California cities facing growing pension costs in new year

SACRAMENTO – After two years of miniscule investment returns, the nation’s largest state pension fund – the California Public Employees’ Retirement System – has once again lowered its expected rates of return. Even some CalPERS officials and consultants argue the lowered financial expectations don’t go far enough to shore up the fund’s financial position, as it now only has 68 percent of the assets needed to pay all its future retirement promises.

This end-of-year board vote to reduce expected investment returns from 7.5 percent to 7 percent portends difficulties for local agencies that provide pensions to their public employees through the CalPERS system. Lowered earnings estimates mean these agencies will have to contribute significantly higher payments to the pension fund to defray the costs of these benefit packages. In 2012, CalPERS dropped its expectations from 7.75 percent to 7.5 percent.

“The three-year reduction of the discount rate will result in average employer rate increases of about 1 percent to 3 percent of normal cost as a percent of payroll for most miscellaneous retirement plans, and a 2 percent to 5 percent increase for most safety plans,” according to a CalPERS statement following the vote. The “normal” cost doesn’t address the growing size of the fund’s unfunded liabilities (i.e., debt), so local governments will also have to boost their “unfunded accrued liability payments” by as much as 30 percent to 40 percent.

California local governments already have faced 50-percent hikes in their CalPERS payments over the past several years, which has led local officials and pension reformers to increasingly fear a continuing cycle of service cut-backs and tax increases. Indeed, there was some pressure at CalPERS to push the expected return rates down to the 6 percent range, but some officials expressed concern about what this would mean, cost wise, for member agencies.

“The reduction in the rate of return is not as big as was discussed last month,” according to a Dec. 21 report in Pensions & Investments. “Chief Investment Officer Theodore Eliopoulos said at last month’s finance and administration committee meeting that given diminished investment return assumptions over the next decade, 6 percent was a more realistic return for the coming 10 years. Andrew Junkin, president of Wilshire Consulting, which serves as CalPERS’ general consultant, said at the November meeting that Wilshire was predicting an annual return of 6.21 percent for the next decade, down from its estimates of 7.1 percent a year earlier.”

Even a 6 percent expected rate of return would be overly aggressive, according to many pension-reform advocates who note that CalPERS received a 0.6 percent return last fiscal year – and 2.75 percent in the previous fiscal year. Furthermore, beginning in 1999, the state and most local agencies began a spree of retroactive pension increases.

These massive benefit hikes – oftentimes 50 percent or more – put additional strain on the system. Critics call for CalPERS to embrace rate returns that are considered risk free – i.e., tied to the Treasury bond rate. That would mean an expectation of about 3 percent a year for the coming decade.

The burden falls mainly on local governments, but public employees hired after a 2013 pension-reform measure (the Public Employees’ Pension Reform Act, or PEPRA) will face higher personal contributions to their pension plan. Because of something known as the “California Rule,” the state’s public employees cannot be forced to increase their contributions or receive fewer benefits than promised – but that doesn’t apply to those hired under a new set of rules. (A court decision last year opened the door to reduce benefits for current workers, but that case has yet to be resolved.)

Few California cities will face what is taking place in Loyalton, a tiny Sierra County town west of Reno, Nevada. The town could no longer afford to pay its fees to CalPERS, and the fund has threatened to cut off its four retirees’ pensions. As Calpensions explained, “According to a state controller’s report for 2015, Loyalton had revenues of $1.17 million, expenditures $1.68 million, liabilities $6.16 million, assets $11.1 million, fund equity $4.8 million, and population 733.”

This is an extreme version of the stress faced statewide, a problem exacerbated by the fact that the pension fund will soon have more retirees collecting pensions than active workers paying into the system. That situation wouldn’t be a problem if the system were entirely sustainable – i.e., if it weren’t amassing unfunded liabilities.

Gov. Jerry Brown applauded CalPERS’ decision to reduce its assumptions. “Today’s action by the CalPERS Board is more reflective of the financial returns they can expect in the future. This will make for a more sustainable system,” the governor said in a Dec. 21 statement.

These debates over the “rates of return” are so significant because of the way CalPERS and other defined-benefit systems operate. In defined-contribution systems (401/k-style systems, for instance) typical in the private sector, employees contribute a portion of their income into their retirement fund. Employers often match a certain percentage of these contributions. The money is invested in, say, a mutual fund. If the returns are high, the employee gains more retirement income. If they are low, the employee receives less. There are no future liabilities.

By contrast, public employees receive a promised benefit level determined by a formula based on years worked and a percentage of salary. Pension funds invest the money and their investment returns help assure the system has enough cash to meet all the current and future promises. If investment returns sag (or benefits are increased), the funds incur large unfunded liabilities or debts. Ultimately, the state’s taxpayers are responsible for any shortfalls. So the expected rate of return carries enormous public-policy implications for the state and municipalities.

Critics complain that the CalPERS board is comprised largely of public employees, retirees and elected officials with close ties to public-employee unions, which provides a strong incentive to push funding problems further into the future. But even with that dynamic there’s only so much that can be done in a world of weak investment returns and stepped up accounting standards. Efforts by CalPERS’ investment staff and board members – and by the Brown administration – to deal more realistically with the issue is viewed by most Sacramento observers as an encouraging sign.

Steven Greenhut is Western region director for the R Street Institute. Write to him at [email protected]

10 comments

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  1. Ron
    Ron 4 January, 2017, 08:56

    It’s the inmates running the pension Asylum that are loading up system with lucrative “defined benefits” packages for themselves.

    The international business world is intelligent enough to know that DEFINED BENEFITS are financial disasters to any business, thus all businesses focus on the known, i.e., defined CONTRIBUTIONS alone.

    Stealing from the young who silently shoulder the costs and bear the burden of unfunded promises of these programs to enrich the old seems to describe the Governments expansion of entitlement benefits and other government services, along with the taxes young people will have to pay to support them, mostly to subsidize older Americans.

    The inmates know that debt for our future generations buys votes. Over the decades, the proven “concept’ practiced by voters is to defer as much financial responsibilities as possible from our current financial responsibilities to future generations, that have no votes on the subject.

    Currently, it’s the future generations that will have the responsibilities to pay for the unsustainable pension programs, other boondoggle projects, and added inefficiencies built into our government. Simply stated, if we cannot afford it today, pass it off to the future generations to minimize any impact on our current lifestyles.

    Virtually all elected officials are heavily financed by unions which are focused on entitlements for their current members. Thus, no changes can be expected in the foreseeable future for elected officials to ever abandon their source of votes.

    It’s unfortunate that those future generations, unable to vote today, will bear the costs of many enacted entitlements and boondoggle projects.

    Reply this comment
    • eck
      eck 4 January, 2017, 19:32

      All I can say Ron, is duh! No-brainer stuff. We’re doomed. No way the leftists in charge will go away. Get out of state, not necessarily now, but not too far in the future. I will. It’ll all collapse. Guaranteed!

      Reply this comment
  2. JPR11
    JPR11 4 January, 2017, 10:35

    and Gov. Gray Davis, we thank you!

    Reply this comment
  3. Dude
    Dude 4 January, 2017, 17:05

    CalPers, and SEIU have always known that there is no investment strategy that could perform well enough to satisfy their mafiaesqe greed. The only solution? Eliminate the unions.

    Reply this comment
    • SeeSaw
      SeeSaw 4 January, 2017, 23:56

      Idiotic suggestion! CalPERS was in existence 40 years before the advent of public-sector unions in CA. Union membership is irrelevant to being a member of CalPERS. The highest paid retirees were not union members when they were active workers. Eliminate unions if you want–CalPERS will still be there and so will the workers.

      Reply this comment
    • Jim
      Jim 5 January, 2017, 12:05

      Frankly, this is the only fix. The unions own the legislature who in turn grant the union wishes. How many $200,000 pensions presently exist in your county, much less, the number who will retire within 5 years. The CAO in EDC has around a $600,00 budget and 1800 employees (frankly small business size), makes over $200,000 and will retire with a number that big. For most. of us that equals wealthy.

      Reply this comment
      • SeeSaw
        SeeSaw 6 January, 2017, 00:00

        One with a $200,000 pension was management–most likely not in a union. The average CalPERS pension is $36,000–that is what a union member would get.

        Reply this comment
  4. Balanced805
    Balanced805 5 January, 2017, 09:33

    Thank you for the information. What the many cities,districts, and boards across California need is information on how to convert to defined contribution program for new employees.

    Reply this comment
  5. Queeg
    Queeg 5 January, 2017, 11:09

    Comrades

    You cannot tax your way to prosperity!

    But they will try!

    Reply this comment
  6. Ted Steele---- Accept no substitute!
    Ted Steele---- Accept no substitute! 6 January, 2017, 21:16

    Comrades

    Looks like the leftists are making you keep promises and contracts you made in exchange for consideration…..lol what a concept!

    Reply this comment

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Steven Greenhut

Steven Greenhut

Steven Greenhut is CalWatchdog’s contributing editor. Greenhut was deputy editor and columnist for The Orange County Register for 11 years. He is author of the new book, “Plunder! How Public Employee Unions are Raiding Treasuries, Controlling Our Lives and Bankrupting the Nation.”

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