The Underrecognized, Undervalued, Underpaid, Unfunded Pension Liabilities

SACRAMENTO, CA - JULY 21: A sign stands in front of California Public Employees' Retirement System building July 21, 2009 in Sacramento, California. CalPERS, the state's public employees retirement fund, reported a loss of 23.4%, its largest annual loss. (Photo by Max Whittaker/Getty Images)

“It’s the economy, stupid.”
–  Campaign slogan, Clinton campaign, 1992

To paraphrase America’s 42nd president, when it comes to public sector pensions – their financial health and the policies that govern them – it’s the unfunded liability, stupid.

The misunderstood, obfuscated, unaccountable, underrecognized, undervalued, underpaid, unfunded pension liabilities.

According to CalPERS own data, California’s cities that are part of the CalPERS system will make “normal” contributions this year totaling $1.3 billion. Their “unfunded” contributions will be 41% greater, $1.8 billion. As for counties that participate in CalPERS, this year their “normal” contributions will total $586 million, and their “unfunded” contributions will be 36% greater at $607 million.

That’s nothing, however. Again using CalPERS own estimates, in just six years the unfunded contribution for cities will more than double, from $1.8 billion today, to $3.9 billion in 2024. The unfunded contribution for counties will nearly triple, from $607 million today to $1.5 billion in 2024 (download spreadsheet summary for all CalPERS cities and counties).

Put another way, by 2024, “normal contribution” payments by cities and counties to CalPERS are estimated to total $2.8 billion, and the “unfunded contribution” payments are estimated to total almost exactly twice as much, $5.5 billion.

So what?

For starters, every pension reform that has ever made it through the state legislature, including the Public Employee Pension Reform Act of 2013(PEPRA), does NOT require public employees to share in the cost to pay the unfunded liability. The implications are profound. As public agency press releases crow over the phasing in of a “50% employee share” of the costs of pensions, not mentioned is the fact that this 50% only applies to 1/3 of what’s being paid. Public employees are only required to share, via payroll withholding, in the “normal cost” of the pension.

Now if the “normal cost” were ever estimated at anywhere near the actual cost to fund a pension, this wouldn’t matter. But CalPERS, according to their own most recent financial report, is only 68% funded. That is, they have investments totaling $326 billion, and liabilities totaling $477 billion. This gap, $151 billion, is how much more CalPERS needs to have invested in order for their pension system to be fully funded.

A pension system’s “liability” refers to the present value of every future pension payment that every current participant – active or retired – has earned so far. In a 100% funded system, if every active employee retired tomorrowand no more payments ever went into the system, if the invested assets were equal to that liability, those assets plus the estimated future earnings on those invested assets would be enough to pay 100% of the estimated pension payments in the future, until every individual beneficiary died.

A pension system’s “normal payment” refers to the amount of money that has to be paid into a fully funded system each year to fund the present value of additional pension benefits earned by active employees in that year. When the normal payment isn’t enough, the unfunded liability grows.

And wow, has it grown.

CalPERS is $151 billion in the hole. All of California’s state and local pension systems combined, CalPERS, CalSTRS, and the many city and county independent systems, are estimated to be $326 billion in the hole. And that’s extrapolated from estimates recognized by the pension funds themselves. Scenarios that employ more conservative earnings assumptions calculate total unfunded liabilities that are easily double that amount.

With respect to CalPERS, how did this unfunded liability get so big?

An earlier CPC analysis released earlier this year attempts to answer this. Theories include the following: (1) Letting the agencies decide which type of asset smoothing they’d like to employ, (2) permitting the agencies to make minimal payments on the unfunded liability so the liability would actually increase despite the payments, (3) making overly optimistic actuarial assumptions, (4) not taking action sooner so the unfunded payment wouldn’t end up being more than twice as much as the normal payment.

One final alarming point.

CalPERS recently announced that for any future increases to the unfunded liability, the unfunded payment will have to be calculated based on a 20 year, straight-line amortization. This is a positive development, since the more aggressively participants pay down the unfunded liability, the less likely it is that these pension systems will experience a financial collapse if there is a sustained downturn in investment performance. But it begs the question – why, if only increases to the unfunded liability have to be paid down more aggressively, is the unfunded payment nonetheless predicted to double within the next six years?

CalPERS information officer Tara Gallegos, when presented with this question, offered the following answers:

(1) The discount rate (equal to the projected rate-of-return on invested assets) is being lowered from 7.5% to 7.0% per year. But this lowering is being phased in over five years, so it will not impact the 2018 unfunded contribution. Whenever the return-on-investment assumption is lowered, the amount of the unfunded liability goes up. By 2024, the full impact of the lowered discount rate will have been applied, significantly increasing the required unfunded contribution.

(2) Investment returns were lower than the projected rate of return for the years ending 6/30/2015 (2.4%) and 6/30/2016 (0.6%). Lower than projected actual returns also increases the unfunded liability, and hence the amount of the unfunded payment, but this too is being phased-in over five years. Therefore it will not impact the unfunded payment in 2018, but will be fully impacting the unfunded payment by 2024.

(3) The unfunded payment automatically increases by 3% per year to reflect the payroll growth assumption of 3% per year. This alone accounts, over six years, for 20% of the increase to the unfunded payment. The reason for this is because most current unfunded payments are calculated by cities and counties using the so-called “percent of payroll” method, where payments are structured to increase each year. CalPERS is going to require new unfunded payments to not only be on a 20 year payback schedule, but to use a “level payment” structure which prevents negative amortization in the early years of the term. Unfortunately, up to now, cities and counties were permitted to backload their payments on the unfunded liability, and hence each year have built in increases to their unfunded payments.

The real reason the unfunded liability has gotten so big is because nobody wanted to make conservative estimates. Everybody wanted the normal payments to be as small as possible. The public sector unions wanted to minimize how much their members would have to contribute via withholding. CalPERS and the politicians – both heavily influenced by the public sector unions – wanted to sell generous new pension enhancements to voters, and to do that they needed to make the costs appear minimal.

As a result, taxpayers are now paying 100% of an “unfunded contribution” that is already a bigger payment than the normal contribution, and within a few years is destined, best case, to be twice as much as the normal contribution.

Camouflaged by its conceptual intricacy, the cleverly obfuscated, deliberately underrecognized, creatively undervalued, chronically underpaid, belatedly rising unfunded pension liabilities payments are poised to gobble up every extra dime of California’s tax revenue. And that’s not all…

Sitting on the blistering thin skin of a debt bubble, a housing bubble, and a stock market bubble, amid rising global economic uncertainty, just one bursting jiggle will cause pension fund assets to plummet as unfunded liabilities soar.

And when that happens, cities and counties have to pay these new unfunded balances down on honest, 20 year straight-line terms. They’ll be selling the parks and libraries, starving the seniors, releasing the criminals, firing cops and firefighters, and enacting emergency, confiscatory new taxes.

Whatever it takes to feed additional billions into the maw of the pension systems.

Budget surplus? Dream on.

*   *   *

Edward Ring co-founded the California Policy Center in 2010 and served as its president through 2016. He is a prolific writer on the topics of political reform and sustainable economic development.

RELATED ARTICLES

How to Restore Financial Sustainability to Public Pensions, February 14, 2018

How to Assess Impact of a Market Correction on Pension Payments, February 7, 2018

California Government Pension Contributions Required to Double by 2024 – Best Case, January 31, 2018

Did CalPERS Use Accounting “Gimmicks” to Enable Financially Unsustainable Pensions?, January 24, 2018

How Much More Will Cities and Counties Pay CalPERS?, January 10, 2018

If You Think the Bull Market Rescued Pensions, Think Again, December 7, 2017

Did CalPERS Fail to Disclose Costs of Historic Bump in Pension Benefits?, October 26, 2017

Coping With the Pension Albatross, October 13, 2017

How Fraudulently Low “Normal Contributions” Wreak Havoc on Civic Finances, September 29, 2017

Pension Reform – The San Jose Model, September 6, 2017

Pension Reform – The San Diego Model, August 23, 2017

California Moves Hard Left

Gavin NewsomOur next election season is underway and unless something changes, Gavin Newsom will be our next governor. Even Gov. Jerry Brown is concerned about the “self labeled state of resistance” against Trump, Republicans and people of faith that is pushing California’s policies and political debate further left. Republicans, church pulpits that founded America or leading conservatives aren’t giving counterarguments or providing checks on unhinged spending and social policies that degrade families, single-family homes and middle class incomes. U.S. Senate races, statewide offices and Legislature races will be filled exclusively with Democrats – setting up races between the left and even harder left – foreshadowing the direction of the party in California and nationally. This younger generation of Godless, leftist Democrats who mock the values that built California will destroy our state the way Chavez ruined Venezuela.

Additionally, unhinged immigration that rewards chain migration, encourages a diversity visa lottery system and doesn’t deport every illegal alien in prison will turn this country deep blue the way California, New York, Illinois and increasingly former red state Virginia are now. Liberal magazine The Atlantic was prescient when it stated in early 2016 that America is moving left and unchecked immigration will destroy this country by importing people who bring leftist and communist values from China, Latin America and Islamic African nations.

To overly pious Christians, leading conservatives, #NeverTrumpers and the Republican establishment that hates Trump, his voters and what he stands for, let Joel Kotkin, a self-described Truman Democrat, be your guide on how he illustrates what the Democratic Party has become. Mr. Kotkin breaks down these “post-industrial information age Democrats” into three groups:

Corporate oligarchs exemplified by Google, Facebook, Silicon Valley, Causists obsessed with hot button issues (abortion on demand, gay marriage, global warming) the most critical to long-term Democratic ascendency, and Populists who bear much of the party’s ‘social democratic message and legacy’ (they are the least of the Democratic Party that gave America FDR, JFK, Pat Brown, Scoop Jackson).”

Each group exemplifies faux compassion while using the media, entertainment, education, government and the courts to intimidate and control any who oppose their policies to bow in serf-like fashion to their whims and desires. Foolish Republicans in California who believe that Democrats can be understood and worked with, instead of being fought against, don’t comprehend how systematically corrupt; evil and plain wrong are today’s Democratic Party.

Two examples illustrate this truth when leading Democrats attended a private dinner with the president of Iran and Louis Farrakhan in 2013 while former President Obama had a smiling picture taken in 2005 with the vile, anti-Semite Farrakhan when he was a Senator. The press, Congressional Black Caucus and Democratic leaders buried these secrets to further the cause of electing Democrats and warring against American values. Meanwhile, Trump has a better approval rating than Obama, despite the relentless attacks, at the same point in his presidency, which is simply amazing.

And what have decades of “phantasmagorical imbecility,” from feckless Republicans and leftist Democrats wrought California for my generation to clean up? The poorest business climate, some of the highest tax rates, and largest number of people living in poverty. Moreover, Los Angeles now ranks as having the worst traffic congestion in the world, California is possibly in another drought without any water capture infrastructure built in recent memory; and The Stanford Pension Institute says, “that CalPERS has a $1.4 trillion unfunded liability.” These could be some of the reasons why more people are migrating out of California. California could use economic growth since our GDP growth rate has slipped to 35th in the nation.

The irony is Trump’s economy has rescued California’s Unemployment Insurance Fund, which has been insolvent since 2009. It was bailed out by the federal government under the Obama administration but the “Trump bump” means California can pay back the $10.2 billion borrowed from the Treasury between 2008-2012. But California’s Democratic legislators never miss an opportunity to “trash President Trump.” Environmental policy and “settled science,” though, is where the Democratic Party isn’t willing to have a serious, reasoned debate to answer what if anything can be done; or if there even is man-made global warming since climates obviously change.

However, is that due to carbon emissions or the earth’s weather patterns that have taken place for millions of years? Two recent studies question the earth warming and the worst case scenarios touted by Al Gore and former President Obama being void of scientific validity. Billions keep flowing for Democratic politicians, interest groups and those vested financially to keep the science settled and the environmental shibboleth of global warming moving forward into the next election cycle while California will ban any crude oil coming from Trump’s offshore drilling plan that could provide billions in economic benefits.

So what can be done against this type of incompetent rule? Fight back. For starters here’s how to approach environmentalists with this statement and then question by Dr. Walter Williams:

“Sixty-Five million (65) years ago the Earth experienced one of the most rapid and extreme global climate changes recorded in geological history named the ‘Paleocene-Eocene Thermal Maximum,’ when oceans were 18 to 27 degrees hotter than today and Antarctica was home to temperate forests, beech trees and ferns. The earth also had no permanent polar ice caps. In the past 65 million years, the Earth’s temperature has increased and decreased with no help from mankind. Therefore, can mankind really stop climate change and what is the correct earth temperature?”

Make no mistake we are in a fight the way the Marines were in an inch-by-inch fight for territory in the Pacific during World War II. Walk precincts, support candidates with your money and realize it will take numerous election cycles, but voters are realizing Trump’s economic strategies are working. It really is the economy stupid. Most importantly, WALK PRECINCTS and get the message to voters about Trump’s economy that is helping Republicans, why single-family homes aren’t being built causing prices to skyrocket (appointed agencies like the Southern California Association of Governments that has counterparts in San Diego and Northern California are the reasons) and why we are terribly vulnerable to the next recession due to some of the above-mentioned reasons.

Inform voters about unfunded pension obligations in the trillions, horrible inequality, sensible ways to protect children in our schools and Democratic leaders that don’t reflect their communities; but most of all, fight back. Run for office locally, regionally, statewide and federal offices but have your facts down, platform legitimized and reasons for running, because Democrats are on the hegemonic march to crush your lives, kill off families and destroy anything that gets in their path by any means possible.

Todd Royal is a geopolitical risk and energy consultant based in Los Angeles.

California Government Pension Contributions Required to Double by 2024 – Best Case

Pension moneyThe employer contribution to California’s state and local government pension systems will double, from $31 billion in 2018 to $59 billion by 2024. This estimate is based on aggregating official projections of cost increases issued by CalPERS to their participating agencies, and extrapolating those projections show the overall impact on all of California’s 87 government pension systems.

As reported in the CPC analysis “How Much More Will Cities and Counties Pay CalPERS?,” each of their participating agencies can now view detailed information on the financial status for each of their local pension plans by accessing the “Public Agency Actuarial Valuation Reports” issued by CalPERS actuaries.

The table below shows, in column one, the sum total of the projections prepared by CalPERS for each of their participating local agencies. As can be seen, local government employers in the CalPERS system are required to contribute $5.3 billion this year. By 2024, that required employer contribution will nearly double, to $10.1 billion.

The middle column in the table extrapolates these projections to the entire CalPERS system, incorporating the state agencies they serve. This is a reasonable extrapolation, since – using data from CalPERS 2016-17 Annual Financial Report – the entire CalPERS system is actually slightly less funded, at 68%, than their local agency plans, at 69%. As can be seen, the entire CalPERS system is estimated to require employer contributions to rise from $13.3 billion this year to $25.3 billion in 2024.

Column three in the table extrapolates this data to incorporate all of California’s state and local government pension systems. Using Census Bureau data, these systems are estimated to have $761 billion in assets. Based on that total, and assuming similar financial profiles for all California’s pension systems – i.e., about 70% funded in aggregate – California’s state and local government employers will pay $31 billion into the 87 various pension systems this year, and by 2024 this payment will rise to $59.1 billion.

Estimated Increase to Employer Pension Contribution
2017-18 compared to 2014-25 ($=B)

Employer Pension Contribution

When assessing the impact of a nearly $30 billion hike in pension contributions between now and 2024, it’s important to note that these projected payments do not include contributions collected from state and local government employees via payroll withholding. Last year, for example, CalPERS collected $12.3 billion from employers – i.e., taxpayers – and supplemented that with $4.2 billion in employee contributions via payroll withholding (ref. CalPERS CAFR, page 31). Why are the employees only paying 25% of the cost for their benefit? Didn’t the PEPRA reform of 2012 put them on track to pay 50% of the cost of their pensions?

To properly answer this, it is necessary to view the projected changes to the employer “normal contribution,” vs. their “unfunded contribution.” The normal contribution is how much money must go into a pension system in any given year. It represents the amount that has to be invested in the present year to eventually fund the additional retirement benefits earned by employees in that same year. According to PEPRA, this so-called normal contribution is the only portion of an employer’s pension fund payment that employees are required to help pay for. And since the normal contribution has never been enough, pension systems have become underfunded – and the money necessary to catch up, the unfunded contribution, falls 100% on the backs of the taxpayers.

If the unfunded contribution was a trivial amount, because pension fund actuaries had made prudent forecasts, this would be a non-issue. But as summarized last week in the report “Did CalPERS Use Accounting “Gimmicks” to Enable Financially Unsustainable Pensions?,” forecasts were not prudent. They were wildly optimistic. This is why, using official projections, CalPERS requires an unfunded contribution this year that is already 21% greater than the normal contribution, and by 2024, CalPERS will required an unfunded contribution that is 53% greater than the normal contribution.

These are best-case projections, since CalPERS and CalSTRS, along with most of California’s major government pension systems are only lowering their long-term projected rate of return assumptions from 7.5% to 7.0%. All of this, this extra $30 billion per year that California’s taxpayers are going to have to cough up by 2024 to feed the pension systems, is assuming that strong investment returns continue indefinitely. If there is a major correction in the stock market, or in real estate, or in bonds, or in all three, then all bets are off.

After a run-up in the value of invested assets that has now lasted for nearly ten years, CalPERS is only 68% funded, and CalSTRS is only 64% funded. These pension systems are already requiring taxpayers to more than double their payments to reduce an unfunded liability that they’ve already racked up, despite realizing unprecedented gains in an overheated market that is ripe for a correction. When that happens, the payments they’ll require to stay afloat could double again.

If you are wondering what is truly driving the state and local governments’ insatiable desire for more tax revenue, look no further.

Did CalPERS Use Accounting “Gimmicks” to Enable Financially Unsustainable Pensions?

Gimmick – a concealed, usually devious aspect or feature of something, as a plan or deal.
– Dictionary.com

SACRAMENTO, CA - JULY 21: A sign stands in front of California Public Employees' Retirement System building July 21, 2009 in Sacramento, California. CalPERS, the state's public employees retirement fund, reported a loss of 23.4%, its largest annual loss. (Photo by Max Whittaker/Getty Images)

In the past week, from Millbrae’s city hall to the inner sanctum of the CalPERS leviathan in Sacramento, defenders of pensions have been active. In particular, they have criticized the recent analysis, published by the California Policy Center, “How Much More Will Cities and Counties Pay CalPERS?” It would advance the ongoing debate over pensions to summarize the points of the CPC analysis, how CalPERS and their allies attacked those points, and how those attacks might be challenged.

On January 19th, in a report published online by Chief Investment Officer magazine entitled “CalPERS: Ring’s Flippant Claim of ‘Tricky Accounting Gimmicks’ Is False,” author Christine Giordano interviewed CalPERS spokesperson Amy Morgan. Tellingly, they did not discuss the substance of the CPC analysis, which specified, using CalPERS’ own data, how much more cities and counties are going to have to pay CalPERS. They focused instead on specific criticisms of CalPERS that followed those payment calculations.

As noted by the title of the report, CalPERS spokesperson Amy Morgan seemed to suggest the characterization of their accounting practices as employing “gimmicks” is not backed up by evidence. Morgan is invited to review the following evidence, after which she may join our readers in deciding whether or not “gimmicks” were employed.

GIMMICK #1  –  THE CORRUPTION OF “ASSET SMOOTHING”

Asset smoothing is a practice whereby pension funds do not overestimate their assets after years of good returns, nor underestimate their assets after years of poor returns. It is a good way to avoid overreacting to market volatility. But in 2001, when the Dow Jones stock index had already been correcting for over a year and the Nasdaq was collapsing, CalPERS abdicated their responsibility to set the rules on smoothing.

When participating agencies in the CalPERS system were contemplating whether or not to follow the lead of the California Highway Patrol (SB 400, 1999) and retroactively increase pension benefits, CalPERS sent projections to these agencies in which a CalPERS actuary presented to elected officials three distinct values for the assets they had invested with CalPERS. Remarkably, that document gave these agency officials the liberty to choose which one they’d like to use – the higher the value they chose for their existing assets, the lower the cost from CalPERS to pay for the benefit enhancements they were contemplating. The usual disclaimers were present, but the mere fact that city officials were given three scenarios is suspect. Obviously these officials would be under pressure to pick the scenario that provided the biggest benefit enhancement for the lowest cost. Read “Did CalPERS Fail to Disclose Costs of Historic Bump in Pension Benefits?” for more details including several source documents.

One of the most revealing documents is exemplified by the “Contract Amendment Cost Analysis,” sent to Pacific Grove by CalPERS in July, 2001. Here is an excerpt from that document, showing the choices CalPERS offered Pacific Grove:

The available rate choices are offered under three different Alternatives:
Alternative 1 – No increase in Actuarial Value of Assets
Alternative 2 – Actuarial Value of Assets increased by twice the increase in the Present Value of Benefits due to the amendment, limited to 100% of Market Value of Assets
Alternative 3 – Actuarial Value of Assets increased by twice the increase in the Present Value of Benefits due to the amendment, limited to 110% of Market Value of Assets

To reiterate: CalPERS provided abundant disclaimers. They suggested that given recent “market volatility,” city officials “are strongly encouraged to have in-depth discussions with your CalPERS actuary about the financial consequences of any amendment.”

Now let’s get real: Further on in this same letter, CalPERS provides a breakdown of how much pension benefit enhancements will cost in terms of annual contributions as a percent of payroll under each of these three scenarios:

Alternative 1 – The actuarial value of the assets is not tampered with, the normal cost goes from 4.6% to 25.0%.
Alternative 2 – The actuarial value of the assets is lifted up to market value, the normal cost goes from 4.6% to 19.9%.
Alternative 3 – The actuarial value of assets goes up to 110% of the market value, the normal cost – to implement a massive, retroactive enhancement to pension benefits – goes from 4.6% to 6.2%.

What option would you choose, if you were a city manager whose own pension would be enhanced, or a city council member who has to answer to powerful unions whose members want more generous pension formulas?

The reason CalPERS was able to cram this through, in July 2001 as the market was cratering, was based on their decision to present various asset “smoothing” options to members. Why? Because the smoothing options they’d been using were understating the value of their assets because stock values had exploded in the final years of the 1990s. One can only speculate as to why they did this as late as July 2001 when it was obvious the internet stock bubble had popped. It’s possible CalPERS officials knew several agencies had already lobbied for pension benefit enhancements and the officials were under pressure to leave no agency behind. But to offer local bureaucrats and elected officials a choice of various asset smoothing methods was passing the buck.

Overnight, the CalPERS practice of asset smoothing went from being a prudent accounting guideline to a clever rationalization for disastrous policy decisions. If that’s not a gimmick, I don’t know what is.

GIMMICK #2 – CREATIVE AMORTIZATION OF UNFUNDED LIABILITY

When you talk about “tricky accounting gimmicks,” it’s hard to find one worse than the methods the participating agencies chose to amortize their unfunded liability. To be fair, final responsibility for these decisions usually rests with the cities and counties. But CalPERS should have tried to crack down on these practices a long time ago, and indeed, has recently become more aggressive in doing just that. The basic choice facing agencies with huge unfunded liabilities is whether they want to pay them off aggressively, or come up with creative accounting techniques that push the tough repayments into the future. For example, instead of using a “level payment” repayment calculation, many of them use a “percent of payroll” scheme which allows for graduated payments.

In practice, this means calculating a stream of payments that will pay off the liability in 30 years, but varying the payments so that as projected payroll increases, the payment increases. This allows agencies to make low payments in the early years of the amortization term, which frequently means the unfunded liability isn’t even being reduced in the early years of the amortization term. Then when the payments become burdensome, they refinance the new, larger unfunded liability, to get that unfunded payment down again, in a new tranche, again using the same “level percent of payroll method.”

Anyone who lost their home because a “negative amortization” loan conned them into buying something they couldn’t afford would likely call that type of loan a “gimmick.” Similarly, negative amortization payment schedules on unfunded pension liabilities are also gimmicks. To their credit, CalPERS is now recommending 20-year straight line amortization. Which begs the question, why didn’t they do this all along?

GIMMICK #3 – OVERESTIMATING LONG-TERM RATE-OF-RETURN ASSUMPTIONS

CalPERS spokesperson Morgan correctly claims that CalPERS returns have averaged an 8.4% return over the past 30 years. But Morgan conveniently selects the 30 year timeframe to capture all of the pre-1999 run-up in stocks that began in the Reagan years as interest rates were reduced from inflation-fighting highs of 16% (30 year T-bill in the early 1980s) and American consumers began piling on debt. The 20-year return for CalPERS investments through June 30, 2017 is 6.58%. And these last 20 years of returns are far more relevant, because not quite 20 years ago is when CalPERS began to offer pension benefit enhancements that were sold as affordable when they clearly are not.

But if CalPERS is exceeding its projected rates of return over the past 30 years, why is it only 68% funded (ref. CalPERS 2016-17 CAFR, page 4, “Funding”)? At the end of a prolonged bull market, pension systems should be overfunded. Being 68% funded would not be terribly alarming if we were at the end of a prolonged bear market, but we’re in the opposite place. How can CalPERS possibly claim their actuaries are doing a competent job, if the system is this underfunded at this point in the market cycle? For more on this, read “If You Think the Bull Market Rescued Pensions, Think Again.”

It is important to emphasize that even if CalPERS can get a 7.0% return on investment – and there is some chance that they can – why did the agency wait until it was 68% funded to announce the drop in its projected returns from 7.5% to 7.0%? The United States economy is in the terminal phases of a more than 60 year long-term credit cycle, and one might argue there is a stronger case to be made that even 7.0% is highly optimistic. But we like optimism, so never mind that for now. Why wait until 2018 to phase in that half-point drop? The actuaries at CalPERS are well aware how sensitive their payment schedules are to even half-point drops in long-term rate-of-return assumptions. Overstating returns understates true cost. Is this an accounting gimmick? Only if you can prove intent. But read on.

GIMMICK #4 – QUIETLY ALLOWING THE UNFUNDED PAYMENT TO DWARF THE “NORMAL” PAYMENT

Every year, each active worker who gets CalPERS benefits vests another year of service. This means that in the future, during their retirement years, they will have an incrementally greater pension benefit in recognition of one more year of work. To pay for that incrementally greater pension benefit in the future, additional money must be invested today. That amount of money is called the “normal” contribution. But when the “normal” contribution isn’t enough, and it hasn’t been for years, the so-called unfunded liability grows. This unfunded liability represents the amount by which invested pension assets need to increase in order to earn enough to eventually pay for all the future pensions that have been promised.

This “unfunded liability” may seem theoretical when a pension system has hundreds of billions in assets. But it has to get paid down, because when there aren’t enough assets in the pension system earning interest, higher contributions are inevitably required from the participating agencies. If the unfunded liability isn’t reduced via catch-up payments, it will grow even if the normal contributions are adequate to cover newly earned benefits.

This reality is corroborated using CalPERS’ own data, which announces that payments required, as a percent of payroll, are set to increase by 50% (in some cases much more) over the next six years in nearly every agency it serves. And where are these projected increases most pronounced? In the unfunded contribution – that payment to reduce the unfunded liability.

And why does the unfunded liability grow in the first place? Because the normal contribution is too low. Why is the normal contribution too low? Could it be because public employees are only required to assist (via payroll withholding) to pay the normal contribution? Could that be the reason that lifespans were underestimated and returns were overestimated? The actuaries obviously got something wrong, because CalPERS is only around 68% funded. You can download the spreadsheet that shows the impact of this on California’s cities and counties here – CalPERS-Actuarial-Report-Data-Cities-and-Counties.xlsx.

In the original CPC report, along with the term “gimmick,” the term “outrageous” was used. If you don’t think sparing the beneficiaries of these pensions any responsibility to share in the costs to pay down the unfunded liability isn’t outrageous, you aren’t paying attention. For example, by 2024, using CalPERS own data, the City of Millbrae will be paying CalPERS a normal contribution of $1.0 million, and an unfunded, or “catch-up” contribution of $5.8 million – nearly six times as much! Is Millbrae just an isolated example? Not really.

Again, using CalPERS’ own data, in 2017-18, their 426 participating cities will contribute $3.1 billion to CalPERS, an amount equal to 32% of their cumulative payroll. In 2024-25, just six years from now, they are estimated to contribute 5.8 billion, 48% of payroll. And the normal vs unfunded contributions? This year in the cities in the CalPERS system, 13% of payroll constitutes the normal contribution and 19% of payroll constitutes the unfunded contribution – for which current employees and retirees have no responsibility to help pay down. In 2024-25? The normal contribution is estimated to increase to 16% of payroll, and the unfunded contribution, rising to $4.0 billion, is estimated to increase to 33% of payroll.

Put another way, today the unfunded “catch-up” pension contribution for California’s cities, cumulatively, is 140% of the normal contribution. By 2024-25, that “catch-up” contribution is going to be 210% of the normal contribution, more than twice as much! And participating individual employees and retirees have zero obligation to help pay it down, even though that payment is now twice as much as the normal payment.

But it’s not the fault of the individual beneficiaries. The responsibility lies with CalPERS and the politicians they reassured for all these years, using gimmicks.

Let’s review these practices: (1) Letting the agencies decide which type of asset smoothing they’d like to employ, (2) permitting the agencies to make minimal payments on the unfunded liability so the liability would actually increase despite the payments, (3) making overly optimistic actuarial assumptions, (4) not taking action sooner so the unfunded payment wouldn’t end up being more than twice as much as the normal payment.

“Gimmicks”? You decide.

THE CASE OF MILLBRAE

On January 22, the San Mateo Daily Journal published an article entitled “Millbrae officials question, criticize pension cost report.”

The paper’s Austin Walsh reports that Millbrae officials told him that using staffing projections to calculate Millbrae’s future pension burden won’t work because Millbrae has fewer employees than most municipalities. Here’s how Millbrae’s Finance Director DeAnna Hilbrants put it: To limit pension costs, Millbrae contracts for positions in police, fire and public works departments. Quote: “Most notably, Hillbrants pointed to Millbrae joining the Central County Fire Department with Burlingame and Hillsborough and contracting with the San Mateo County Sheriff’s Office for law enforcement.”

What Millbrae officials are saying is that because they contract out much if not most of their personnel costs, their pension contribution is a small percent of their total budget. What they neglect to acknowledge is the fact that the Central County Fire Department and the San Mateo Sheriff’s Office themselves have pension costs, which are passed on to Millbrae to the extent Millbrae uses their services. Millbrae may have made a financially beneficial decision to outsource its public safety requirements. But they did not escape the pension albatross.

CALPERS IS NOT UNIQUE

What has been described here does not just apply to CalPERS. It is the rule, not the exception, for every one of California’s pension systems to engage in the same gimmickry. The consequences for California’s cities, counties, agencies, and system of public education are just beginning to be felt.

How Much More Will Cities and Counties Pay CalPERS?

Calpers headquarters is seen in Sacramento, California, October 21, 2009. REUTERS/Max Whittaker

When speaking about pension burdens on California’s cities and counties, a perennial question is how much are the costs going to increase? In recent years, California’s biggest pension system, CalPERS, has offered “Public Agency Actuarial Valuation Reports” that purport to answer that question. Notwithstanding the fact that CalPERS predictive credibility is questionable – i.e., they’ve gotten it wrong before – these reports are quite useful. Before delving into them, it is reasonable to assert that what is presented here, using CalPERS data, are best case scenarios.

In partnership with researchers at the Reason Foundation, the California Policy Center has compiled the data for every agency client of CalPERS, including 427 cities and 36 counties. In this summary, that data has been distilled to present two sets of numbers – payments to CalPERS for the 2017-2018 fiscal year, and officially estimated payments to CalPERS in the 2024-25 fiscal year. In calculating these results, the only assumption we made (apart from the assumptions made by CalPERS), was for estimated payroll costs in 2024. We used a 3% annual growth rate for payroll expenses, the rate most commonly used in official actuarial analyses on this topic.

So how much more will cities and counties have to pay CalPERS between now and 2024? How much more will pensions cost, six years from now?

On the table below, we provide information for the 20 cities that are going to be hit the hardest by pension cost increases. To view this same information for all cities and counties that participate in the CalPERS system, download the spreadsheet “CalPERS Actuarial Report Data – Cities and Counties.”

CalPERS Actuarial Report Data
The Twenty California Cities With the Highest Pension Burden ($=M)

Payments to CalPERS

If you are a local elected official, or if you are an activist, journalist, or anyone else with a keen interest in pensions, these tables merit close scrutiny. Because they not only show costs estimates today, and seven years from now, but they break these costs into two very distinct areas – the so-called “normal” costs, which are how much employers have to pay into the pension fund for current workers who are vesting one more year of future benefits, and the “catch-up” costs, which are what CalPERS charges employers whose pension plan is underfunded.

Take the first city listed, Millbrae. By 2024, we predict Millbrae will have the highest total pension payments of any city in California that belongs to the CalPERS system.

The table presents are two blocks of data – the set of columns on the left show current costs for pensions, and the set of columns on the right show the predicted cost for pensions. In all cases, the cost in millions is shown, along with the cost in terms of percent of total payroll.

Currently, as can be seen on the table, for every dollar it pays active employees in base wages, Millbrae must contribute 59 cents to CalPERS. This does not include payments to CalPERS that Millbrae collects from its employees via withholding. The same data show that, by 2024, for every dollar Millbrae pays active employees in base wages, they will have to contribute 89 cents to CalPERS. Put another way, while Millbrae may expect its payroll costs to increase by $1.4 million, from $6.3 million today to $7.7 million in six years, their payment to CalPERS will increase by $3.1 million, from $3.7 million today to $6.8 million in 2024.

But here’s the rub. Nearly all of this increase to Millbrae’s pension costs are the “catch-up” payments on the city’s unfunded liability. In just six years Millbrae’s payment on its unfunded liability will increase by 99%, from $2.9 million today to $5.8 million in 2024.

Why?

What are the implications?

It is difficult to overstate how outrageous this is. Here’s a list:

1 – Virtually every pension “reform” over the past decade or so has exempted active public employees from helping to pay down the unfunded liability via withholding. Instead, their increased withholding – in some cases supposedly rising to “fifty percent of pension costs” (the PEPRA reforms) – only apply to the normal contribution.

2 – In order to appease the unions who, quite understandably, lobby for the lowest possible employee contributions to pension funds, the “normal cost” is calculated based on financially optimistic projections. The less time an actuary predicts a retiree will live, and the more an actuary predicts investments will earn, the lower the normal contribution.

3 – In order to cajole local elected officials to agree to pension benefit enhancements, the same overly optimistic, misleading projections were provided, duping decision makers into thinking pension contributions would never become a significant burden on cities and counties, and by extension, taxpayers.

4 – Because cities and counties couldn’t afford to pay down the growing unfunded liabilities attached to their pension plans, tricky accounting gimmicks were employed, where minimal catch-up payments were made in the present in exchange for bigger catch-up payments in the future. The closest financial analogy to what they did would be the “negative amortization” mortgages that were popular prior to the housing crash of 2008.

5 – The consequence of this chicanery is that today, as can be seen, catch-up payments on the unfunded liability are typically two to three times greater than the normal contribution. And it’s getting worse. In 2024, Millbrae, for example, will have a catch-up contribution that is nearly six times as much as their normal contribution.

6 – When a normal contribution isn’t enough, and the plan becomes underfunded, the level of underfunding is compounded every year because there isn’t enough money in the fund earning interest. The longer catch-up payments are deferred, the worse the situation gets.

Yet the normal contribution has always been represented as all that should be required for pension plans to remain fully funded. Just how bad it has gotten can be clearly seen on the table.

Take a look at Pacific Grove, fourth on the list of CalPERS cities with the highest pension burden. Pacific Grove is already paying 40 cents to CalPERS for every dollar it pays to its active employees. But in six years, that amount will go up to 75 cents to CalPERS per dollar of salary to active employees. And take a look at where the increase comes from: Their catch-up payment goes from 1.7 million to $4.4 million in just six years.

Why?

Why isn’t Pacific Grove paying more, now, so that it can avoid more years of having too little money in its pension plan, earning interest to properly fund future pensions? The reason is simple: Telling Pacific Grove to go out and find another $2.7 million, right now, is politically unpalatable. In six years, most of the local elected officials in Pacific Grove will be gone. But where is Pacific Grove going to find this kind of money? Where are any of California’s cities and counties going to find this kind of money?

One final point: These pension plans are underfunded after a bull market in stocks has doubled since it’s last peak in June 2007, and has nearly quadrupled since it’s last low in March 2009. When stocks and real estate have been running up in value for eight years, pension plans should not be underfunded. But they are. CalPERS should be overfunded at a time like this, not underfunded. That bodes ill for the financial status of CalPERS if and when stocks and real estate undergo a downward correction.

CalPERS, and the public employee unions that dominate CalPERS, have done a disservice to taxpayers, public agencies, and ultimately, to the individual participants who are counting on them to know what they’re doing. They were too optimistic, and the consequences are just beginning to be felt.

  *   *   *

Dubious Investments Further Imperil California Pension Plan Already in Crisis

pension-2The California Public Employee Retirement System, known as CalPERS, is in crisis. And it sure looks like things are going to get a whole lot worse before they can get a whole lot better.

The system already has a $153 billion unfunded liability, one of the largest shortfalls of any state, and it only has funds to cover 68 percent of promised benefits into the future. And because CalPERS is already cash negative, paying out $5 billion more in benefits to retirees each year than it takes in, there aren’t many scenarios whereby the system would be able to make good on those promises absent outside intervention (read: taxpayer bailout).

Lawmakers and the fund’s board should be considering reforms to improve the system, but California voters and taxpayers faced another setback recently. Overseers of the pension plan — the nation’s largest — passed a funding plan earlier this year that projects shortfalls over the next decade but assumes rosy investment returns in coming decades to make up the difference. Given the high market valuations today, that assumption seems dubious.

When the CalPERS investment committee reallocated its investments recently, it assumed a 7 percent annualized rate of return. While CalPERS has enjoyed some good years — for example, its 2017 return may exceed 11 percent — that’s not the norm. The fund has averaged a 4.6 percent rate over the past decade, and its 2016 rate was an abysmal 0.6 percent.

CalPERS’ strategy — and to a large extent that of the state in general — seems crafted first and foremost to advance the interest of public sector labor unions. The high compensation for state government workers and the state’s munificent retirement benefits make it difficult for local government officials to find the money necessary to meet their obligations. Rising contribution rates for local governments mean that municipalities and schools have less money to educate children, build roads or provide other essential government functions.

CalPERS’s school district contribution rates to the pension plan are projected to skyrocket in the near future. The rates have risen to 15.5 percent from 11.8 percent in the 2015-2016 fiscal year, and are scheduled to reach 22.7 percent in 2020. School districts have little power to fight the increases, which are mandated at the state level. The only way to reduce pension contributions is to cut staff. Some layoffs may make sense for districts facing declining enrollment, but they can also harm educational outcomes.

Fund managers should be laser-focused on increasing investment returns for its beneficiaries, which would lessen the fund’s burden on taxpayers. But its board is more interested in pursuing a political agenda. For the majority of California taxpayers who hold a portion of their retirement assets in the stock market, CalPERS’ activism means that some of their money will be used to support a political agenda that hurts their investment returns.

CalPERS has played an increasing role in politicizing annual shareholder meetings in recent years. These elections are on the horizon—a majority of U.S. public companies hold the mandated meetings between March and July—and CalPERS is already planning to force votes on proposals on environmental and social issues.

Traditionally, these proxy votes have been about improving corporate governance with one goal in mind: improving shareholders’ returns. But CalPERS and other activist investors have aggressively pushed proposals irrelevant to companies’ missions that could have a harmful impact on shareholder value.

CalPERS has prioritized relatively poor-performing environmental, social and governance (ESG) investments at the expense of other options more likely to optimize beneficiary returns. As a recent study by the American Council for Capital Formation shows, four of CalPERS’ nine worst performing funds were ESG-focused.

CalPERS responded to the criticism by noting that the plan’s private equity portfolio, which includes the funds, has performed well overall. But CalPERS would serve its beneficiaries—and taxpayers—better if it focused on investment returns and not politics.

Making investment decisions based on social issues has real consequences. Last year CalPERS’ board expanded its ban on investing in companies that produce tobacco products, against recommendations by its professional staff. In an analysis of the cost of divestment produced for CalPERS, Wilshire Consulting placed the system’s total foregone investment gains at more than $3.6 billion.

CalPERS is facing a serious, long-term crisis that could cripple school districts and local governments while forcing tax increases to pay for the pension system. Getting the fund out of politics won’t alone fix the system’s fiscal woes. But it would be a good first step.

California pension funds likely to face new pressure to divest from fossil-fuel companies

Calpers headquarters is seen in Sacramento, California, October 21, 2009. REUTERS/Max Whittaker

New York Gov. Andrew Cuomo’s call for his state’s biggest government pension fund to stop new investments in fossil-fuel companies and phase out existing investments is likely to lead to renewed calls for the Golden State’s two massive pension funds – the California Public Employees’ Retirement System and the California State Teachers’ Retirement System – to do the same.

The Common Fund – New York’s pension fund for state and local public sector employees – has $200 billion in holdings. Cuomo, a Democrat who is expected to run for president in 2020, said it was time to craft a “de-carbonization roadmap” for the fund, which “remains heavily invested in the energy economy of the past.”

New York City Comptroller Scott Stinger agreed with Cuomo and called for changes in the investment policies of the city’s five pension funds, with holdings of about $190 billion.

The announcements were hailed on social media as a reflection of the mission statement of the 2015 Paris Accord outlining international efforts to address global warming.

It’s possible Brown could use his State of the State speech later this month to reveal his call for CalPERS and CalSTRS climate-change divestment. The pension giants have already been forced to end investments in coal companies because of a 2015 law signed by the governor, selling off shares worth less than $250 million, a tiny fraction of their overall portfolios.

But selling off stakes in energy companies would be a much more impactful event. Giant firms like ExxonMobil are among the most common holdings of pension funds around the world.

Some unions worry divestment will hurt CalPERS finances

And while the California Democratic Party has been largely unified behind Brown’s and the state Legislature’s efforts dating back to 2006 to have California lead the fight against global warming, such unanimity is unlikely should Brown follow Cuomo’s lead because some public employee unions are worried about divestment damaging the finances of CalPERS and CalSTRS.

As of July, CalPERS had $323 billion in assets and said it was 68 percent funded – meaning it had about $150 billion in unfunded liabilities. As of March, CalSTRS had $202 billion in assets and said it was 64 percent funded, leaving unfunded liabilities of about $100 billion.

CalPERS’ steady increase in rates it charges local agencies to provide pensions and the heavy costs facing school districts because of the Legislature’s 2014 CalSTRS’ bailout have taken a heavy toll on government budgets.

Corona Police Lt. Jim Auck, treasurer of the Corona Police Officers Association, has testified to the CalPERS board on several occasions, imploring members to focus on making money with investments, not making political statements.

According to a July account in the Sacramento Bee, Auck said public safety is hurt when police departments must spend ever-more money on pensions.

“The CalPERS board has a fiduciary responsibility to the membership to deliver the best returns possible,” Auck testified. “Whatever is delivering the return they need, that’s where they need to put our money.”

The International Union of Operating Engineers, which represents 12,000 state maintenance workers, has taken the same position, according to the Bee.

In New York, Gov. Cuomo also is not assured of success. The sole trustee of the Common Fund is State Comptroller Thomas P. DiNapoli. While he agreed to work with Cuomo in establishing a committee to consider possible changes in its investment strategies, his statement pointedly emphasized that there were no present plans to change the fund’s approach to energy stocks.

While DiNapoli cited his support for reducing global warming and the Paris Accord, his statement concluded with a sentence emphasizing his priorities: “I will continue to manage the pension fund in the long-term best interests of our members, retirees and the state’s taxpayers.”

City services slashed to fund pensions, but your taxes are still going up

PensionsIn the coming months and years, California voters can expect to see a variety of tax increases pop up on their local election ballots. They will be called “public safety” taxes to hire more police or firefighters or “parks” or “library” taxes to pay for those popular public services. But don’t be fooled. Any new tax proposal is in reality a “pension tax” designed to help the California Public Employees’ Retirement System make up for shortfalls in its investment strategy.

In fact, liberal interest groups are getting ready to circulate a statewide ballot initiative that will gut Proposition 13 – the 1978 initiative that has limited property tax increases to 1 percent of a property’s sales price. It also limits property tax increases to 2 percent a year. The new initiative would remove those protections from many commercial property owners, thus raising taxes by another $11 billion a year. Money is fungible, so this is partly about paying for pensions, too.

California has an enormous problem with pension costs. Many observers see it as a crisis that threatens the economic health of the state. A recent study from the well-respected Stanford Institute for Economic Policy Research, run by former Democratic Assemblyman Joe Nation, details how pension costs already are “crowding out” public services, especially at the local level. Cities pay so much for retired employees that they are cutting spending on everything else.

“California public pension plans are funded on the basis of policies and assumptions that can delay recognition of their true cost,” according to the report. Yet pension costs still are rising and “are certain to continue their rise over the next one to two decades, even under assumptions that critics regard as optimistic.” So they are cutting “core services, including higher education, social services, public assistance, welfare, recreation and libraries, health, public works, and in some cases, public safety.”

Aside from cutting public services and running up and hiding debt levels, there’s only one other way that localities can come up with the cash to pay for these overly generous pensions, especially as pension costs consume 15 percent or more of their general-fund revenue. They will raise taxes. Meanwhile, the state government has to backfill pension costs as well, which leads to constant pressure for legislators to promote additional state-level tax increases. It’s a “heads they win, tails you lose” situation, as Californians pay more to get less.

Much of the problem goes back to 1999, when the Legislature rammed through a law to provide 50-percent pension increases to the California Highway Patrol. Backers knew that once CHP received these overly generous deals (including retroactivity, which is a pure giveaway that hikes pensions back to each employee’s starting date), pension increases would spread across the state. Indeed, they did. CalPERS said it wouldn’t cost taxpayers a “dime” because of stock-market growth, but then the market crashed.

Under the current defined-benefit system, public employees are promised an irrevocable level of pension benefits based on a formula. For instance, most California “public safety” workers (police, fire, billboard inspectors, prison guards, etc.) receive “3 percent at 50.” If they work 30 years, they get 90 percent of their final three years’ pay (often higher, because of pension-spiking gimmicks) until they die. They can retire with full benefits at age 50. Non-safety workers often receive a pension formula that lets them retire with 81 percent of their final pay beginning at age 57. These are very generous benefits given their typically high final salaries.

CalPERS invests the money in the stock market. It calculates the “unfunded pension liabilities” (i.e., debt) based on a projected rate of return for their investments. Higher expectations enable the pension funds and cities to go along their merry way, not worrying about their ability to pay for all the promises and avoiding pressure to pare back pay levels. CalPERS just lowered its rate of return from 7.5 percent to 7 percent, which is still overly optimistic.

But the lowered assumed rates mean that cities have to pay the pension fund additional fees to cover the difference. This is cutting into their operating budgets. In fact, cities have faced four rate increases in the past five years and are expecting a fifth one. A recent article tells the stories of El Segundo and Arcadia, two Los Angeles County cities that are considering hiking their sales taxes to maintain their current level of service.

El Segundo’s mayor pro tem said that in five years “the payment to CalPERS is expected to be $18 million and 25 percent of general fund revenue as the employer rate for safety employees increases from 50 percent of pay to 80 percent of pay,” reported Calpensions’ Ed Mendel. He noted that cities face a statewide cap on the size of their sales tax, but that Gov. Jerry Brown in October signed a law that allows some localities to bust through that cap.

You can see what’s coming: A push by unions to eliminate the sales-tax cap across the state, and a torrent of sales tax increases to pay for soaring pension costs. The other thing to expect: Continuing efforts to hide the size of the pension debt.

“The nation’s largest pension system is expected to adopt a funding plan … that anticipates shortfalls during the next decade and then banks on exceptional investment returns over the following half century to make up the difference,” wrote Contra Costa Times columnist Dan Borenstein this week. “It’s an absurd strategy designed to placate labor unions, who want more public money available now for raises, and local government officials who are struggling to make annual installment payments on past debt CalPERS has rung up.”

The only other hope beyond debt and taxes is if the California Supreme Court guts the so-called California Rule, which forbids governments from reducing pension benefits even going forward unless they are provided with something of equal or greater value. That “rule” has made it nearly impossible to reduce costs for current employees. But there’s no guarantee the court will roll back the rule in a case it will soon consider –  or that the state and localities will bother to cut back benefit levels even if they are allowed to do so given union political power.

In the meantime, expect not only more of the same of hidden debt and reduced government services – but tax increases at every turn.

Steven Greenhut is a contributing editor for the California Policy Center. He is Western region director for the R Street Institute. Write to him at sgreenhut@rstreet.org.

This article was originally published by the California Policy Center

California cities look at tax hikes to pay rising pension costs

El Segundo and Arcadia were among two dozen cities urging the CalPERS board last month to avoid another employer rate increase, the fifth in the last five years, when adjusting its $344 billion investment portfolio this month.

Last week, the two well-funded cities, both with currently balanced budgets and high service levels, considered sales tax increases. Despite cutting costs, the cities now face deficits from a steep rise in CalPERS rates scheduled for the next seven years.

El Segundo’s mayor pro tem, Drew Boyles, told the California Public Employees Retirement System board last month the city’s required pension contribution this year is $11 million or 16 percent of general fund revenue.

In five years, Boyles said, the payment to CalPERS is expected to be $18 million and 25 percent of general fund revenue as the employer rate for safety employees increases from 50 percent of pay to 80 percent of pay.

“These increases are not sustainable and may result in the reduction or elimination of service to our community,” he said, “such as a hiring freeze, furloughs or even potential layoffs, reduction in parks and recreation services, library services, public safety, deferred maintenance on city infrastructure, and reduction to overall infrastructure.”

Steps already taken to “address the immminent financial crisis,” said Boyles, include a pension trust fund, advance payments of pension debt, no pay raises for some employee groups for the last five years, and deferring $2.3 million per year in facility repairs and maintenance.

The El Segundo city council considered a sales tax proposal last week (see video 1:26) for an unusual reason beyond maintaining the “exceptional level of municipal services” expected by residents and the business community.

A 3/4-cent sales tax or 0.75 percent is all that remains available for El Segundo under state law that caps the Los Angeles County sales tax at 10.25 percent. So, the city wants to get the 3/4 cent sales tax before the county takes it.

“It’s like the earthquake,” Mayor Suzanne Fuentes told the council last week. “It’s not a matter of if, it’s when the county puts the next tax item on the ballot. And it will pass, because every county tax ballot issue gets passed.”

Voters approved a 1/4-cent county sales tax increase in March to help the homeless, Measure H, and a 1/2-cent county sales tax in November last year to fund transportation projects, Measure M.

The original El Segundo proposal would ask city voters in April to approve a 3/4-cent sales tax generating $9 million a year that would not take effect until the county approved a new sales tax. If the county measure is rejected, the city tax would be suspended.

As a better defense against a legal challenge, the council told staff to prepare another option for consideration at its next meeting. The city tax would be triggered when the county places a measure on the ballot or on a date several years after the April vote, whichever comes first.

At the request of Boyles, who pointed to a pension debt of more than $100 million, the staff also was told to prepare a proposal to close a $400,000 budget deficit expected to open next October as a growing budget gap begins.

“I want to start with the mindset now because taxing is not going to get us there,” Boyles said. “There is no way we are going to continue to tax our way out of this hole we are in right now.”

Legislation can lift the state sales tax cap for local governments. Gov. Brown signed legislation (SB 703) in October that allows Alameda and Santa Clara counties and the city of Santa Fe Springs to impose limited sales tax increases outside of the state cap.

arcadia

“In every way we are the envy of everybody in the San Gabriel Valley,” the Arcadia city manager, Dominic Lazzaretto told the CalPERS board last month.

He said Arcadia has sales tax revenue from a thriving regional mall, increased property tax revenue from a luxury housing boom, and revenue streams not available to other cities from the Santa Anita Park thoroughbred racetrack.

“And still, in all, I cannot afford the flight path we are on,” Lazzaretto said, urging the board to avoid another employer rate increase. He said the city’s required CalPERS contribution, $11.6 million this year, is expected to increase to $17 million in five years.

Arcadia already has done “right-sizing,” negotiated “takebacks and pensions reforms,” maintained strong reserves that can cover a funding gap for a short time, and may like other cities ask voters to approve a sales tax increase, Lazzaretto said.

Last week, the Arcadia city council was told (see video 1:06) that a survey done by a consultant hired to explore a sales tax found residents are “extremely satisfied” with city services but “looming fiscal challenges are not well understood.”

The city council decided to shelve a tax proposal and extend the contract of the consultant, the Lew Edwards Group, to conduct a campaign to educate the public about the fiscal challenge and explore possible solutions.

“We should not be promoting one thing over another,” said council member April Verlato. “We should not be promoting that we are looking for a tax increase.”

Council members mentioned a state Fair Political Practices Committion probe into county television ads and social media posts appearing to support Measure H. The Howard Jarvis Taxpayers Association complained that campaign law had been violated.

Council member Roger Chandler reminded the council that Measure H used up some of the remaining sales tax allowed in Los Angeles County under the 10.25 cents state cap.

“Any new tax that is passed by the county will go against the city of Arcadia’s tax,” Chandler said. “We still have something left because our city has never used a sales tax to finance anything.”

More than a half dozen cities in Los Angeles County have approved sales taxes that, with the state’s 7.5-cent share and the county taxes, total 10.25 cents: Compton, La Mirada, Long Beach, Lynwood, Pico Rivera, Santa Monica, and South Gate.

Pension costs for cities are rising mainly because the CalPERS board lowered the investment earnings forecast used to discount future pension obligations from an annual average of 7.5 percent to 7 percent.

More money from employers is needed to fill the funding gap created by the lower investment earnings forecast. Rate increases for cities begin next year and are scheduled to continue until 2024.

The sharp drop in the discount rate last December was irregular, prompted by a 10-year forecast of lower investment earnings and the failure of CalPERS funding to recover from huge investment losses a decade ago.

Now as part of a regular four-year process, the CalPERS board is expected to choose one of four investment allocation options next week. One would leave the earnings forecast at 7 percent, requiring no additional change in employer rates.

Reporter Ed Mendel covered the Capitol in Sacramento for nearly three decades, most recently for the San Diego Union-Tribune. 

This article was originally published by CalPensions.com

California Cities Spiking Taxes to Pay Spiking Pension Costs

Calpers headquarters is seen in Sacramento, California, October 21, 2009. REUTERS/Max Whittaker

California cities are being forced to spike taxes to pay for spiking public employee pension funding costs.

California Public Employees’ Retirement System (CalPERS) has just reported that its $344.4 billion defined benefit pension plan, which covers most state and local government employees, has fallen from a $2.9 billion surplus in 2007 to a $138.6 billion deficit as of June 2016. The rate of funding decline accelerated over the prior year by $27.3 billion.

With the pension plan’s funded ratio — equal to the value of plan assets divided by present pension obligations — having fallen to 68 percent, far below what actuaries call the 80 percent minimum for adequate fund, CalPERS is demanding that cities increase payments.

A recent report warned that CalPERS’ poor investment return of just 4.4 percent over the last decade could be further reduced by large and politically motivated “environment, social and governance” investment strategies. These so-called ESG strategies have drastically underperformed other pension plan returns, which explains why CalPERS is “in the midst of a plan to lower its investment return assumptions to 7% from 7.5% by July 1, 2019.”

CalPERS will pay out $21.4 billion in benefits to retirees and beneficiaries in 2017, a 5.5 percent increase from 2016 and more than double the $10.3 billion in 2007. But most of the 1.93 million retirement system members and 1.4 million health care participants who receive administration services from CalPERS are associated with local governments that are directly responsible for paying spiking benefit costs.

At the September CalPERS meeting in Sacramento, eight cities told the pension plan’s trustees that they are experiencing spiking pension funding costs. Representatives from the largest local governments in the Sacramento area claimed that pension funding costs are set to spike by 14 percent next fiscal year.

The city manager of Vallejo, which recently emerged from bankruptcy, said that the city’s police pension funding costs are expected to jump from about 50 percent to 98 percent of payroll over the next decade. Both Lodi and Oroville officials stated that they have had to cut a third of their staff over the last decade.

El Segundo mayor pro tem Drew Boyles told the CalPERS board last month that his city’s CalPERS required pension contribution will be $11 million next year, or about 16 percent of the general fund’s revenue. But the cost in five years is expected to hit $18 million, or 25 percent of general fund revenue. He blamed the increase on funding for police and fire pension costs that are set to spike from 50 percent to 80 percent of payroll.

The California legislature passed SB 703, which will allow Alameda County and its local cities to raise about $148.9 million by exceeding the 2 percent local sales and use tax rate cap. The City Council of El Segundo plans to spike the local sales tax by an additional 3/4-cent to 10.25 percent to generate $9 million to pay for spiking pension funding costs.

All the local government representatives that have been addressing CalPERS’ monthly meetings complain that even after eliminating of services, slashing infrastructure spending, and planning for layoffs, they will still be forced to raise taxes to fund pension costs.

Despite California already being the highest-taxed state in the nation, the California Tax Foundation warned in June that Sacramento politicians were proposing another $16.9 billion in “targeted taxes and fees.” If passed, much of that tsunami of new cash could end up at CalPERS to fund pension shortfalls.

This article was originally published by Breitbart.com/California