CalPERS is delaying a contribution rate hike for local governments and schools a year, pushing back the impact of huge investment losses in the stock market crash last year.
The change puts even more distance between the historic crash and the higher annual payments from employers needed to make up for the losses, which will not fully kick in until five or six years later.
If the critics are right and the current level of retirement benefits are “unsustainable” for future employees, the financial crunch may not be a sudden rate shock but instead a kind of slow-motion train wreck over a number of years.
In any case, there will be no big CalPERS rate hike to point to next year during the campaign for an initiative to cut retirement benefits for new state and local government hires, if enough signatures are gathered to put the measure on the ballot.
Ron Seeling, the CalPERS chief actually, told a board committee last week that what had been expected to be three years of roughly equal rate increases will now have little or no increase in the first year.
Seeling said the rate increases approved by the CalPERS board last June were based on an estimate that investment losses during the fiscal year that ended that month would be 29 percent, but the amount turned out to be 24 percent.
“I wanted to make you aware that the 5 percent better performance than we had anticipated does have that impact,” he said.
There will now be little or no change in the contribution rate for non-teaching school employees next July 1, the first year of a three-year “smoothing” of the rate increase required by the market crash.
And there will be little change in the contribution rate for the 2,000 local government agencies in CalPERS on July 1, 2011, when their three-year smoothing starts after a lag caused by reporting and the time needed for the many actuarial calculations.
“It’s really a two-year phase-in and it comes two years out for the local governments,” said Seeling.
Facing opposition from the Schwarzenegger administration, the CalPERS board has taken no action on a contribution increase for state workers scheduled to begin next July along with the new rate for non-teaching school employees.
The administration opposed the proposed smoothing plan that pushes the big contribution increase required by the market crash into the future, arguing that CalPERS and future state budgets could be harmed by deferring payments.
“While the proposal achieves short-term savings, the employer rate would increase for 28 years thereafter as a result of that deferral,” Dave Gilb, Personnel Administration director and a CalPERS board member said in a letter last June.
“It resembles a form of borrowing from the fund because the employer rates are lower for two years, but must be paid back with higher rates in future years,” he said.
Gilb estimated that the state payment to CalPERS, $3.3 billion this fiscal year, should increase $879 million next July to reflect the crash. He said the increase under the proposed smoothing would be a small fraction of that, about $29 million.
But things have changed since June. Gilb retired, replaced by Debbie Endsley. More importantly, nonpartisan Legislative Analyst Mac Taylor estimated last week that the state budget has a $21 billion shortfall over the next year and a half.
Seeling told the CalPERS board last week that his staff has given the Schwarzenegger administration a half dozen options for increasing contributions for state workers.
Greg Beatty, Endsley’s board representative, thanked Seeling and said the administration will respond next month. Seeling said CalPERS wanted to accommodate the administration, but it “goes without saying” that the CalPERS board can set the rate.
“We could have set the rate for the state using the same methodology that we used for everybody else and said, ‘If you would like to pay it faster, send in some extra money,’” said Seeling, “and that may be where this turns out.”
A chart given to the CalPERS board last spring shows that after the three-year smoothing, contribution rates for most workers were expected to slowly climb for three decades, going from roughly 17 percent of payroll now to 27 percent.
The actuaries said they were treating the market crash as a unique event, “isolating” its cost from the rest of the fund and paying it off over 30 years with contribution increases.
“We believe that this year should be handled differently and that it should be paid separately and outside the smoothing process,” the actuaries told the board. “We do not want to rely on future investment returns to pay for the 2008-09 investment losses.”
Critics who argue that the current level of retirement benefits are “unsustainable” and should be reduced for new hires say CalPERS is too optimistic about its expected investment earnings, an annual average of 7.75 percent.
Among the experts who think average earnings will be less than 7.75 percent in the years ahead is Laurence Fink, chairman of BlackRock, the world’s largest money managing firm, who spoke to the CalPERS board last summer.
The CalPERS chief investment officer, Joe Dear, addressed the earnings issue last week during his monthly report to the board. He said 5.25 percent of the earnings assumption is “real” and 2.5 percent is inflation.
Dear said the 7.75 percent earnings assumption is below the national average for pension funds, 8 percent, and below the earnings average of CalPERS during the last two decades, 7.9 percent.
He said CalPERS believes, among other things, that stocks will yield 3 to 4 percent more on average than bonds and that private equity investments will average 3 percent more than domestic stocks.
Dear said he might agree with money managers, who tend to have a short-term investment horizon, that earnings may average 6 percent in the short term. But, he said, CalPERS has decades in which to repeat its past investment performance.
“It will take prudence, discipline, conviction and skill to repeat this performance over the next 20 years,” Dear said. “But I believe we have what it takes.”
If CalPERS earnings fall short of their target, the annual contributions required from state and local governments will grow even larger, taking money that could be used for other programs.
But as the aftermath of the historic stock market crash apparently shows, the financial squeeze could take years to play out.