Maverick CalPERS Board Member Won’t Run Again

Reporter Ed Mendel covered the California Capitol in Sacramento for nearly three decades, most recently for the San Diego Union-Tribune. More stories are at Calpensions.com

CalPERS board member J.J. Jelincic, known for being reprimanded by fellow board members and asking frequent and detailed questions about agenda items, was expected to seek a third four-year term but decided not to run.

A collective sigh of relief from the board majority of the California Public Employees Retirement System may be premature.

A late entry last week in the race for the open seat, Michael Flaherman, a former board member, criticized the CalPERS board for watering down private equity fee reform legislation and has supported Jelincic in his latest board battle, calling it “procedurally atrocious.”

Among the three other candidates for the open seat is the current chairman of the CalPERS finance committee, Richard Costigan, who wants to switch from one-year appointments to an elected four-year term.

Costigan has been annually chosen by the State Personnel Board to fill its seat on the CalPERS board for seven years in a row. His appointment by former Gov. Arnold Schwarzenegger to a 10-year term on the Personnel board expires this year.

The other candidates are David Miller, a state Department of Toxic Substances Control scientist, and Felton Williams, a retired Long Beach Community College dean of business and social sciences.

The major public employee unions have not yet publicly endorsed a candidate. Flaherman said he has the endorsement of two large retiree groups, the Retired Public Employees Association and the California State Retirees.

Jelincic has been at odds with the CalPERS establishment since winning a race for an open board seat in 2009. It was a rare, if not unprecedented, case of a CalPERS employee becoming one of the 13 members of the powerful CalPERS board.

With the backing of the two retiree groups and a $74,812 contribution from the American Federation of State, County and Municipal Employees, the 25-year CalPERS investment officer defeated a candidate backed by the Service Employees International Union.

In his first year on the board, Jelincic was reprimanded by the CalPERS board for sexual harassment of co-workers, with words and suggestive looks. He was stripped of some committee posts and ordered to take sensitivity training.

Jelincic remained on his CalPERS job until being placed on leave with pay early in 2011. Three opinions from the state attorney general said he should not participate in board meetings on personnel, particularly about top management under which he may serve later.

The CalPERS board reprimanded Jelincic again for telling Pensions and Investments in 2014 that the newly promoted chief investment officer, Ted Eliopoulos, “doesn’t have the temperament or the management skills” needed for the job.

Jelincic told the publication he worked under Eliopoulos from 2007 until being placed on leave. Eliopoulos and another CalPERS officer reportedly had warned Jelinicic in 2009 about complaints of sexual harassment.

Two years ago, Jelincic seemed to trigger a committee discusion of “board member behavior” after filing Public Records Act requests to get weekly reports from new federal lobbyists, as specified in the contract, rather than monthly reports approved by the board.

A more serious clash surfaced at a CalPERS board meeting in Monterey last January. Board member Bill Slaton accused Jelincic of leaking confidential information from a closed-door session and urged him to resign.

The confrontation was first reported by Yves Smith on her website, Naked Capitalism. Flaherman said the article was accompanied by his video of the meeting, taken after Jelincic told him a key part might be omitted in the CalPERS video.

The CalPERS board disciplined Jelincic by requiring him to attend special training on open-government laws, the Sacramento Bee reported last month. Jelincic denies that he leaked the information, which remains formally unidentified because it’s confidential.

Jelincic said last week the latest disciplinary action isn’t the reason he decided not to run for re-election — adding if anything, it would motivate him to remain. But he will soon be 69 years old, Jelincic said, and he pointed to the frustration expressed on his website.

“I originally ran for the CalPERS Board because I thought the Board was not doing its job and was too often being manipulated by staff,” Jelincic said on his website. “After eight years on the Board, I can tell you it was even worse than I realized.”

He helped improve the situation, Jelincic wrote, but in doing so “angered some senior management and fellow Board members who are invested in the status quo. It is clear to me that this Board has abdicated its responsibilities to challenge, monitor and supervise the staff.”

Jelincic said the staff controls information given to the board, which routinely rubber stamps staff recommendations. He apparently referred to a closed-door action last September, not revealed until November, that shifted investments to less risky but lower-yielding investments.

“The Board recently changed asset allocations. Why? Secret! What factors were considered? Secret! What costs were evaluated? Secret! Was the impact on beneficiaries and employers considered? Secret!” he said on his website.

As an alternative, Jelincic has suggested CalPERS could look at covering four years of costs with bonds and other nearly risk-free investments, while putting much of the portfolio (valued at $323.3 billion last week) into riskier but potentially higher-yielding investments.

Flaherman also has ideas for change. He was a Bay Area Rapid Transit planner when elected to two four-year terms on the CalPERS board ending in 2002, followed by a decade of work for a private equity firm before becoming a visiting scholar at UC Berkeley.

Last year Flaherman said he got help from Jelincic in persuading state Treasurer John Chiang to seek legislation requiring more disclosure of private equity fees. He said AB 2833 was weakened by CalPERS, which reportedly feared some firms might reject investments.

If Flaherman is elected to the CalPERS board, he might be an advocate of change much like Jelincic. But he would not have the burden of being suddenly promoted from subordinate to superior, while continuing to wear both hats within the bureaucracy.

“We’d like to have a collegial board again, a board that works together,” Rob Feckner, CalPERS board president, told the Bee last month. “Mr. Jelincic can have great value if he puts his efforts in a positive manner.”

Jelincic is scheduled to leave the board in January. Active and retired CalPERS members are eligible to vote in the election for his open seat. Voter turnout often is very low, about 16 percent of 1.3 million eligible voters when Jelincic won in 2009.

In another election for a similar board seat, board member Michael Bilbrey is running for re-election with some union support.

The other candidates are Wisam (Sam) Altowaiji, retired Redondo Beach city engineer; Margaret Brown, Garden Grove Unified School District business services director, and Bruce Jennings, retired Senate Rules Committee principal consultant.

New York Pension Systems Outperform California

Reporter Ed Mendel covered the Capitol in Sacramento for nearly three decades, most recently for the San Diego Union-Tribune. More stories are at Calpensions.com.

New York state pension systems are better funded than California state pension systems, currently take a smaller bite out of state and local government budgets, and still provide pension benefits well above the national average.

How do they do it?

Part of the answer seems to be that the New York systems, following state law, more quickly pay down the debt or “unfunded liability” mainly created when pension fund investments earn less than expected.

Investments are crucial, often expected to pay two-thirds of future pensions. To hit earnings targets critics say are too optimistic (7 percent for CalPERS and CalSTRS), half of investments usually are in the unpredictable stock market, with higher yields and larger losses.

Much of the pension funding debate in California has been about whether investment earnings can hit the target over the long run. The California-New York gap shows how quickly raising employer rates, when earnings fall below the target, can keep a lid on pension debt.

Last month, the Pew Charitable Trusts, using the most complete data available, reported the nationwide funding gap for state pensions two years ago was $1.1 trillion.

The New York state systems had 98 percent of the projected assets needed to pay future pension obligations in 2015, said the Pew report, and the California state systems had 74 percent.

“Large increases in state contributions prevented rapid growth in unfunded pensions following stock market losses created in part by the bursting of the dot.com (in the early 2000s) and housing (in 2008) bubbles,” said a Moody’s rating service report on New York state pensions last July.

The importance of continuing to make annual pension contributions large enough to pay down debt is getting more attention, driven in part by additional information reported under new government accounting rules.

Pew and Moody’s both have developed new benchmarks showing when employer-employee payments into the pension system are enough, if investment returns are exactly on target, to prevent debt from growing.

Using its “net amortization” benchmark, Pew said the combined pension contributions of the California Public Employees Retirement System and the California State Teachers Retirement System were 79 percent of the $18.9 billion needed to keep debt from growing.

While the California contribution in 2015 was under the benchmark, the New York State and Local Retirement System contributed 163 percent of the $3.7 billion needed to keep debt from growing.

Similarly, Moody’s reported last October that in 2015 California state pension contributions were 74.3 percent of its “tread water” benchmark needed to keep debt from growing, while New York state contributions were 120.8 percent.

“If all plan assumptions are met, including investment returns and demographic changes, a contribution equal to the tread water benchmark would result in a yearend NPL (Net Pension Liability) equal to its beginning of year value,” Moody’s said.

Moody’s makes an adjustment of pension debt by using a less optimistic earnings forecast to discount future pension debt. For California it’s 4.33 percent, for New York 4.54 percent.

The total adjusted net pension liability for all state pension systems was $1.25 trillion in fiscal 2015, said Moody’s. Using its method, half of the states are not contributing enough to halt debt growth, less than the 32 states with positive amortization under the Pew benchmark.

Eye-popping pension debt can be a slippery number, unintentionally changed by demographics or investment gains and losses, deliberately pushed further into the future by longer payment schedules or annual refinancing.

One benefit of rigorous debt payment, and a high funding level like New York’s, is a cushion against huge investment losses. CalPERS investments plunged from $260 billion to $160 billion during the 2008 financial crisi, dropping funding from 101 percent to 61 percent.

The CalPERS funding level was 64 percent in January. For several years, some CalPERS board members have been saying experts think dropping below 50 percent could be crippling, making a return to 100 percent funding very difficult.

CalSTRS was 64 percent funded last June. Last month, Nick Collier, a Milliman actuary, told the CalSTRS board: “I would say if you get below 50 percent, it’s really hard to recover. Maybe the number is a little bit higher than that. But I wouldn’t go below 50 percent.”

Pew said Illinois state funds in 2015 were 40 percent funded and Connecticut state funds 49 percent. Moody’s said: “If Illinois made at least a tread water contribution, its fixed costs would consume 33.5 percent of revenue, followed by Connecticut’s 30.6 percent.”

The New York State and Local Retirement System, like CalPERS and CalSTRS, has lowered its earnings forecast used to discount future pension obligations to an annual average of 7 percent.

The New York employer contribution rates for 2016, the same for state and local government, were 17.9 percent of pay for miscellaneous employees and 25.6 percent for police and firefighters, according to the NYSLRS annual financial report.

The CalPERS state rate for 2017 is 54.1 percent of pay for the Highway Patrol and 28.4 percent for miscellaneous. The average 2017 rate for local government police and firefighters is 40.6 percent of pay and 28.6 percent for miscellaneous.

An Urban Institute study of New York state pension costs last year said the average pension benefit was $31,300 in 2014, compared to the national average of $26,500. A half dozen states had higher average benefits than New York, including California at about $36,000.

Unlike a modest California reform for new hires, the Urban Institute said a New York reform in 2012 gives new hires a pension that, depending on how long they work, will only be 10 to 60 percent as large as the pensions of workers hired four decades ago.

New York has cut employer contributions when the pension fund had a surplus, like CalPERS. But a chart in the Urban Institute report shows that New York, twice in this century, more than doubled employer rates in just several years.

“After the 2000 collapse of the dot-com bubble and the 2008 financial crisis, the state passed ad hoc legislation easing plan funding rules and allowing public employers to make up funding shortfalls gradually over time instead of in a single year,” said the Urban Institute report.

Only a handful of the 717 employers in the New York State Teachers Retirement System opted to pay the rate increase gradually, Moody’s said. The NYSTRS employer contribution rate was 13.3 percent last year, down from 19.5 percent the previous year.

While CalSTRS was 64 percent funded last year, NYSTRS was 104 percent funded, according to its annual financial report. Under legislation three years ago, the CalSTRS employer rate for school districts is doubling in annual steps to 19.1 percent in 2020.

The CalPERS rate for non-teaching school employees is projected to be doubling to 27.3 percent of pay in 2023, further straining school budgets.

Unlike CalPERS and other California public pension systems, CalSTRS has lacked the power to raise employer contribution rates, needing legislation instead. For years CalSTRS officials pleaded with legislators: “Pay now or pay more later.”

So, here’s another way of looking at the gap between pension funding policy in New York and California. With a funding level of 64 percent in January, CalPERS has only kept pace with a pension system whose rates were frozen until recently.

CalPERS, CalSTRS Dislike Divestment As Dakota Access Pipeline Reignites Debate

Reporter Ed Mendel covered the Capitol in Sacramento for nearly three decades, most recently for the San Diego Union-Tribune. More stories are at Calpensions.com.

A bill that began life as a requirement that CalPERS and CalSTRS divest holdings in Dakota Access Pipeline firms emerged from a legislative committee last week reborn — a requirement that the pension funds only report on their “engagement” with the firms.

The revised AB 20 by Assemblyman Ash Kalra, D-San Jose, reflects a new emphasis on what the two big state pension funds say is often a less costly and more effective alternative to divestment: remaining a shareholder with a “seat at the table” to advocate change.

Since the sale of investments in firms doing business with apartheid South Africa in 1986, all CalPERS divestments have resulted in a total loss of $7.9 billion, including transaction costs and foregone investment returns, Wilshire consultants estimated earlier this year.

The two state pension funds, still struggling to recover from huge investment losses a decade ago, are taking a harder look at a small wave of divestment bills proposed by legislators on a wide range of political issues.

Both pension funds recently were about 64 percent funded, CalPERS as of last January and CalSTRS last June. Most of their employer contribution rates are doubling over a decade or less, squeezing local government and school budgets.

Experts predict that investment earnings, expected to pay nearly two-thirds of future pension costs, will weaken after a long bull market. Both pension funds recently dropped their investment earnings forecast from an annual average of 7.5 percent to 7 percent.

The small wave of divestment bills followed Gov. Brown’s signature two years ago on a bill by Senate President Pro Tempore Kevin de Leon, D-Los Angeles, requiring divestment, if fiduciarily responsible, of thermal coal companies not transitioning to clean energy.

Last year three bills that failed passage required pension fund divestment of any holdings in securitized home rental properties, banned additional investments in firms that further the boycott of Israel, and prohibited investments in Turkey government bonds.

This year, in addition to the pipeline, there are divestment bills on firms building a Mexican border wall and Turkey government bonds and a bill requiring the two pension funds to consider financial climate risk in the management of their funds.

Critics say divestment limits investment opportunity, decreases diversification, burdens staff, and may limit returns, increase risk, and result only in a turnover of shares with little or no effect on the target.

A union-sponsored constitutional amendment (Proposition 162 in 1992), a response to a legislative “raid” on pension funds, made paying benefits the top pension board priority, up from equal standing with minimizing employer contributions and reasonable administrative costs.

“A retirement board’s duty to its participants and their beneficiaries shall take precedence over any other duty,” said the amendment. Arguably, the two state pension boards could legally decline to divest, citing net losses and their fiduciary duty to pensioners.

“The Legislature may by statute continue to prohibit certain investments by a retirement board where it is in the public interest to do so, and provided that the prohibition satisfies the standards of fiduciary care and loyalty required of a retirement board pursuant to this section,” said the amendment.

A revised investment policy adopted by the CalPERS board last week in a second reading drew opposition during public comment from RL Miller, president of Climate Hawks Vote and the elected chair of the California Democratic Party’s environmental caucus.

Miller said the divestment policy can be summed up as “no divestment ever.” The policy said divestment “appears to almost invariably harm investment performance” and often is a mere transfer of ownership that only results in a loss of influence on the company.

“This Policy, therefore, generally prohibits Divesting in response to Divestment Initiatives, but permits CalPERS to use constructive engagement, where consistent with fiduciary duties, to help Divestment Initiatives achieve their goals,” the policy said.

Despite hearing in February from dozens urging Dakota pipeline divestment, Miller said, the only CalPERS response was a letter urging Energy Transfer Partners to reroute the pipeline, then 90 percent complete and only weeks away from moving oil through Sioux sacred land.

And despite a Democratic Party resolution in 2015 urging the California Public Employees Retirement System and the California State Teachers Retirement System to divest fossil fuel, she said, two of the largest CalPERS holdings are in Exxon and Chevron.

“You are deliberately choosing to shun the single most effective tool in an engaged shareholder’s tool box, divestment,” Miller said at a CalPERS investment committee meeting. (See CalPERS video, remarks begin at 1:14)

State Controller Betty Yee, who sits on the CalPERS and CalSTRS boards, told Miller she thinks the policy encourages engagement but is not an outright ban on divestment, which should be considered on a case-by-case basis.

“We are fiduciaries of this fund,” Yee said. “Our sole focus is how we are going to pay the benefits that our public-sector workers and educators have earned during their career, and it’s becoming a tougher business to be in as you heard this morning.”

People listen when CalPERS (investments valued at $317.5 billion last week) speaks, Yee said, but it lacks clout to make change on its own and does much engagement with other large investors. She said some work is not reported in documents that might reveal strategy.

“But understand, we are not letting up on this,” Yee said. “We also see the risk, the huge risk that climate is going to place on this fund relative to the ability of companies to continue to create long-term value.”

The CalSTRS board discussed divestment early this month while taking an “oppose unless amended” position on three bills. A forum to help legislators better understand work already being done was mentioned as a way to slow the introduction of divestment bills.

CalPERS did not take a position on the divestment bills. Kalra said he was influenced by the CalPERS and CalSTRS advocacy of engagement as he told the Assembly public pension committee his Dakota pipeline measure was no longer a divestment bill.

A bill requiring divestment of companies that build President Trump’s Mexican border wall was rescheduled for a hearing in the Assembly committee on May 3, an author of AB 946, Assemblywoman Lorena Gonzalez Fletcher, D-San Diego, said in a news release.

The committee approved a bill requiring divestment of Turkey bonds for failure to recognize the Aremenian genocide. The author, Adrin Nazarian, D-Van Nuys, said AB 1597 would only take effect if the federal government acts first.

Today, the Senate pension committee is scheduled to hear a bill requiring the two pension funds to consider climate risk in fund management and to make annual reports of climate risk in their investment portfolios, SB 560 by Sen. Ben Allen, D-Santa Monica.

CalPERS State Rate Doubles in Decade to $6 Billion

Reporter Ed Mendel covered the California Capitol in Sacramento for nearly three decades, most recently for the San Diego Union-Tribune. More stories are at Calpensions.com.

The annual cost of state worker pensions would increase to $6 billion in July in a recommendation from CalPERS actuaries, up $521 million from the current fiscal year and double the amount paid a decade ago.

School districts would pay $2 billion next year for the pensions of non-teaching employees, up $342 million from the current fiscal year and also double the amount paid a decade ago.

California Public Employees Retirement System rates, already at an all-time high, will continue to climb for at least another half dozen years as the last of four rate increses enacted since 2012 are phased in.

The nation’s largest public pension system is in a bind.

As rates go up, the investment earnings expected to pay nearly two-thirds of future pension costs are expected to go down. In February, CalPERS lowered its long-term annual earnings forecast from 7.5 to 7 percent.

The CalPERS investment fund was valued at $315.5 billion Monday. But like many pension systems, CalPERS has not recovered from huge investment losses during the financial crisis, when its fund plunged from $260 billion in 2007 to $160 billion in March 2009.

State worker pension funds had an average of 65 percent of the projected funds needed to pay future pensions last June, according to the new actuarial valuation expected to be approved by the CalPERS board next week.

The California Highway Patrol was the most troubled of the six state worker funds in the report, only 58.5 percent funded. Experts have told CalPERS that falling below 50 percent makes recovery very difficult, if not impractical.

A generous “3 at 50” pension formula negotiated by the Highway Patrol union and approved in landmark CalPERS-sponsored legislation, SB 400 in 1999, provides 3 percent of final pay for each year served at age 50, capped at 90 percent of pay.

The “3 at 50” formula was widely adopted by local police and firefighters. Critics say the high cost of pensions for crucial safety workers, who are a large part of local government budgets, is one of the reasons retirement costs are crowding out funding for basic services.

In 2007 the rate paid by the state for Highway Patrol pensions was 32.2 percent of pay. The Highway Patrol rate recommended for the new fiscal year beginning in July is 54.1 percent of pay. By 2023 the Highway Patrol rate is projected to be 69 percent of pay.

The miscellaneous rate for most state workers in 2007 was 16.6 percent of pay. The recommended miscellaneous rate for next fiscal year is 28.4 percent of pay, projected to increase to 38.4 percent of pay in 2023.

Highway Patrol members contribute 11.5 percent of pay to their pensions and do not receive Social Security. Miscellaneous members, who do receive Social Security in addition to their pensions, contribute 6 to 11 percent of pay, many of them at 8 percent.

A cost-cutting pension reform requires state workers hired after Jan. 1, 2013, to work two years longer to receive the same pension benefit as previously hired workers. Due to their union clout or other factors, state workers are exempt from a reform cost-sharing requirement.

The reform requires new hires in CSU, the California State Teachers Retirement System, 21 independent county systems, and CalPERS school plans to pay half the “normal” cost of their pensions, excluding the now large debt or “unfunded liability” from previous years.

As new hires fill positions, the reform is expected to curb growing pension costs, but significant results are likely years away (see Los Angeles Times/CalMatters analysis). Meanwhile, CalPERS state rates will continue to climb.

In 2007 the state paid CalPERS $2.7 billion, less than half the $6 billion recommended for the new fiscal year. School districts and other education employers paid CalPERS $920 million in 2007, less than half the $2 billion recommended for the new year.

School districts pay a higher rate for non-teaching employees in CalPERS than for teachers in CalSTRS. And unlike teachers, non-teaching school employees receive Social Security in addition to their pensions.

The CalPERS rate recommended for non-teaching school employees next fiscal year is 15.5 percent of pay. Last week the CalSTRS board approved a rate of 14.4 percent of pay for teachers in the new fiscal year.

Under a funding plan enacted by legislation three years ago, the CalSTRS rate for teachers will reach 19.1 percent of pay in 2020. The CalPERS non-teaching rate is projected to be 23.8 percent of pay in 2020 and 27.3 percent in 2023.

The pension rate hikes will take a big bite out of school district budgets. In 2013 the combined rate was 19.65 percent of pay (CalPERS 11.4, CalSTRS 8.25). In 2020 the combined rate is expected to be 42.9 percent of pay.

Teachers pay more toward their pensions than non-teaching school employees. Teachers hired before the reform contribute 10.25 percent of their pay to CalSTRS. Non-teaching school employees hired before the reform contribute 7 percent to CalPERS.

The CalPERS rate for new non-teaching school employees hired after the 2013 reform is recommended to increase to 6.5 percent of pay in the new fiscal year, up from 6 percent. The CalSTRS rate for new teachers, 9.2 percent of pay, is not expected to increase until 2018.

CalPERS rate increases began in 2012 when the earnings forecast used to discount future pension costs was dropped from 7.75 percent to 7.5 percent. An actuarial method that no longer annually refinances debt was adopted in 2013.

A rate increase for a longer retiree life expectancy adopted in 2014 is still being phased in. One of the reasons listed for the CalPERS school rate increase next fiscal year is “the second year of a 5-year phase in of 2014 change in assumptions.”

And one of the reasons for the CalPERS state worker rate increase is the first year of a three-year phase in of lowering the discount rate from 7.5 to 7 percent. The discount rate next fiscal year is 7.375 percent.

Yet another complication is a five-year phase in of the rate increase resulting from the lower discount rate. As a result, the new actuarial report can project annual rates through 2023.

New actuarial valuations recommending rate increases for the pension plans of 1,581 local governments are expected this fall. The cities, counties and special districts in CalPERS have a wide range of funding levels.

This week Marc Joffe of the California Policy Center issued an updated report saying local governments will pay about $5.3 billion to CalPERS in the new fiscal year. He projects the payments to CalPERS will rise to $9.8 billion in fiscal 2022-23, an increase of 84 percent.

“In Fiscal Year 2015-16, at least 26 California cities and counties devoted over 10 percent of their total revenue to pension contributions,” said Joffe’s report.

“San Rafael, San Jose and Santa Barbara County shouldered the highest pension burdens — exceeding 13 percent of revenue. Major local governments that have recently surpassed the 10 percent pension contribution of total revenue threshold include Contra Costa County, Berkeley and Newport Beach.”

CalSTRS to Tap State as Funding Shortfall Grows

Reporter Ed Mendel covered the California capitol in Sacramento for nearly three decades, most recently for the San Diego Union-Tribune. More stories are at Calpensions.com.

Using new power for the first time, the CalSTRS board is expected to increase the state contribution to the teacher pension fund this week, a response to new forecasts of lower investment earnings and longer retiree life spans.

The new forecasts adopted in February increased the funding shortfall. But actuaries still expect CalSTRS to stay on a long path to full funding, thanks to a long-delayed record rate increase in 2014 that will more than double school district pension costs by 2020.

At a media briefing last week, an actuary said one of the factors maintaining a projection of full funding by 2046, despite the larger shortfall from the new forecasts, is new but tightly limited rate-setting power given CalSTRS as part of the funding package three years ago.

“We still think that probability is greater than 50 percent,” said David Lamoureux, CalSTRS deputy chief actuary. A new annual risk report issued last November, before the new forecasts, put the probability of reaching full funding in three decades at 60 percent.

The big risk for public pension funds like the California State Teachers Retirement System is that investment earnings, expected to pay nearly two-thirds of future pensions, will fall below the forecast in the long run, creating massive debt or “unfunded liability.”

California public pension funds originally were limited to bonds with predictable earnings, limiting the risk of major long-term losses. But voters approved initiatives in 1966 and 1984 that now allow any “prudent” investment.

Much of the pension money was shifted into stocks and other higher-yielding but risky investments. Reaching “full funding” when stock markets boomed was used as a rationale (see previous post) for increasing pensions and cutting employer contributions.

But “full funding” is based on earnings forecasts for stocks and other risky investments. Since CalSTRS, like CalPERS, cut contributions and raised pensions when fully funded around 2000, the stock market has fallen, crashed and then rebounded to all-time highs.

A report by Milliman consulting actuaries in 2013 said if CalSTRS were still operating under its 1990 structure, without the changes made around 2000, pensions would have been 88 percent funded instead of 67 percent.

Now a new actuarial report prepared for the board this week said CalSTRS funding is 63.7 percent with an unfunded liability of $96.7 billion as of last June 30, compared to 68 percent funded and a $76.2 billion unfunded liability the previous year.

The new report is based on an earnings forecast lowered from 7.5 to 7.25 percent. The forecast will be lowered again to 7 percent next year. Using current data, funding would drop to 61.8 percent and the unfunded liability would increase to $105.1 billion.

A four-decade history of CalSTRS funding in the new actuarial report shows the funding level or ratio increased each year from 1975, when it was only 29 percent, to 1999 when it remained at 104 percent before peaking in 2000 at 110 percent.

The string of steady increases continued through a major transition when legislation in 1982 gave CalSTRS management of its investment fund, which previously was managed by the larger California Public Employees Retirement System.

The history also shows how the downward zig-zag of CalSTRS funding since the peak in 2000 is the result of rapidly growing future pension costs outpacing the modest gains from contributions and investment earnings.

The actuarial assets increased by more than half, growing from $102 billion in 2000 to $170 billion in 2016. The actuarial obligation for future pensions nearly tripled, growing from $93 billion in 2000 to $267 billion in 2016.

The table showing the history of CalSTRS funding does not include a large and unusual inflation-protection side fund, valued at $12.8 billion last June. In the latest report, the fund had a surplus of $5.6 billion as of June 30, 2015.

Most pension funding is based on projections of money received in the future. But the CalSTRS Supplemental Benefit Maintenance Account is expected to have enough money on hand to keep pensions at 85 percent of original purchasing power through June 30, 1989.

The account is funded by a vested annual payment from the state of 2.5 percent of teacher pay ($607 million last fiscal year) and a rare fixed investment return equal to the CalSTRS earnings forecast, whether actual earnings are above or below the target.

The table shows that since the stock market crash in 2008 the CalSTRS pension fund grew from $155.2 billion to $170 billion last fiscal year. The inflation-protection account more than doubled, growing from $5.3 billion in 2008 to $12.8 billion last fiscal year.

During the same period, the number of CalSTRS retirees receiving the inflation-protection payments dropped from 89,412 receiving $348 million in 2008 to 47,764 receiving $172 million last fiscal year.

In the latest biennial report for the fiscal year ending June 30, 2015, Milliman actuaries projected that if inflation remained at 3 percent, the account could keep pensions at 85 percent of original purchasing power forever or at 91 percent through June 30, 1989.

But if inflation remained at 3.75 percent, Milliman projected the account would be empty in 40 years. CalSTRS members do not receive Social Security, and their annual 2 percent cost-of-living adjustment is based on the original pension amount, not compounding.

Will the big surplus in the inflation-protection account become a target as school budgets continue to be squeezed by the doubling of CalSTRS rates for teachers, in addition to the doubling of CalPERS rates for non-teaching employees?

The state withheld payment to the account in 2003 to help close a budget gap. An appeals court ruled in 2007 that the account must be repaid $500 million, citing a law (AB 1102 in 1998) that made the state contribution, 2.5 percent of pay, a vested right.

Why the law made the contribution a vested right, but not 85 percent of orginal purchasing power, is unclear. (See previous post) Perhaps the intent was to create a fund surplus large enough to allow an increase in purchasing power protection.

The Supplemental Benefit Maintenance Account began with legislation in 1989 that restored 68.2 percent of original purchasing power. Later legislation moved the purchasing power to 75 percent in 1997, 80 percent in 2001, and 85 percent in 2008.

There apparently has been no study or analysis of whether the CalSTRS inflation-protection program is cost efficient or wasteful. CalPERS, for example, provides inflation protection through its overall employer-employee contribution rate.

The new risk report issued last November said the inflation-protection account is expected to grow from the current 6.4 percent of combined CalSTRS investments to nearly 15 percent in 30 years.

The growth will create “increased volatility” or larger swings in investment returns and the need for contribution increases, said the report. The CalSTRS board, with its limited power, will have more difficulty setting contribution rates that ensure full funding if long-term returns fall short.

The funding legislation in 2014 authorized CalSTRS to raise state rates by up to 0.5 percent a year, reaching a maximum of 23.8 percent of pay before the legislation expires in 2046.

This week, the CalSTRS board is expected to use the power for the first time, raising the current state rate of 8.8 percent of pay by 0.5 percent. The increase is included in the $2.8 billion payment to CalSTRS in Gov. Brown’s proposed state budget.

The funding legislation will more than double CalSTRS rates paid by school districts, up from 8.25 percent of pay to 19.1 percent by 2020. After that, CalSTRS can raise school district rates to no more than 20.5 percent.

Reform legislation giving teachers hired after Jan. 1, 2013, lower pensions requires them to pay half the “normal cost” of pensions earned during a year, excluding debt or unfunded liability from previous years that can be a much larger amount.

The CalSTRS board previously was expected to raise the rate for new teachers by 1 percent of pay in July, up from the current 9.21 percent of pay. Now the increase is not expected until next year, actuaries said last week.

Paper Argues Full Pension Funding Not Needed

Reporter Ed Mendel covered the California capitol in Sacramento for nearly three decades, most recently for the San Diego Union-Tribune. More stories are at Calpensions.com.

A paper issued by Stanford graduates seven years ago helped shift public focus to what critics call a “hidden” pension debt. Now a paper issued by UC Berkeley’s Haas Institute last month argues that full pension funding is not needed and may even be harmful.

The Stanford paper came after record losses in crucial investment funds expected to pay two-thirds of future pension costs. Whether investment earnings forecasts used to offset or “discount” future pension debt are too optimistic became a key part of pension debate.

It’s not clear at this point, needless to say, that the UC paper will mark another turning point in the debate. But pension funding has not recovered from the huge investment losses nearly a decade ago, despite a lengthy bull market that has nearly tripled the Dow index.

The California Public Employees Retirement System, only 63 percent funded last month, fears investment losses in another big market downturn could be crippling. Even a prolonged stagnant or slumping market could erode the management outlook.

It seems possible (who knows how likely) that in the years ahead there may be a growing movement, out of necessity, to accept or rationalize low pension funding as normal, reducing the pressure for employer rate increases that are already at an all-time high.

Seven years ago, the Stanford graduate student paper contending that California’s three big public pension funds had a shortfall of $500 billion, not the reported $55.4 billion, drew national media attention.

A New York Times story called it a “hidden shortfall.” A Washington Post editorial said it’s “more evidence that state governments are not leveling with their citizens about the costs of pensions for public employees.”

The Stanford study, using the principles of financial economics, discounted future pension obligations using risk-free bonds, not government accounting rules that allow pension funds to use earnings forecasts for stocks and other higher-yielding investments.

Responding to economic forecasts, not accounting theory, pension funds have lowered their forecasts. CalPERS and CalSTRS recently dropped their discount rates from 7.5 percent to 7 percent, increasing the need for more employer rate increases to fill the funding gap.

Far from signaling that low funding is becoming acceptable, Gov. Brown told Bloomberg news early this month he thinks CalPERS, which covers half of all state and local government employees, will “probably” lower its earnings forecast again.

“All that imposes greater costs on local and state government,” Brown told Bloomberg. “The pressure will mount.”

The UC paper issued last month, “Funding Public Pensions: Is full funding a misguided goal?” by Tom Sgouros, did not get major media attention. A quick internet search finds articles in The Week, The Fiscal Times, and the American Retirement Association news.

Sgouros argues that the Governmental Accounting Standards Board goal of full funding is needed for private-sector pensions but not for pensions offered by state and local governments, which are unlikely to go out of business.

The paper examines the problems created by the accounting rules in eight different categories, including actuarial and political. The conclusion is that the rules result in the “waste” of government funds that could be used for basic services.

A pension plan is “mutual insurance” for a group, not an attempt at “intergenerational equity” in which those who receive the services of government employees pay for their pensions, instead of pushing the cost to future generations.

Under the right conditions, the paper argues, a pension system with much less than full funding can pay benefits indefinitely: “Unless the combination of funding level and demographhics creates a liquidity crisis, there is always room to ‘kick the can’ further.”

A cautionary example of extreme full funding is a federal law in 2006 requiring the U.S. Postal Service to estimate pension and retiree health care liabilities 75 years in advance. By 2015 the USPS had put aside $335 billion and was 83 percent funded over 75 years.

But building a “breathtaking” retirement fund resulted in major operating losses, said the paper, that “shorted new capital investment and service expansions and left the service open to persistent charges that it is an an obsolete money-loser.”

The example in the paper of how pension funds that reach “full funding” tend to raise pensions and cut employer contributions is the California State Teachers Retirement System around 2000, as described in a Legislative Analyst’s Office report.

The UC paper said accounting rules “have been a convenient club to wield against public employee unions,” enabling claims that poor pension funding shows “the public has been duped into obligations it cannot afford.”

The author argues that many union leaders have weakened their own position by demanding full funding of pensions and viewing suggested cost-cutting reforms as an attack on benefits.

The paper quotes a source of support mentioned by other skeptics of the need for fully funding pensions, a report by the Congressional Government Accountability Office in 2008.

“Many experts and officials to whom we spoke consider a funded ratio of 80 percent to be sufficient for public plans for a couple of reasons,” said the GAO report.

“First, it is unlikely that public entities will go out of business or cease operations as can happen with private sector employers, and state and local governments can spread the costs of unfunded liabilities over a period of up to 30 years under current GASB standards.”

Girard Miller, debunking 12 pension myths, said in a 2012 Governing magazine column the view that 80 percent funding is healthy comes from anonymous GAO and Pew sources and a federal requirement that private pensions take action when funding falls below 80 percent.

Miller said pension funds should be 125 percent funded at the market peak. Based on equity losses in 14 recessions since 1926, a pension plan 100 percent funded at the end of a business expansion is likely to lose 20 percentof its value during an average recession.

“A plan funded at 80 percent going into a recession will likely find itself funded at 65 percent at the cyclical trough — and that’s a toxic recipe calling for huge increases in employer contributions to thereafter pay off the unfunded liabilities,” Miller said.

Now CalPERS is about 65 percent funded and phasing in the fourth in a decade-long series of rate increases ending in 2024. Getting back to 80 percent funding has been mentioned at the last two monthly CalPERS board meetings.

As a five-year strategic plan was adopted in February, board member Dana Hollinger suggested that a goal of 75 to 80 percent funding in five years would be more “attainable” and “realistic” than the goal that was aproved: 100 percent with acceptable risk, beyond five years.

Last week, Al Darby of the Retired Public Employees Association urged the board to reverse a short-term shift last September to lower-yielding investments expected to reduce the risk of funding dropping below 50 percent, another of the goals adopted in February.

“Restoring public equity allocation to pre-2016 levels would contribute a lot to reaching the 80 percent funding status that we are all hoping to restore,” Darby said.

CalPERS Cuts LA Works Pensions: Who’s at Fault?

Reporter Ed Mendel covered the California Capitol in Sacramento for nearly three decades, most recently for the San Diego Union-Tribune. More stories are at Calpensions.com.

CalPERS board members voted last week to cut the pensions of about 200 former employees of a disbanded job-training agency known as LA Works, unless the four founding cities agree to make a $406,345 payment before July 1.

The cities that formed the East San Gabriel Valley Human Services Consortium joint powers authority — Azusa, Covina, Glendora, and West Covina — have told CalPERS they will not pay because the pension contract is with the disbanded agency, not the cities.

But the CalPERS board members left the door open for one last chance to avoid a 63 percent cut in the pensions of the former consortium employees: 62 retired, 93 separated, 36 retired, and six hired after a pension reform in 2013.

Among nearly a dozen employee letters urging CalPERS not to cut their pensions was one from JuLito Hidalgo, 65, a 15-year employee. He said his $1,600 monthly CalPERS pension and his wife’s $1,800 from Social Security barely cover the mortgage and expenses.

“We are both not in good health,” Hidalgo wrote. “We are both diabetic. We have hypertension and cholesterol issues. I have a heart condition and had two stents from two angioplastys.”

The California Public Employees Retirement System cut pensions for the first time last November, a reduction of about 60 percent for five former employees of Loyalton. The tiny Sierra town voluntarily terminated its CalPERS contract in March 2013.

But Loyalton did not pay the $1.7 million termination fee required by CalPERS to continue making full pension payments. The city council, once deeply divided, is making monthly payments to the retirees to replace the CalPERS pension cut.

The East San Gabriel Valley consortium closed in June 2014 after Los Angeles County supervisors rejected its bid for a new six-year $32 million contract. Auditors said the consortium had overbilled the county $1 million for job training inmates and the unemployed.

A consultant was hired to wind down the consortium operations, the CalPERS board was told, and the consortium board continues to meet. The consortium stopped making monthly payments to CalPERS in July 2015.

Matthew Jacobs, CalPERS general counsel, told the board last month the four cities have a “moral and ethical” obligation to pay for the pensions. He disagreed yesterday with the view of one city official that payment beyond the contract would be a “gift of public funds.”

Jacobs said the “dividing line” is whether the payment is for a private or public purpose, citing a case in which extra pay for judges was ruled not to be a gift of public funds because it served a public purpose.

Board member Theresa Taylor said monthly payments would not be “that much money” if each of the four cities “pitched in.” She said criticism of rising CalPERS rates and calls for pension cuts by city officials suggest giving employees more time to plead for city aid would be futile.

“They have a specific agenda behind what they are saying here,” Taylor said of the remarks reportedly made by two city officials, “and that’s not for defined benefit pension plans.”

The $406,345 payment sought by CalPERS is for two fiscal years. So presumably, after that debt is paid, the annual payment for each of the four cities might begin at roughly $50,000.

But it’s a long-term unpredictable cost that would continue for decades, perhaps as long as the life spans of the consortium employees and their beneficiaries. The termination fee to leave CalPERS and fully fund the pensions is $19.4 million.

Apart from the emotional personal letters to CalPERS, a letter from retirees stating the general issues asked CalPERS to delay action until retirees could address the board “face to face.”

One of the two signers of the letter, Kathryn Ford, received a $100,240 CalPERS pension in 2015, according to the Transparent California website that lists the pensions and pay of individual state and local government employees.

The former chief executive of the consortium, Salvador Velasquez, received an annual pension of $120,777. Velasquez, vacationing out of the country when audit questions arose, was called a “big part of the problem” by a San Gabriel Valley Tribune editorial in June 2014.

“For pension reasons, he is technically retired and retained by the board as a consultant,” the Tribune said. “The board dragged its feet on finding a replacement who could have ferreted out the problems, which obviously were myriad.”

After the six-figure pensions of Velasquez and Ford, consortium pensions listed by Transparent California drop sharply to $51,919 and continue to decline until reaching the lowest annual pension, $1,738.

The Ford letter said PERS attorneys should “research and pursue” city liability for the pensions. City governance of the consortium was built in through “compensated, voting board positions” that were “composed of mayors/councilmembers appointed by each city.”

If holding the cities responsible is not an option, said the letter, retirees request that CalPERS consider merging the consortium pensions into the Terminated Agency Pool without a reduction.

The letter said a merger into the pool without cutting pensions is allowed by state pension law (Section 20577.5) if the board finds that the merger would not impact the pool’s “actuarial soundness.”

A report to the CalPERS board this week said the pool was 249 percent funded as of June 30, 2015, well above the 100 percent considered adequate. The pool fund was valued at $222.5 million last June 30, a slight increase after paying $5.5 million in benefits last fiscal year.

The latest annual valuation of the Terminated Agency Pool, as of June 30, 2014, shows 91 plans, including Loyalton, with 733 retirees and beneficiaries receiving an annual average pension of $6,529.

Going into the pool without pension cuts was not discussed at the CalPERS board yesterday until the president, Rob Feckner, said he received email on the issue. The CalPERS chief actuary, Scott Terando, described the process.

Because employer and employee contributions are no longer available, CalPERS assumes all of the investment and mortality risk for terminated plans. So CalPERS requires employers to pay a lump sump projected to cover all future pension costs.

A termination fee, $19.4 million for the consortium, is based on a risk-free bond rate, now about 2 percent, rather than the risky but higher-yielding rate assumed for the CalPERS investment portfolio, now 7 percent.

The big termination fee, adopted in 2011, is controversial. Several cities have considered leaving CalPERS (Villa Park, Pacific Grove, Canyon Lake) but did not due to the large fee. A federal judge in the Stockton Bankruptcy called the fee a “poison pill.”

The impact on the “actuarial soundness” of the Terminated Agency Pool from accepting the nearly 200 former consortium employees without a pension reduction was not estimated at the board meeting.

CalPERS apparently has a number of employers that, like the East San Gabriel Valley joint powers authority, lack the authority to tax or raise their own revenue and rely only on contracts for their funding. Nonprofit organizations are said to be another example.

Board member Richard Costigan, referring to what some call “barnicles on the bottom of the CalPERS barge,” said the funding sources of some of the 3,500 employer plans are being reviewed to identify weaknesses.

Board member Bill Slaton said CalPERS must have assumed that the East San Gabriel Valley joint powers authority would be in existence as long as a city or county, essentially in perpetuity.

“We don’t have a plan that can operate with organizations that have a fixed term of life,” Slaton said. “It doesn’t work, given our pension system.”

California Payroll Retirement Savings Plan Can Take Hit

Reporter Ed Mendel covered the California Capitol in Sacramento for nearly three decades, most recently for the San Diego Union-Tribune. More stories are at Calpensions.com.

A Secure Choice lawyer thinks private-sector employees can still be automatically enrolled in the new state retirement savings plan, even if the Republican-controlled Congress repeals a regulation exempting state savings plans from federal pension law.

California and a half dozen other states are creating state-run “automatic IRAs” for employees with jobs that do not offer a retirement plan. If employees do not opt out, a payroll deduction will go into their new tax-deferred savings account.

Oregon plans to launch the first state retirement savings plan in July, a small pilot. Like the California Secure Choice lawyer, Oregon Saves also thinks the federal pension law allows an exemption without the specific language of the regulation, a spokesman said last week.

Secure Choice does not plan to begin payroll deductions until at least late in 2019, after preparation and enrollment for businesses with 100 or more employees begins in mid-2018. Smaller businesses, with five or more employees, will be added in the following two years.

An automatic payroll deduction for a tax-deferred Individual Retirement Account is said to be a proven way to increase savings. But it’s opposed by parts of the financial sector as competition and by conservatives as government expansion that could lead to more public debt.

State retirement plans are strongly backed by some public employee unions, who think improving private-sector retirement can help counter pressure to cut government pensions or switch to 401(k)-style individual investment plans, following the corporate trend.

Secure Choice advocates say the program is being created with donations and repayable state loans, will become self-sustaining under legislation that allows no debt liability for employers or the state, and the investments will be managed by private-sector firms.

The plan is needed, say advocates, because more than 75 percent of California’s low-and-moderate income retirees rely exclusively on Social Security and nearly half of workers are on track to retire with incomes below 200 percent of the federal poverty level.

Last month, fast-track legislation to repeal the Obama administration labor regulation, HJR 66 and 67, moved out of the House and to the Senate floor. Gov. Brown sent the California congressional delegation a letter urging opposition to the repeal.

“I understand that Wall Street institutions strongly object to California and other states setting up such systems,” Brown said in the letter, the Sacramento Bee reported. “They think the dollars that move into Secure Choice should instead flow into their own products.

“I consider this a feature, not a defect of Secure Choice. Indeed, we hope to enroll those who historically (have) not been served by the savings industry.”

State Treasurer John Chiang was among 19 state treasurers, including six Republicans, that sent a letter to the Senate opposing the repeal. A Chiang adviser, Ruth Holton-Hodson, has helped coordinate the opposition campaign.

The treasurer is authorized by the legislation that created Secure Choice to appoint an executive director. His board representative, Steve Juarez, said two of the nine board members, Yvonne Walker and Heather Hooper, will assist in the selection expected soon.

choice

A Secure Choice exemption or “safe harbor” from the federal pension law, ERISA (Employee Retirement Income Security Act of 1974), is needed to reduce opposition from business employer groups and the potential for lawsuits.

Chiang and Senate President pro Tempore Kevin de Leon, D-Los Angeles, who first proposed legislation for the program in 2008, joined officials from other states in urging the Obama administration to issue a labor regulation exempting Secure Choice-style programs from ERISA.

A Secure Choice attorney, David Morse of K&L Gates, told the board last week that the regulation specifically says employees with no workplace retirement plan can be automatically enrolled in a state-mandated program that allows employees to opt out.

But the regulation also says it’s only the view of the Labor department, not the only way to create an exemption, and the final determination of whether a program is exempt from federal pension law will be made by the courts.

If the fast-track resolutions are blocked in the Senate, the repeal of the regulation could be pursued through the standard regulatory process, which unlike the fast-track allows public hearings, Holton-Hodson told the board.

Morse said that if the regulation is repealed Secure Choice could return to the original plan to use the exemption provisions in the 1974 federal pension law, with some Labor guidance issued later.

“It’s not like you have to start from zero,” Morse said. ‘We would go back to trying to rely on the old safe harbors to keep the program free from ERISA regulation. So, it doen’t mean that it’s the end of the road.”

Juarez said talks have begun with Morse and the state attorney general’s office about possible modifications in the final Secure Choice legislation signed last September by Brown in a ceremony with De Leon, the author of SB 1234, Chiang and others.

“Our thought is we have to prepare for the worst, but hope for the best,” said Juarez.

Employees would contribute 3 percent of their pay to Secure Choice under the legislation, unless altered by the board. The board also could increase the contribution by 1 percent of pay a year up to 8 percent. Employees would have the option of setting their own rate.

Investments during the first three years would be in U.S. Treasury bonds or the equivalent, giving the board time to develop options for riskier higher-yielding investments protected against losses, possibly by insurance or pooling investments to build a large reserve.

Taking a different path, Oregon Saves investments will be in “target date” or “aged-base” funds that shift the amount of stocks, bonds and other assets to less risky but lower-yielding investments as the employee approaches retirement age.

Oregon Saves options are a conservative “capital preservation” fund to limit the risk of loss and, going the other way, an “investmentment growth” fund with higher yields and a higher risk of loss. The Oregon plan has no guarantee preventing losses.

Secure Choice is operating this fiscal year with a $1.9 million state loan that will be repaid from an administrative fee collected from employee investments that cannot exceed 1 percent of total assets.

Donations totaling $1 million for a feasibility and market study came from very different sources. The California Teachers Association and the SEIU each contributed $100,000 of the match for a $500,000 grant from the Laura and John Arnold Foundation, often vilified by unions for supporting public pension reform.

Yvonne Walker, president of the largest state worker union, SEIU Local 1000, is a member of the Secure Choice board. She joined Jon Hamm, Highway Patrol union executive, in a proposal at a legislative hearing in 2011 on Gov. Brown’s pension reform.

Look at ways to improve retirement security for private-sector workers, the two union officials told lawmakers, instead of only focusing on cutting public employee retirement benefits.

De Leon’s original bill in 2012 drew on proposals from several policy, labor and consumer groups in addition to the National Conference on Public Employee Retirement Systems, said a report last year by the Center for Retirement Research at Boston College.

“The NCPERS plan reflected the recognition by public employees that the quality of their own retirement coverage could be at risk if their counterparts in the private sector lack access to a retirement system,” said the report by Alicia Munnell and others.

A proposed state constitutional amendment, SCA 1 by Sen. John Moorlach, R-Costa Mesa, would prohibit the state from incurring liability for Secure Choice benefit payments and bar state general funds for Secure Choice after the startup and first-year administrative costs.

 

CalPERS Investment Priority Shifts to Avoiding Loss

Reporter Ed Mendel covered the California Capitol in Sacramento for nearly three decades, most recently for the San Diego Union-Tribune. More stories are at Calpensions.com.

CalPERS is focusing on avoiding another big loss, not risky attempts to maximize investment earnings.

A shift from stocks and growth investments in September to lower the risk of losses had reduced CalPERS gains by $900 million, the CalPERS board was told on Feb. 13. The post-election market surge has continued since then, increasing the Dow blue-chip average Friday for the 11th day in a row.

CalPERS also sped up its “risk mitigation” policy this month, lowering the trigger for tiny cuts of .05 to .25 percent in the earnings forecast used to discount future pension obligations. Now cuts will occur when annual earnings are 2 percent above the forecast, not 4 percent.

Reflecting a major change of outlook, CalPERS lowered its discount rate from 7.5 percent to 7 percent in December, causing a large increase in employer rates to help fill the projected gap created by a lower investment earnings forecast.

The lower discount rate will be phased in over three years, easing the strain on local government budgets from the fourth CalPERS employer rate increase since 2012. The risk mitigation policy was delayed until fiscal 2020, when the discount rate phase-in is complete.

The policy could gradually lower the discount rate by 1 percentage point over several decades. Whether even the smallest incremental rate decrease, .05 percent, would be enough to cause an employer rate increase is “unique to each individual employer,” Scott Terando, CalPERS chief actuary, told the board.

The lower discount rate adopted in December was mainly a response to Wilshire consultants’ view that CalPERS investments were likely to earn 6.2 percent during the next decade, before rebounding to 7.8 percent in the following two decades.

Critics contend that CalPERS and other public pensions have overly optimistic earnings forecasts that conceal massive debt, avoid needed contribution increases, and encourage risky higher-yielding investments that increase the chances of big losses.

The shift to investments with less risk of loss adopted by the California Public Employees Retirement System in September dropped the earnings forecast to 5.8 percent. It looks like a rare attempt at market timing by an extremely long-term investor.

The new short-term investment allocation is intended to remain in place only until CalPERS completes its usual lengthy review, done every four years, and adopts a new allocation next February, taking effect in July 2018.

Ted Eliopoulos, CalPERS chief investment officer, told the board on Feb. 13 that the investment fund had earned about $900 million less than would have been earned under the previous allocation.

After a dispute with Eliopoulos about the link between the lower discount rate and the short-term investment shift, board member Theresa Taylor said: “I just want to make sure that you guys are exploring all options so that we are not leaving money on the table.”

The CalPERS investment fund, valued at $300.7 billion on Nov. 10, was worth $311.3 billion last week. Some attribute the market rally to the election of President Trump and a Republican-controlled Congress that is expected to cut taxes and roll back business regulation.

Eliopoulos reminded the board that the short-term investment allocation was a response to factors such as uncertain market conditions, the size of the negative cash flow gap, and a greater “downside” risk to the CalPERS funding level.

“That is our primary concern and our primary portfolio priority right now — to try and lower the risk of falling to a lower funding status,” he said.

Rob Feckner, CalPERS board president, made a similar point in a news release when the original risk management policy was adopted in November 2015 with a 4 percent above the earnings forecast trigger, taking effect without delay.

“Ensuring the long-term sustainability of the fund is a priority for everyone on this board, and this policy helps do that,” Feckner said. “It makes significant strides in lowering risk and volatility in the system, and helps lessen the impacts of another financial downturn.”

flow

After a long bull market nearing eight years, CalPERS only has 63 percent of the projected assets needed to pay future pension obligations, little changed from its 61 percent funding level at the market bottom.

You might think that CalPERS would be trying to maximize investment earnings, which are expected to cover two-thirds of the cost of future pensions. Most of the rest is expected from employers, who are on the hook for pension debt, and a smaller share from employees.

But CalPERS is still suffering from a massive $100 billion investment loss during the financial crisis and stock market crash. Its investments plunged from $260 billion to $160 billion, dropping the funding level from 101 percent in 2007 to 61 percent in March 2009.

Now CalPERS has no cushion if the market plunges again. Experts have told the CalPERS board that a funding level that drops below 40 percent, or perhaps even 50 percent, could be a crippling blow.

Raising employer contribution rates (already at an all-time high) and the discount rate (still criticized as too optimistic) high enough to project 100 percent funding could become impractical.

Rising CalPERS employer rates for police and firefighters have already reached 60 percent of pay in cities like Costa Mesa, 50 percent for the Highway Patrol, and 40 percent for Richmond, where a CALmatters/Los Angeles Times project reported some fear bankruptcy.

CalPERS employer rates for the non-teaching employees of school districts are expected to double from 13.9 percent of pay this fiscal year to 28.2 percent of pay in fiscal 2023-24.

With CalSTRS teacher rates that also are more than doubling, the school district pension cost increase next fiscal year, $1 billion, is more than the $744 million funding increase proposed by Gov. Brown’s new budget, the Legislative Analyst’s Office said this month.

While adopting the risk mitigation policy two years ago, the CalPERS board rejected a proposal from a Brown administration board member, Richard Gillihan, to lower the discount rate from 7.5 to 6.5 percent, which would have resulted in a major employer rate increase.

Brown said the incremental lowering of the discount rate was “irresponsible” and would “expose the fund to an acceptable level of risk.” Feckner replied that the policy emerged from concern about putting more strain on cities “still recovering from the financial crisis.”

As a maturing pension system, CalPERS faces new structural problems. The number of retirees will exceed the number of active workers. “Negative cash flow” means some investment funds must be used to help pay annual pension costs.

Last year, CalPERS said, about $5 billion in investment funds was added to $14 billion in employer and employee contributions to pay the $19 billion in pensions received by retirees.

But perhaps the main structural change that made avoiding another major investment loss a top CalPERS priority is what actuaries call the “asset ratio volatility.” In board discussions it’s often referred to as the “volatility level” and quantified. (See risk mitigation staff report)

The investment fund in a maturing pension system becomes much larger than the active worker payroll, which means that replacing an investment loss requires a much larger employer contribution increase.

The California State Teachers Retirement System board was given this example last November:

Replacing a 10 percent investment loss below the earnings forecast in 1975, when the teacher payroll and investment fund were about equal, would have required a contribution increase of 0.5 percent of payroll.

Replacing a 10 percent investment loss today, when the investment fund is six times greater than the payroll, requires a contribution increase of 3 percent of pay.

CalPERS Tells Four Cities: Pay Debts to Avoid Pension Cuts

Reporter Ed Mendel covered the California Capitol in Sacramento for nearly three decades, most recently for the San Diego Union-Tribune. More stories are at Calpensions.com.

CalPERS has asked four San Gabriel Valley cities that formed a job-training agency 40 years ago, the now-disbanded LA Works, to begin paying down an 18-month-old pension debt totaling $3.37 million.

A rejection of the request, for which replies were due last Friday, could lead to a 63 percent cut in the pensions of 62 retirees. CalPERS cut pensions for the first time last November, a 60 percent reduction for five former employees of Loyalton, a tiny Sierra town.

The CalPERS board was told last week that LA Works is an unusual problem. Under the CalPERS contract, only the disbanded joint powers authority is liable for the pension debt, not the founding cities of Covina, West Covina, Glendora, and Azusa.

“Whether or not they have a legal obligation, our view is they have a moral and ethical obligation,” Matthew Jacobs, CalPERS general counsel, told the board. “They’re the folks who put this thing together, and it’s their employees, essentially.

“And just like they need to take care of their own employees who happen to have been lucky enough to have worked directly for that city, they ought to be taking care of these folks who they have sent over to the JPA. That’s why we sent the letter.”

The joint powers authority, the East San Gabriel Valley Humans Services Consortium, doing business as LA Works, has not made a monthly payment to the California Public Employees Retirement System since June 2015.

“They are an inactive JPA, and they have basically closed their headquarters office, laid off their staff, and they lost their funding,” Arnita Paige, CalPERS contract management chief, told the board.

Los Angeles County supervisors voted in May 2014 to stop contracting with LA Works. Auditors found the consortium had overbilled the county by nearly $1 million for job training for jail inmates and the unemployed.

LA Works had submitted the low bid for a new contract, $32 million over six years, the Los Angeles Times reported. But after the audits the supervisors decided to give the contract to another bidder.

The consortium formed by the four cities in 1976 grew to have a staff of 125 with a $12 million annual budget while also representing Claremont, Diamond Bar, Irwindale, La Puente, La Verne, San Dimas and Walnut, a San Gabriel Valley Tribune editorial said in June 2014.

A “big part of the problem” was the chief executive, Salvador Velasquez, who had been with the agency since the beginning, said the Tribune. He was out of the country on vacation when audit questions arose.

“For pension reasons, he is technically retired and retained by the board as a consultant,” the Tribune said. “The board dragged its feet on finding a replacement who could have ferreted out the problems, which obviously were myriad.”

Velasquez received an annual pension of $120,777 in 2015, according to Transparent California, a website that lists the annual pay and pension of individual state and local government employees.

Another East San Gabriel Valley Human Services Consortium employee, Kathryn Ford, received a $100,240 pension. The other 42 listed pensions ranged from $51,919 to $1,832.

A CalPERS staff report said the consortium’s pension plan has 191 members — 62 retired, 36 transferred, and 93 separated. The annual pension debt payment expected next fiscal year is $365,419, but it’s a long-term commitment. A termination payment is $19.4 million.

CalPERS sent a final collection notice to the consortium last Nov. 1, followed by a final demand letter on Jan. 6, before sending a letter seeking payment from the four founding cities on Feb. 2, with a response date of Feb. 17.

“If payment is not received from East San Gabriel or the founding cities the next step is for CalPERS staff to recommend to the Board involuntary termination,” Brad Pacheco, CalPERS spokesman, said via email. “If the Board approved then benefits would be cut.”

san-gabriel

The number of local government agencies that are falling behind on their monthly payments to CalPERS, mainly very small ones, is increasing during a decade-long phase in of a series of four rate hikes that began five years ago.

“Yes, we are starting to see more,” Paige replied last week when asked by board member Theresa Taylor if the number of monthly payment delinquencies is increasing.

Paige said she could not give the board the number of delinquent employers and contracts with joint power authorities, including those solely liable, but it’s being researched. CalPERS provides pensions for 3,000 local governments, nearly half of them school districts.

The historic decision to cut Loyalton pensions last November, coming nearly four years after the city stopped making monthly payments to CalPERS in March 2013, seemed to be a clear signal of a crackdown on unpaid pension bills, followed by new attention from the board.

In the first quarterly collections and termination report last week, the interim CalPERS chief financial officer, Marlene Timberlake D’Adamo, outlined a number of improvements, including a new “team approach” using members of several departments.

Copies of pay-up letters will be sent to employees, making them aware of the problem and giving them a chance to apply what pressure they can. Legislation may be proposed to shorten a one-year delay in contract termination.

To set a termination fee, CalPERS drops the earnings forecast used to discount future pension debt (now 7 percent) to a risk-free bond rate (now 2 percent), saying a lump sum large enough to pay all future pensions is needed because employer-employee contributions stop.

Several cities have considered leaving CalPERS (Villa Park, Pacific Grove, Canyon Lake) but did not due to the large fee. A federal judge in the Stockton Bankruptcy called the fee a “poison pill.” Others say of CalPERS: “You can check in, but you can’t check out.”

The report last week said four local governments left CalPERS, paying the termination fee to avoid pension cuts:

Citrus Pest Control District No. 2 of Riverside County, seven members, $447,041 termination fee; Newport Beach City Employee Federal Credit Union, six, $1,207,695; Metro Gold Line Foothill Extension Construction Authority, 23, $10,109,618, and San Diego Rural Fire Protection District, 40, $3,567,318.

Since February 2015, two local governments adopted resolutions to terminate contracts, Niland Sanitary District and Trinity County Waterworks District No. 1, and four sent a notice of intent to terminate: Alhambra Redevelopment Agency, California Redevelopment Association Foundation, Herald Fire Protection District, and Exposition Metro Line Construction Authority.

In the last four months, four delinquent local governments paid up and avoided termination, including the Central Sierra Planning Council.

At Loyalton, which faced a $1.7 million termination fee, Mayor Patricia Whitley was unavailable. But a city hall spokeswoman confirmed a report that the city, on a month-to-month basis, is paying retirees the amount of the 60 percent pension cut.