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Archive for the ‘Pension Crisis’ Category

The town of Loyalton, CA is a short scenic drive north of Truckee and, seemingly, a world away from the financial strain facing Calpers. It is the equivalent of a gnat on an elephant’s back.

Yet, the town’s pension woes provide insight to the overwhelming crisis facing other – and much larger – municipalities whose employees are participants in Calpers.

An article in the Los Angeles Times reads like a case study in the dangers of unsustainable promises.

In summary, the last of the town’s covered employees retired; there are four retirees with a vested full retirement benefit.  Loyalton’s City Council elected to pull out of Calpers when the fourth one retired.

Calpers smacked the town with a $1.7M termination fee,

Why?

Because the long-term liability associated with future pension benefits was grossly underfunded. The article does not say that, but it is the primary underlying reason.  You see, if the town’s plan had been properly funded, there would have been sufficient assets to cover the four until the day they died, plus spousal benefits to the extent they existed.

Loyalton does not have anywhere close to that money lying around, so pensions will be slashed by 60%.

The retirees are screaming foul.  After all, they were promised a sum-certain benefit for life.

To be fair, the employees, council and mayor should have done the math a long time ago. The town itself was not managed well, but you can say that about many municipalities., including Los Angeles (LA does not participate in Calpers.  Nevertheless, it faces the same fundamental problem within its own retirement plans).

What Calpers is doing is financially and technically justifiable, but it demonstrates just how deluded many beneficiaries have become.  The promise of  guaranteed pensions for life is only as good as the assets backing them.

Loyalton could have weathered the crisis had it stayed in Calpers. What that points out, though, is the weakness in the assumptions underlying the entire retirement fund. It depends too heavily on contributions from current employees to cover past service.  It is a Ponzi scheme, in that respect.

But it does not have to be.  A defined benefit plan can work….if contribution levels are sufficient.  I accounted for several small defined benefit plans back in the day when I was just out of college. We used conservative assumptions and were straightforward in our projections to the employers and employees.

Employees throughout the state need to contribute more of their own money to close the funding gap.  It is unfair to charge the taxpayers for the state’s years of over-promising more than it could afford.

The good news is that higher contributions can be spread over many years.  The pain would be no worse than felt by private sector employees who do the math and decide to increase their 401-K payroll deductions.

If employees want a guaranteed benefit, they must pay a premium for the protection. That’s no different than when we choose  lower-yielding investments in return for less risk.

It is also essential to educate the participants in Calpers about what a promise really is.

No sense in trying to teach that to our legislators.  They have been in bed with the public union leaders for way too long.

 

 

 

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In several of my articles, I’ve characterized the City of Los Angeles’ finances as being in a state of virtual bankruptcy.  Pension costs are the key drivers of the city’s unsustainable model. Growing pension costs are plugged by reducing service levels or holding them flat in the face of higher demand.

It appears as if I am not the only one to coin a term for this form of neglect.

An article published by the California Policy Center describes it as “Service Insolvency.

I like mine a little better.  It’ packs more punch.

No problem, though. Service Insolvency gets the point across.

One need not look much further than police staffing to understand what it all means.

The city’s population grew from 3.7M in 2010 to 4.0M in 2017….and the trend will continue.   The 300-thousand increase is the equivalent of a small city.

Violent crime grew 38% over the two-year period ending December 2016, after a period of stability going back to 2010.

Robberies increased 14% since 2015 citywide.

The LAPD ranks have fallen below the 10,000 achieved in 2013.  Its per capita numbers rank way below New York’s and Chicago’s.

Despite the widening gap between higher crime and LAPD’s resources, there has been no serious plan offered to narrow it.

City Controller Ron Galperin’s recommendation to reassign officers from desk jobs to the streets was a good one, and has the potential to free up 450 officers.  But the city requires a force of 12,500 to perform effectively, that’s according to our current police chief, Charlie Beck, and his predecessor, William Bratton. That level requires a bit more than what Galperin’s proposal would cover.

One can argue about the exact size of the force required to maintain an acceptable level of service, but trends clearly support the need for a sizable increase.  Let’s not forget the additional civilian jobs needed to support a larger force and those hired to backfill the desk jobs.

The problem is money; that has always been the case.

To put it in perspective, if you assume the LAPD has a budget of $1B, a 25% staffing increase would add $250M per year.  That’s a very raw number and does not factor in economies of scale. Still, an overall increase of well north of $100M would not be a surprise.

A key factor which limits how much can be budgeted is the city’s share of pension costs. They consume 20% of the general fund budget, up from 5% in 2002. In 2008, the beginning of the great recession, it was 15%. So, despite a robust recovery, the slice has increased in size.

And let’s not get into the unfunded liability, which has also grown significantly since 2003. It is a leading indicator of more financial stress in the years to come. Citywatch’s Jack Humphreville could teach a course on the subject.

It is difficult to increase the level of service while lugging that much baggage.

Former Mayor Antonio Villaraigosa promoted a trash fee hike to pay for an additional 1,000 officers (although it fell far short of that number).  But the public is not going to tolerate a layer of expensive new fees, especially if they disproportionately fall on property owners.

Until City Hall pushes back against the public unions and demands higher employee contribution levels to go towards their incomparable retirement benefits, look for the mayor and City Council to propose fees. Probably not all at once – that would never fly – but over time.  A parcel tax here, a sanitation fee there.

Outsourcing many civilian jobs to the private sector would also help to decrease the benefit load.

Restructuring the labor force and increasing employee contributions are not going to happen given the composition of our current city council and the grip the unions have on its members.

Diminution of vital public safety services will continue until reaction time and effectiveness become intolerable.

And for many, that is probably the case today.

If only they voted.

 

 

 

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In a recent news release, State Treasurer John Chiang said:  “…the Governor and I are partnering on a fiscally prudent plan to buy down our pension debt using what Albert Einstein once called ‘the eighth wonder of the world,’ compound interest. ”

It’s not Albert Einstein he should be crediting, but Bernie Madoff.

The plan calls for shifting $6B from the state’s short-term investment pool, where it earns less than a point, to Calpers, where it could conceivably earn 7% (the most recent 20-year average).  The difference in earnings could generate $11B over the next 20 years for the financially challenged fund.

The math is theoretically correct, but it is a classic example of papering over a problem.

Just as Madoff used cash from recent investors to pay established clients, Chiang is shortchanging the needs of the rest of the state by denying access to these monies for general purposes.

He is also ignoring the risks of shifting funds from a risk-free pool to a highly volatile investment fund.  As I have stated before, the world economy has undergone major structural change over the last few decades.  Increased competition, which has been generally good for consumers, has also heightened investment risk.  Chiang should know that past performance is no indicator of future returns, especially when the past has little resemblance to the present. Whipsawing is a more appropriate description of Calpers performance in more contemporary times.

Rather than coming to grips with the real problem, that is, insufficient employee contributions to cover very generous benefits, Chiang wants to play a shell game. Yes, even assuming the 5.1% rate for the most recent 10 years, more cash would be generated, but any improvement in returns is lost to the general fund.

Chiang should be considering altering the investment strategy of the short-term pool.  A targeted rate of 1.5 points (about one-third more than  the current return) could be accomplished without undue exposure to additional risk. It would be much safer than allowing Calpers to roll the dice and pray we do not have a major economic crisis.

But regardless, he is re-purposing cash and locking it up at a time when the state has other pressing needs.

Once the $6B is transferred to Calpers, it becomes political capital benefiting only one segment of the state’s population – public employees.

But then, they are who Brown and Chiang represent.

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Both the New York Times and LA times have recently published informative articles about the status of public pensions, particularly Calpers. LA Times’ Jack Dolan and James Koren have provided sober analysis in recent weeks.

The reporters have echoed the same concerns I, Jack Humphreville, respected members of academia and many in other publications have been sounding for years – concerns over the diminishing sustainability of the defined benefit plans that almost every politician at the state and local government levels have ignored. A few, including Governor Brown and former Governor Schwarzenegger, have attempted modest reforms and failed, because of the death-grip public unions have on our elected officials.

The NY Times article, by Mary Williams Walsh, is particularly interesting because it reads like a case study. For all intents and purposes, it is one. It deals with a small fund managed by Calpers. Since this particular fund is so small, it is easier for readers to wrap their heads around the math. But it is the same math behind every other defined benefit plan, large and small. Just as a lab experiment on a single cancerous cell can speak volumes about the greater disease, so can this case shed light on the cancer of public pensions.

Basically, the problem boils down to using aggressive favorable assumptions to gauge the financial health of plans, plans which are required to fully guarantee the promises made to their members. The assumptions have masked the weakness of the underlying numbers.

The important difference between a market vs actuarial approach to funding defined benefit plans is critical, as the article suggests. As the small pension unit in the article learned, Calpers charged them the market rate to liquidate the plan, which was a sum far greater than the actuarial value Calpers uses to assess the health of any plan.

Quite a shock to the participants who assumed things were just peachy.

Calpers wants it both ways: use the blue-sky view for public disclosure, but penalize participants based on reality. It’s called “having your cake and eating it too” (a few of my colleagues at Citywatch know how much I detest that expression, but it applies here).

The truth is, Calpers should not be hanging its hat on one approach vs the other. A range of values needs to be shared with the public, and funding should be based on at least a blend of outcomes.

That means either taxpayers fork over more money, or the participating employees contribute more. The taxpayers are already covering too much, not to mention bearing the risk if there are insufficient funds to pay participants.

How much more participants should pay is arguable, but it would cause some degree of pain in any event – manageable pain.

In the private sector, typical employees pay 6.2% for SSA retirement and contribute at least 6% into a 401K. State employees contribute anywhere from 5% to 11.5% of their salaries. Pretty good compared to the 12.2% absorbed by their counterparts. Safety workers are at the higher end, but can retire much earlier and collect up to 90% of their salaries.

A private-sector worker would pay $1 million to purchase an annuity comparable to an average CalPERS’ benefit starting at age 60. A state employee earning an average of $100,000 and contributing 10% would pay in $300,000 over 30 years in gross terms. Obviously, discounting the amount would lower it considerably.

That’s a pretty large gap. In any event, Calpers would still be a good deal for employees if their contribution rates doubled.

And why not?

Investors pay more, in the form of a lower yield, for less exposure to risk. Why shouldn’t public employees pay a premium for what is a risk-free, lifetime benefit?

The system is not going to collapse tomorrow. It’s similar to a sinking ship, which takes on water but stays afloat….that is until buoyancy is lost.

When that happens, it goes down faster than the Edmond Fitzgerald.

Time to start pumping and sealing the leak.

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The Los Angeles Times reported that CALPERS incurred its worst rate of return since 2009.

One year does not make or break the pension fund. Two years of low returns in a row hurt, but alone are not enough to register as a crisis.

What is telling is the average rate over the last 10-20 years has fallen well below the assumed rate of return of 7.5%, which is a major factor in determining the long-term funding of the retirement plan.

The rates reported were as follows:
7.03% over the last 20 years
Less than 6% over 10-15 years (Bloomberg reported 5.1% over the last 10 years).

LACERS has not published its updated rates yet, but almost all would expect a similar set of results. The fund was in negative territory for the year as of March 2016, which will drag down the average rates over the 10-20 year period. LACERS’ 20 year return will probably be treading close to the 7.5% earnings assumption, while those for the 10-15 year range will miss the mark by a significant margin.That range was already well below the assumed rate as of last fiscal year.

What’s so special about the 10-20 year range?

It is what I refer to as the relevant range.

Think of it like comparing baseball players from different eras. Hard to decide who was the greater slugger – Babe Ruth or Hank Aaron – because they played under markedly different conditions and levels of competition.

Comparing investment returns rooted in the years prior to 20-30 years ago is like going through a time warp. The world economy has changed drastically since then due to globalization. As I pointed out in an article several years go, the United States is no longer the lone 800-pound gorilla in the market. As competition has increased, so has investment risk.

Relying on more recent returns as a predictive gauge has even greater risk, since one extraordinary year will skew the results.

Assuming a rate much beyond a very conservative level is playing with fire in an age where markets whipsaw in response to both rational and irrational reasons. Public employee pension managers are under pressure to hit artificially high rate assumptions that they willfully incur more pronounced risks.

Bad timing can kill you. It could also deliver one-off major gains, but who wants to take a Las Vegas approach to investing funds underlying a guaranteed payout?

Public retirement funds are probably not going to collapse. Instead, they will require higher contributions to assure retiree benefits are covered.

The additional cash will have to come from either greater employee contributions and/or the taxpayers. In case you haven’t noticed, the ballots are always filled with tax measures, utility rates are tracking upwards and the costs of government services has steadily increased. We do not need another bill to pay.

In a city like Los Angeles, where the taxpayer contributions have grown from 10% of the general fund to 20% in ten years, the ability to provide basic services will diminish.

It’s what I have repeatedly referred to as virtual bankruptcy, a slow and painful path for the public.

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As I pointed out in Monday’s edition of Citywatch, the City of Los Angeles booked a $7.6 billion adjustment to recognize the unfunded pension liability owed to the beneficiaries of its public pension programs. It is an admission that the residents and stakeholders of the city are on the hook for very generous retirement benefits offered to municipal employees. For the record, the adjustment does not cover exposure to virtually free health benefits.

Anyone who follows the city’s finances expected this. All of our elected officials have been expecting this.

I got around to reading the Comprehensive Annual Financial Report, which was issued on February 5th, on last Saturday, February 27th. I wrote and published my article about the very significant adjustment on February 28th. Citywatch picked it up on the 29th….and still beat the city’s press release by a day! I thought I was slow.

It is common- in the interest of transparency – to disclose material adjustments to an entity’s financial position in sufficient detail to stakeholders, whether they are shareholders, investors or, in the case of a governmental unit, taxpayers and others who pays fees for public services. Such disclosures should be timely, too. Almost a full month after the financial statements were released is not timely.

However, worse than the poor timeliness, was the lack of sufficient detail.

The nature of the disclosure was simply that it was mandatory. The Governmental Accounting Standards Board (GASB) issued pronouncement 68 requiring that unfunded pension liabilities be included in the face of the financial statements, identified as Net Pension Liability. The statements, cover letter and subsequent, but late, press release did not offer any explanation as to why GASB issued the new reporting requirement, that it was necessary to emphasize the impact defined benefit plans had on governments’ long-term resources.

Furthermore, the treatment on the financial statements is still not as transparent as it should. According to a white paper issued by California Committee on Municipal Accounting (a joint committee comprised of representatives of the League of California Cities and the California Society of Certified Public Accountants) the Unfunded Pension Liabilities will become a new liability on the Statement of Net Position, appropriately named “Net Pension Liability.”

I challenge anyone to find a line in the CAFR’s Statement of Financial Position that states “Net Pension Liability.”

Instead, you will find “Non-Current Liabilities due in more than one year.”

Only if you compared that line with last year’s CAFR could you determine the impact on the liabilities. So, the most significant, long-term liability is buried. You must dig much further by diving into the notes to get a sense of what occurred – that is simply what GASB 68 was trying to avoid.

As I mentioned, the press release is short on details.

But it also obfuscates the result by aggregating the impact on a city-wide basis instead of the operating segments.

If you break it out by segments, the Government Activities segment took the brunt of the adjustment, putting its equity in negative territory. This is the segment responsible for core services residents depend on for quality of life. It includes public safety, recreation and transportation, among others.

No where is there a discussion of how the Net Pension Liability is likely to grow. City contributions to retirement plans as a percentage of payroll has been growing steadily (see my previous article). That is a reflection of the increasing burden the retirement plans are having on the budget.

Ron Galperin is the best controller Los Angeles as ever had – by far.

If the city elections were held tomorrow, he would have my vote.

However, this all demonstrates how strong the influence politics has on the Office of Controller. No one wants to risk raising awareness over this controversial and costly problem, because doing so could create tensions with the powerful public unions many of our elected officials depend on for their re-election campaigns.

Galperin may not be a beneficiary of such support, but he must work with city officials who are.

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Did you see it?

Can’t blame you if you missed it. It is sad when only numbers geeks take notice – nothing wrong with being a numbers geek, though, because they are a rare breed in City Hall.

As reported in the Comprehensive Annual Financial Report (CAFR)for FY June 30, 2015, issued by the City Controller on February 5, 2016, the equity of the City of Los Angeles took a hit to the tune of $7.6 billion, perhaps the most significant single adjustment ever recorded in its history. Most of the adjustment ($6.7B) fell on the Government Activities segment of the balance sheet. That segment went from positive territory of $5.1B to a negative ($.5B).

The adjustment was required under Statement 68 issued by the the Government Accounting Standards Board (GASB). 68 required government entities to recognize unfunded pension liabilities in the body of the financial statements instead of buried in the footnotes.

There was no discussion as to the background and reasoning behind it, nor the ramification – moving the liability from the hypothetical realm to the real world.

It would have been worse had the earnings rate assumption for pension assets been more realistic – say somewhere around 6.5% instead of 7.5%.

As revolutionary as Statement 68 was by requiring recognition of the net pension liability, it failed to rein in the discretion cities have in setting the earnings rate. Only the worst of the worst government pension plans would be subject to the application of a low risk-free rate. Please read my earlier article on the subject.

City Hall likes to suppress controversial news. Encouraging open debate over a delicate political issue, such as public pensions, creates tension.

To be fair, though, most people would not understand the nature of an unfunded liability, but it’s not complicated when you think about it. The liability is not much different than a negative amortization loan – and more than a few people wrestled with one during the mortgage meltdown.

Your loan balance grows faster than the value of the house because the variable interest rate runs higher than the one used to calculate the monthly payment. The balance grows to the point where refinancing is impossible and selling the home requires a short sale.

We are seeing a version of that scenario playing out in the city’s finances. Employer contributions as a percentage of payroll has steadily grown from 19.9% in 2006 to 36.5% in 2015 for Police and Fire, and 14.2% to 20.8% for civilian employees (LACERS) – Source: 2015 CAFR.

Controller Ron Galperin has done an unprecedented job of educating the public about the city’s finances. I particularly like his Community Financial Report, sort of a CAFR-light for the vast majority of the population with no times to review the 400 pages of the mother document.

The CFR covers the $7.6B as a one-liner on page 6.

Ron, whose public outreach should be a model for other officials to follow, needs to take this issue on the road and encourage an open discussion as to what it means to the city’s long-term capability of delivering cost-effective services.

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