CalPERS payment up $262 million

After the stock market crashed last fall, actuaries thought there might be a small drop in the state’s annual pension payment to CalPERS because of a one-year lag in the way rates are calculated.

No such luck.

A new look at the numbers was scheduled to go before the CalPERS board for approval this week. It calls for a $262 million increase for the new fiscal year beginning July 1, pushing the total annual state payment to $3.3 billion. Most of the rate increase is due to something the actuaries had not foreseen last fall — an increase in the state payroll driven by salary increases and a growing number of state workers during the fiscal year that ended last June 30.

The impact of the stock market crash is not included in the new California Public Employees Retirement System rate because of the one-year lag.

But after the current fiscal year ends next month, the big plunge in the value of the CalPERS investment portfolio will be part of the calculation for new state contribution rates beginning in July of next year.

The CalPERS investment portfolio, valued at $260 billion in the fall of 2007, had fallen to $165 billion by last February and was back up to $179 billion last week. If the recovery does not continue, the state could be in for a real rate shock next year.

Here’s one clue to the potential magnitude.

The payroll-driven rate increase of $262 million this July is said to be less than 0.4 percent of payroll. CalPERS warned last October that rates could increase 2 to 5 percent of payroll in July 2010, if the investment loss is 20 percent in this fiscal year.

Simple math would seem to suggest that a rate increase of $1 billion or more is possible next year.

Under the one-year lag, the fiscal year ending last June is used to set annual rates for the year beginning this July. And the current fiscal year ending next month (which includes the market crash) will be used for the rates in July of next year.

The contribution rates set by the board of CalPERS, and other public employee pension systems in California, are protected by law and cannot be cut by elected officials trying to balance state and local government budgets.

“Unlike most other areas of the budget, the Legislature has very little control over these costs in the short run,” the nonpartisan Legislative Analyst said in a report earlier this year warning that “State Retirement Costs May Skyrocket in Future Years.”

“Case law establishes that the bulk of these payments — principally those for CalPERS and CalSTRS (California State Teachers Retirement System) pension programs — are enforceable contractually by retirement systems and their members,” the analyst said.

In addition, the trustees who serve on the boards of state and local public pension systems have limited room to manipulate contribution rates. They have a legal “fiduciary” obligation to protect retiree benefits. (See Calpensions 27 Mar 09 “Local pension funds: The layoff scenario”)

The irony, if that’s the right word, is that the pension trustees rely on actuarial forecasts of pension needs several decades into the future. Contributions must be increased if there is a projected shortfall or “unfunded accrued actuarial liability.“

But the actuarial forecasts based on projections of retirement dates, payrolls, investment earnings, inflation and other hard-to-know factors are far from an exact science. (See Calpensions 19 Apr 09 “Actuaries see pension future — or not”)

A report from CalPERS actuaries last October, warning of the possible big rate increase in 2010, said the “good news” is that investments earned double-digit returns in the four years prior to the stock market downturn that began in fiscal 2007-08.

CalPERS also adopted a “smoothing” policy in 2005 that spreads market gains and losses over 15 years, instead of three years. The longer period helps reduce big swings in the contribution rate.

The report said the result was that as of June 30, 2007, about 14 percent of the CalPERS funds were in effect “set aside for a rainy day,” providing a cushion as the market downturn began.

The actuaries estimated that the contribution rate for the state, and non-teaching school employees and local government systems in CalPERS, would on average be reduced 0.1 to 0.2 percent of payroll in the next annual calculation.

But that’s how things looked in October. The new view of the CalPERS actuaries calls for an annual state contribution increase in July of $262.4 million, an amount said to be less than 0.4 percent of payroll.

“The main reason for this increase is the growth in payroll for all state plans between the June 30, 2007, valuation and the June 30, 2008, valuation,” said the report. “This growth in payroll was a combination of pay increases granted to existing employees as well as the growth in the number of active employees.”

The report contains a table showing the state contributions to CalPERS since 1996, when it was $1.2 billion. As a high-tech boom boosted investment earnings, the state contribution dropped to $159 million in 1999 and $156 million in 2000.

Then as the stock market fell and legislation in 1999 made a major increase in benefits, the state contribution to CalPERS “skyrocketed” in just a few years to $2.2 billion in 2003 and $2.5 billion in 2004.

Citing the dramatic increase, Gov. Arnold Schwarzenegger briefly backed a proposal in 2005 to switch all new state and local government employees to the 401(k)-style retirement plans now common in the private sector.

The 401(k) plan is a tax-sheltered investment account, rising and falling with the market, liked by employers because contributions are capped. Public employee pensions, liked by labor unions, have monthly payments guaranteed for life.

Systems such as CalPERS assume that 70 to 75 percent of future pension payments will come from investment earnings, not contributions from employers or employees.

But contributions remain a keystone of the public pension systems.

The CalPERS board, presumably with an eye toward the governor, adopted its “smoothing” policy in April 2005 to reduce big swings in contribution rates.

The new CalPERS actuarial forecast calls for a $115 million annual increase in July for non-teaching school employees, bringing the total to $1 billion. There is a two-year lag for calculating contributions for the 2,000 local government plans in CalPERS.

The report said it would be premature to speculate on the impact of the market crash, beyond the estimates made last October, until after the close of the current fiscal year on June 30.

“Once the return for fiscal year 2008-09 is available, staff will make an extensive communication effort to all employers,” said the report. “Further, staff continues to look at alternatives regarding the impact of the investment return for fiscal 2008-09 on employer rates and will bring those alternatives to the board shortly.”

Reporter Ed Mendel covered the Capitol in Sacramento for nearly three decades, most recently for the San Diego Union-Tribune. More stories are at http://calpensions.com/ Posted 10 May 09.