be Done

The 2013-14 fiscal year ended June 30, which means we’ve entered a new year for public pension funds, at least in fiscal terms. It also means that the latest investment performance data is being released, and that data has some funds smiling.

California is one state that has to be happy with what it sees: big investment returns for both of the state’s major pension funds, CalPERS and CalSTRS. From SWFI:

The California Public Employees’ Retirement System (CalPERS) returned 18.42% for the fiscal year that ended on June 30th. CalPERS defeated its custom benchmark of 17.98% and surpassed last fiscal year’s return of 13.2%. The private equity portfolio of CalPERS generated 19.99% returns, just 3.31% shy of the benchmark. The asset classes of real estate and fixed income beat their respective benchmarks.

And CalSTRS saw similar success, says SWFI:

Looking toward the other Sacramento pension giant, CalSTRS posted 18.66% for the fiscal year that ended on June 30th.

The CalSTRS global equity portfolio posted 24.73% in returns. CalSTRS private equity posted 19.61% in returns.

But just because you can see the light doesn’t mean you’re out of the tunnel. CalPERS still has a lot on its plate. From the Sacramento Bee:

Happy days are hardly here again for the California Public Employees’ Retirement System, or for taxpayers who must make good on government pensions.

“There’s much, much work to be done,” said Ted Eliopoulos, CalPERS’ interim chief investment officer. “We’re ever vigilant; we try not to get too excited in good years or bad years about one-year results.”

Eliopoulos knows better than most that CalPERS remains in a deep hole.

Even with the 18.4 percent return, CalPERS estimates that it is only 76 percent funded, a remnant of overpromises made by the Legislature in 1999 and the finanical crash of 2007 and 2008. CalPERS would need to make 18 percent on top of 18 percent for several years running, and no one should expect that to occur.

CalPERS was also in the news last week when its former chief executive, Fred Buenrostro, pleaded guilty in a sordid federal criminal case in which he admitted to taking bribes of $200,000 in cash, some of it delivered in a shoebox, no less, as detailed by The Sacramento Bee’s Dale Kasler.

The case against Buenrostro and Villalobos is salacious, but it’s also a sideshow. No matter how corrupt they might have been, they would not have affected the giant pension fund in any significant way.

The far bigger problem is CalPERS’ unfunded liability. That will take years to fix.

In fact, although both funds have come a long way since 2008, neither one is out of this mess. From the Sacremento Bee:

On the surface, CalPERS and CalSTRS have recovered from the crippling multibillion-dollar losses they suffered when the housing bubble burst and the stock market crashed in 2008. CalSTRS’ portfolio, for example, has risen to $189.1 billion in market value, well above the pre-crash watermark of roughly $160 billion. Similarly, the CalPERS portfolio has soared 83 percent since bottoming out at $164 billion in 2009, putting it at $299 billion.

Despite the comeback, the funds spent several years after the crash with a much smaller pool of money to invest. That limited the amount of money they could earn. Even as they made gains, they’ve been unable to keep pace with their pension obligations, which have continued to rise as government workers accumulate years of service.

As a result, CalPERS is 76 percent funded. CalSTRS is 67 percent funded. They have more than enough money to pay pension benefits for now and the foreseeable future, but don’t have enough for the long term. Experts say 100 percent funding is ideal, although a funding level as low as 80 percent is acceptable.

To be fair, California isn’t in denial about the funding status of its two largest funds. And it isn’t letting big returns blind them to the issue, either.

Both funds are increasing contributions rates for members and employers, and the state has increased its own 2014 contribution to both funds. The changes will bring in billions more dollars annually to the system.

New Details Emerge In CalPERS Conspiracy Case; Ex-CEO Accepted $200,000 in Bribes

Slowly but surely, we are learning more details about the bribery, conspiracy and cronyism that took place within the walls of CalPERS between 2002 and 2008. Prosecutors have had working theories since early 2013, but the case broke wide open last week when former CalPERS Fred Buenrostro pleaded guilty to charges of fraud conspiracy and bribery.

Now, he’s telling his story. Much of what he is saying we already know: he and his friend Alfred Villalobos (a placement agent) conspired to direct billions of dollars in CalPERS investments to a private equity firm called Apollo, for which Villalobos was working as a placement agent.

They also falsified documents to make sure Villalobos raked in massive finders fees to the tune of $14 million; Buenrostro was rewarded with a Lake Tahoe condo, free trips to Dubai and Hong Kong, and a cushy $300,000 a year job at an investment firm after his retirement from CalPERS.

But in a new twist, Buenrostro says he received $200,000 in bribes, delivered via paper bags and shoeboxes, for his trouble. Breitbart reports:

What was new Friday was the blockbuster admission that Buenrostro took $200,000 in cash from Villalobos. In his written plea agreement, Buenrostro said Villalobos paid him in three installments in 2007, “all of which was delivered directly to me in the Hyatt hotel in downtown Sacramento across from the Capitol.”

According to Buenrostro, Villalobos told him to be careful how he deposited the cash in order to avoid detection by banking authorities. “Villalobos told me to be sure to ‘shuffle’ the currency before making any deposit, as the bills were new and appeared to be in sequential order,” Buenrostro wrote.

Later, after he’d left CalPERS and the investigation into their relationship gained momentum, Buenrostro said he accepted an additional $50,000 from Villalobos, paid by check.

Buenrostro is hoping that by cooperating with the investigation, his prison sentence will be reduced. But that depends on how much he has to tell; after all, much of what he has said was already public knowledge. Ed Mendel of CalPensions has read the plea agreement:

Apart from providing the bogus disclosure documents for Apollo, the plea agreement has few specifics about what Buenrostro accomplished for Villalobos while taking gifts and cash from late 2004 until leaving CalPERS in May 2008.

Would Buenrostro tell what success he had in influencing specific CalPERS investment decisions? Does he know if confidential information helped Villalobos, who received at least $50 million in fees, get specific clients seeking CalPERS investments?

What additional information, if any, federal prosecutors may want is not mentioned in the plea agreement.

But there are hints of a larger conspiracy here. Is it possible other CalPERS board members were in on it? Or is Buenrostro simply dropping half-truths to improve his bargaining position with authorities? Again from Mendel:

The Buenrostro plea agreement twice uses the phrase “I did knowingly and intentionally conspire with Villalobos and others.” Whether “others” refers to persons not yet named or is just a legal catch-all term is not clear.

An oddly veiled incident briefly described in the plea agreement seems to suggest that Villalabos used undue influence, if not small bribes, to get the CalPERS board to approve a pharmacy benefits contract.

“In approximately 2005, I observed Villalobos provide valuable casino chips to certain (now former) members of the CalPERS board as well as my wife before the board considered a proposal from Health Care Company No. 1 in connection with CalPERS’ health care benefit program,” said Buenrostro.

Without naming the company or board members, Buenrostro said he saw two of the board members recommend a contract with the company in a CalPERS committee, and then at the full CalPERS board all three chip recipients voted for the contract.

A similar incident is described with names and more detail in a special review of placement agents done for CalPERS by the Steptoe & Johnson law firm and Navigant Consulting, costing $11 million and issued in March 2011.

In 2004, Medco Health Solutions, which lost the CalPERS pharmacy benefits contract several years earlier, hired Villalobos as a consultant for $4 million, said the special review.

Later that year three CalPERS board members — Charles Valdes, Kurato Shimada and Robert Carlson — met with Villalobos, Buenrostro and the Medco CEO, David Snow, at Villalobos’ home at Lake Tahoe.

The five men (excluding Snow) had served together on the CalPERS board ten years earlier, said the review. Buenrostro was hired as CEO in 2002 with the support of Valdes, Shimada and Carlson.

“Valdes also reportedly joined Buenrostro and Villalobos at casinos local to the Villalobos home, where he and others are said to have accepted hundreds of dollars in playing chips from Villalobos while there,” said the review.

“We understand that the chips were offered to Valdes, Buenrostro’s wife at the time, and others to allow Villalobos more time to speak with Buenrostro alone.”

The review said “Shimada also reportedly joined Buenrostro, Valdes and others on visits to casinos local to the Villalobos home and has, at different times, denied and acknowledged accepting playing chips from Villalobos while there.”

Valdes left the CalPERS board in 2009 without seeking re-election.

Shimada resigned from the board in 2010. In 2007, he was the head of a CalPERS committee that rejected a proposal to disclose placement agent fees associated with CalPERS investments.

CalPERS Sends Message to Cities: Pay Up

In 2012, the city of San Bernardino, California made an unprecedented move: bankrupt and financially handcuffed, the town defied pension juggernaut CalPERS and simply stopped paying its contributions to the system. It has since resumed making those payments, but the fight is far from over. Now, CalPERS wants the city to pay back the payments it missed:

At issue is the $17 million in back payments and penalties that San Bernardino failed to make between declaring bankruptcy in August 2012 and resuming payments in July. Calpers has maintained that it is owed in full. But now in bankruptcy negotiations, the city is hoping to pay only a fraction of that, arguing that the city’s creditors must all share in the bankruptcy pain. The amount may be small, given the system’s assets, but if San Bernardino gets a reduction, the precedent could be huge, opening the door to other struggling municipalities using bankruptcy law to justify delaying or withholding payments to the pension system.

“This city has taken on the 800-pound gorilla, which is Calpers,” said Ron Oliner, a lawyer for the San Bernardino Police Officers Association, which represents the city’s uniformed officers. “Everyone in California is watching San Bernardino, and everybody in the nation is watching California.”

Calpers has for many years resisted all efforts to allow cities, for whatever reason, to stop making their required payments. (Federal law allows bankrupt companies to slow them greatly.) While agreeing that “significant progress has been made in the mediation,” Rosanna Westmoreland, external communications manager for Calpers, said the pension system’s hands were largely tied by statutes mandating that all the pension system’s participants make their full contributions on time and that no workers’ benefits be reduced. “It is the law,” she said.

The problem is that it remains unclear whether, in cases like this, federal bankruptcy law trumps state pension laws. A federal judge hearing the Detroit bankruptcy case ruled, for instance, that federal laws took precedence in that case, so the benefits of city workers in Detroit could be reduced in defiance of state law. But Calpers has insisted that this does not apply to the situation in California, an assertion that may be tested in court, if the mediation provides no solution.

Even before a recent wave of municipal bankruptcies hit California, the California Public Employees’ Retirement System, known as Calpers, had also insisted that under state law, no local government or public agency could reduce the benefits of current workers or retirees.

Cutting pension costs have proved difficult in California. That’s due to the so-called “California Rule”, which prohibits the rollback of pension benefits, even on a go-forward basis. Economist Sasha Volokh explains:

Most states are free to alter public employee pensions, as long as they do so on a purely prospective basis. For instance, a state can reduce cost-of-living adjustments (COLAs), say from 3% to 2%, as long as the amount accrued so far is still subject to the old COLA. But the rule is otherwise in California: California courts have held that ‘upon acceptance of public employment [one] acquire[s] a vested right to a pension based on the system then in effect.
In California, when a public employee begins work, he not only acquires a right to the pension accumulated so far—presumably zero on the first day, and increasing as he works longer—but also the right to continue to earn a pension on terms that are at least as generous as the ones then in effect, for as long as he works. And if pension rules become more generous in the future, then those more generous terms are the ones that are protected. Any changes to these rules must be reasonable, meaning that they ‘must bear some material relation to the theory of a pension system and its successful operation,’ and any disadvantages to the employees ‘should be accompanied by comparable new advantages.’ This is the ‘California rule.

Cities have tried to roll back their pension obligations. San Jose was one such city; earlier this year, it passed a plan forcing employees to pay more towards pensions. But the courts responded with a resounding “you can’t do that”. Volokh, for one, doesn’t like the economics behind that ruling.

When pensions are given special protection that’s unavailable for other job characteristics, the mix of wages and pensions is distorted relative to what it would otherwise be (given collective bargaining, tax policy, employee time and risk preferences, and other factors). If market or fiscal pressures mean government compensation must become less generous, it’s salaries and other benefits that must take the hit, even if some employees would prefer to take some of the blow in terms of decreased pension benefits. Those with shorter life expectancies — men, the less-educated, the poor, minorities, and those in bad health — suffer the most from policies that protect pensions at the expense of current salaries. Some of the pain will also fall on taxpayers, and some of that pain may result in trimming state government services (e.g., police, fire, garbage collection, DMV, schools). The California rule thus makes reductions in government compensation either more painful for employees or more expensive to taxpayers than they would be if pension terms could adjust together with salaries and other benefits.

Anyhow, CalPERS is setting a precedent with its action towards San Bernardino. It’s a precedent that indicates, bankrupt or not, cities still owe CalPERS its money.

Photo by Pete Zarria via Flickr CC

A Former CalPERS CEO Is Finally Pleading Guilty to Conspiracy Charges, So Let’s Take Stock of the Damage He Did

For years, CalPERS—the largest public pension fund in the country— was a hotbed of backdoor scheming, shady dealings and outright fraud.

That was thanks to two long-time friends, Fred Buenrostro and Alfred J.R. Villalobos, who we now know (well, allegedly) profited greatly from greasing the wheels on billions of dollars of CalPERS investments from behind the scenes in 2007-2008, and probably years before.

Buenrostro was CalPERS’ CEO from 2002-2008, and Villalobos sat on the fund’s Board from 1993-1995.

The story starts in 2007 when Villalobos, acting as a placement agent, was hired by the investment firm Apollo Global Management to secure investment business from CalPERS.

And, with the help of Buenrostro, he would get it, although not by legal means:

The two men created a series of fake letters on CalPERS’ stationery to make sure Villalobos got paid millions in commissions by a Wall Street private equity firm that was investing the pension fund’s money.

Buenrostro created phony letters on the pension fund’s letterhead after another CalPERS official refused to sign the disclosure documents. After receiving the letters, Apollo was able to obtain $3 billion in CalPERS investments between August 2007 and April 2008.

Villalobos, by the way, earned around $50 million worth of commission from those deals, according to CalPERS reports.

But Buenrostro made out well, too: after he retired from CalPERS in 2008, he was allegedly gifted a free Tahoe condo and a cushy job at Villalobos’ investment firm.

Thankfully, it didn’t take long for their scheme to unravel:

In March 2013, former California Public Employee Retirement System CEO Fred Buenrostro was indicted by a San Francisco grand jury and charged with conspiracy in connection with a scheme involving fraudulent documents related to a $3 billion investment by the retirement system in funds managed by Apollo Global Management.

Now, over a year after charges were filed against the two men, it seems one of them has finally admitted to himself that the gig is up—Buenrostro’s lawyer told a judge Monday that he plans to enter a guilty plea and cooperate with authorities. That includes assisting the government with its case against Villalobos.

Buenrostro’s plea bargain isn’t yet final, so it isn’t clear how much jail-time he is now looking at.

The True Cost?

This isn’t nearly the first time corruption and fraud has made its way in the public pension system, and it won’t be the last. That’s why its important to assign some numbers to these news stories—if only so we can appreciate the tangible costs that this type of cronyism incurs to the system, its members and taxpayers on the whole.

CalPERS had been putting money in Apollo funds for years—at least as far back as 2002. But the alleged misconduct supposedly happened between 2007 and 2008, when CalPERS put quite a lot of money in the hands of Apollo.

Those investments included at least six Apollo funds: Apollo Investments FD III LP; Apollo Group Inc Cl A; Apollo investment Fund VII LP; Apollo Global Management LLC; Apollo Real Estate Investment Fund; and Apollo Euro Principal Finance.

CalPERS still has all of those funds on the books as of 2013 except for two: Real Estate Investment and Europe Principal Finance. The system offloaded those two in 2012 with mixed results—Real Estate Investment Fund had lost $19 million of its book value, a 32% loss. Meanwhile, Europe Principal Finance had fared well, and saw its value increase 23% by the time CalPERS got out.

Of the four funds still on CalPERS’ books, three of them are now worth significantly less than their book value: Investment FD III LP is down 43%; Group Inc Cl A is down 57%; and Global Management LLC was down over 8%. All in all, those funds lost about $56 million of their book value. (These are all 2013 numbers—the most recent CalPERS provides.)

However, CalPERS got bailed out by one Apollo fund which did so well it erased all those losses and then some: the Investment Fund VII LP, whose market value in 2013 stood 47% higher than its book value. If CalPERS got out today, they would come out with over $200 million.

With great risk comes great reward. And Fund VII was certainly a risk—it was invested heavily in distressed companies:

In Fund VII, 57 percent of Apollo’s deals involved buying debt of distressed companies or buying distressed companies outright, while only 28 percent were straightforward acquisitions of companies not in distress. Corporate carve-outs of divisions accounted for 15 percent.

It paid off for CalPERS, as Fund VII has been one of the best-performing private equity funds in the world since 2008.

Still, four out of those six funds lost value. If CalPERS had invested that money in other funds, would they have fared better? We’ll never have any idea.

But the point is, these investment decisions were not made on the merit of the investments themselves, but instead on the basis of friendship and monetary gain for the dealmakers involved.

Oh, and the corruption (that we know about) goes back even further than 2007:

In late May 2004, Alfred Villalobos hosted a meeting at his home in Nevada, a few miles from Lake Tahoe and the California border. Villalobos was joined by David Snow, the Chairman and Chief Executive Officer of Medco Health Solutions, one of the nation’s largest pharmacy benefit management (“PBM”) companies, and Fred Buenrostro, who was the Chief Executive Officer of CalPERS at the time.

Soon after the May 2004 meeting at the Villalobos home, Medco agreed to retain Villalobos as a consultant and pay him $4 million.

Buenrostro was married in 2004, while serving as CEO, and allowed Villalobos to not only host the wedding at his home in Nevada, but reportedly also allowed Villalobos to pay for the event as well as lodging nearby for Buenrostro’s guests who attended the ceremony.

In October 2005, the year after Buenrostro got married on Snow’s consultant’s dime, Medco got the CalPERS contract.

That contract was worth $48 million dollars, and you can bet Villalobos got a hefty finders fee for that, too.

One thing’s for sure: he’ll be able to afford a lot of cigarettes in prison.

California Passed A New Budget—Here’s What It Means For Pensions

California is a state known for its positive vibes, but those vibes have not historically extended to its financial condition. That’s changed just a bit in the last week, due to a string of financially sound (and therefore surprising) budget decisions on the pension front.

It happened last Tuesday, when Gov. Jerry Brown signed into law a section of the state’s new budget that addressed CALSTRS’ $74 billion shortfall by raising contributions rates from teachers, school districts and the state. The budget also addressed CalPERS’ underfunding by increasing the state’s 2014-15 contribution by a pretty sizeable amount.

An important note: it took Moody’s less than 24 hours to upgrade California’s credit rating after seeing this budget—from A1 to Aa3—and predictably, those pension provisions were a big reason why. That’s important, because states need all the positive reinforcement they can get when it comes to making these politically tough decisions.

And they were politically tough (albeit economically obvious) decisions—the California Teachers Association donated $290,000 to state politicians during the last election cycle, and put $4.7 million in Gov. Brown’s coffers to help elect him in 2010.

Okay, now the details of the budget.

The portion of the budget summary that addresses the state’s pension systems, which you can read here, leads with this line:

In its 101‑year history, contributions to CalSTRS have rarely aligned with investment income to meet the promises owed to retired teachers, community college instructors, and school administrators.

Indeed. That’s refreshingly honest, even if those issues only represent a fraction of California’s larger pension problems.

To be fair, the state’s recent pension reform law addressed some of these issues in 2012 by raising retirement ages and reducing benefits. But it wasn’t enough, and the budget says as much:

Even with those changes, and despite recent investment success, the viability of CalSTRS ultimately requires significant new money on an annual basis.

My god, the state budget has become self-aware! And it doesn’t matter if lawmakers are playing the part of Captain Obvious here. It’s still a positive sign to see this stuff, in writing, in the document that’ll be determining the state’s expenditures for the next fiscal year.

Onto the numbers: The budget directs an additional $276 million in contributions from teachers, schools and the state to the CALSTRS system in fiscal year 2014-15. That will be accomplished by:

Increasing teacher contribution rates from 8 percent of pay to 10.25 percent of pay, to be phased in over the next three years.

Increasing school contribution rates from 8.25 percent of payroll to 19.1 percent of payroll, to be phased in over the next seven years.

Increasing the state’s contribution rate from 3 percent of payroll to 6.3 percent of payroll over the next three years.

The budget gives the CALSTRS Board the authority to increase school and state contributions if they see fit. On the other hand, the Board gets the authority to reduce them, too.

CalPERS is also set to receive a big contribution from the state, which is good news because California was consistently lagging behind in that department before modestly increasing its contribution last year. But 2014 represents a big step forward, as the state increases its contribution by 20 percent.

This coming fiscal year (2014-15) will also represent the 7^th straight year California has increased its contribution to CalSTRS. All told, the plan is to fully fund CALSTRS in 30 years.

Of course, that projection is contingent on CalSTRS meeting its investment return assumptions, which currently sit at 7.5% annually. How likely is it to meet that target over the next 30 years?

“Highly unlikely,” said Gov. Brown at a press conference back in May.

He’s right. And it’s important to maintain perspective.

This is but a small step on the road to responsibly managing the state’s pension funds. Declaring victory now is like buying a house on a 30-year mortgage, making the first payment without a hitch and then proclaiming, “We did it!”

All the same, it is a step forward, and you need to crawl before you can walk. Let’s hope California learns how to run sooner than later.

Photo by Steve Rhodes via Flickr CC License

CalPERS votes in favor of rate hikes

Retirees are living longer—and that’s bad news for the many pension funds that are already suffocating under the weight of their unfunded liabilities.

But one of the world’s largest pension funds has taken a step to counteract the soaring expenses that accompany longer life spans: the CalPERS board voted today to incorporate retirees’ longer lives into the formula used to determine taxpayer contributions to their fund.

The result will be higher contribution rates to the fund by the state and local governments of California; the state, starting July 1, will be expected to contribute $5 billion over three years to the fund, an increase from $3.8 billion previously.

Local governments will not see their contribution rates increase until 2016, in an effort curb some stress on the state’s cities, some of which are going through bankruptcy proceedings.

The CalPERS board took into account projections that by 2028, men are expected to live 2.1 years longer and women an average of 1.6 years longer. Such an increase, if not addressed, would lead to the state’s pension expenses ballooning by $1.2 billion, or 32%, annually.

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