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Pension funds should disclose when investment earnings miss the mark

A new advisory panel, following a move by CalPERS last year, recommends that public pensions take a small step that touches on a big issue: What happens if pension fund earnings fall below the forecast?

Investment earnings are expected to provide two-thirds or more of the money needed to pay pensions in future decades. Critics say earnings forecasts, 7.75 percent a year for CalPERS and CalSTRS, are too optimistic and conceal massive taxpayer debt.

To make more pension information public, the first report of an actuarial panel recommends, among other things, that retirement systems add a “sensitivity analysis,” which is likely to show what happens if earnings miss their target in the next few years.

It’s not a long-term forecast like a Stanford graduate student study two years ago. Using a lower risk-free bond rate advocated by some economists, 4.1 percent, the study showed how state pension debt ballooned from the reported $55 billion to $500 billion.

Pension debt has become a political issue cited by reform advocates, who say public pensions must be overhauled to prevent the growing cost from eating up money needed for basic government services.

A short-term “sensitivity analysis” is intended to be practical, a way to help state and local governments know how much their annual pension costs may vary in the next few budget cycles if investment earnings or other factors miss their target.

For the first time, the annual California Public Employees Retirement System actuarial report last fall on state and non-teaching school pensions included a sensitivity analysis.

The report showed how employer contributions could vary if, all other factors remaining unchanged, earnings during three fiscal year are above or below the target by a little or a lot.

For example, if earnings hit the target of 7.75 percent the employer contribution in fiscal 2015-16 for most state workers would be 19.5 percent of pay. (The employee contribution, 8 percent of pay, is bargained with labor and presumably unchanged.)

But if total investment earnings this fiscal year and the next two fiscal years show a loss, minus 3.64 percent, the employer contribution in 2015-16 would increase by about half to 28.9 percent of pay.

Falling short of the 7.75 percent target with earnings of 2.93 percent would increase the 2015-16 contribution to 22.6 percent of pay. Exceeding the target with earnings of 19.02 percent would produce little change, dropping the rate to 18 percent.

The sensitivity analysis may not be the long-term debt calculation sought by reformers. But it does clearly show the risk of how a double-dip recession, and another plunge in the stock market, could drive up government costs.

The California Actuarial Advisory Panel, with eight members appointed by public officeholders and agencies, was created by legislation recommended by the California Public Employee Post-Employment Benefits Commission four years ago.

“There is no single clearinghouse for funding policies and practices from around the state and country which can be used to evaluate the actuarial assumptions, crediting rates, or proposed actions of a particular retirement system,” the commission said.

Actuaries have a key role in setting the annual payment that state and local governments must make to pension funds. During a push to cut pension costs, former Gov. Pete Wilson obtained legislation giving lawmakers control of the CalPERS actuary.

A labor-backed initiative, Proposition 162 in 1992, returned control of the actuary to the CalPERS board, while also giving all public pension boards control of their administration and pension funds to prevent Wilson-like “raids” on “surpluses.”

The importance of actuary control was seen in a major state pension increase, SB 400 in 1999. The trendsetting benefits now called “too rich” and “unsustainable” by some are being rolled back for new hires and blamed for soaring pension costs.

CalPERS, the SB 400 sponsor, told legislators the increased pensions would be paid for by a surplus, investment earnings and inflating pension fund assets, leaving state pension costs unchanged for a decade, said a legislative bill analysis.

A 17-page CalPERS brochure touting SB 400 that was distributed to legislators said in capital letters: “NO INCREASE OVER CURRENT EMPLOYER CONTRIBUTIONS IS NEEDED FOR THESE BENEFIT IMPROVEMENTS.”

The bill negotiated by public employee unions and the administration sailed through the Legislature in September 1999 during the last two days of the session, passing the Assembly 70-to-7 and the Senate 39-to-0 without questions or debate.

report issued by the nonpartisan Legislative Analyst’s Office in December 1999 estimated the SB 400 pension increase would cost the state $420 million the first year. But CalPERS agreed to two actuarial changes lowering the net cost to $205 million.

CalPERS had used its actuarial power as leverage, agreeing to the cost-cutting changes only if pensions were increased. The worth of assets was increased from 90 to 95 percent of market value, and the amortization of excess assets was shortened.

“Coupled with the benefit increases, PERS agreed to change the two actuarial valuation methods discussed above, but only if the increases were adopted,” said the analyst’s report. “(PERS could have made these changes independent of the improved benefits.)”

Legislators also were not told of an accurate forecast made by CalPERS actuaries in 1999. If investment earnings hit the target, then 8.25 percent, the state payment a decade later in fiscal 2010-11 would be $679 million, similar to the 1988 payment.

But if earnings averaged 4.4 percent, the actuaries predicted that the state payment in fiscal 2010-11 would be $3.9 billion — almost precisely the amount expected before unions agreed to employee contribution increases lowering the current payment to $3.5 billion.

If legislators had been shown something like the sensi
tivity analysis recommended by the actuarial panel, would there have been some discussion of SB 400 in the Senate, possibly even opposition?

The public pension “disclosure” recommendations issued by the panel last month are the first step. The panel is working on a “model for actuarial polices and methods” that may be released for comment early next year.

A bill enacted last year, AB 1247, requires CalPERS to issue an annual report showing state pension contribution rates and liabilities if investment earnings miss the target, currently 7.75 percent, and are 2 percent above or 2 percent below.

Within 30 days of receiving the CalPERS report, the chairman of the actuarial panel (currently Alan Milligan, the CalPERS chief actuary) or someone named by the chairman is supposed to give a legislative hearing an analysis of the report.

But the panel would like to work with lawmakers on two concerns about the new law: targeting the work of another public agency actuary, which is outside the scope of the panel charter, and the ability of the panel to handle the additional workload.

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