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Posts Tagged ‘calpers’

If your financial adviser suggested that you invest in an arbitrage arrangement but offered no information concerning the risks, would you?

That is exactly what State Treasurer John Chiang and Governor Brown want us to do with $6 Billion of our money.

The plan to allow Calpers to borrow from the state’s short-term investment pool to pre-pay the state’s contribution to the pension plan is inherently risky. It is a pig-in-a-poke without a thorough independent analysis. Did Chiang earn his degree from the Robert Rizzo School of Management?

According to the Legislative Analyst’s Office: “…the administration is asking the Legislature to approve a large commitment of public resources with insufficient consideration. The administration has provided few of the legal or quantitative analyses that the Legislature should expect when receiving a request of this magnitude and complexity.”

The LAO went on to state: “Instead, the administration plans to conduct this analysis after the Legislature has approved the loan.”

The budget deadline is fast approaching; it all but appears that the proposal is going to be forced through with scant analysis and even less time for the public to voice concerns to their legislators.

The governor is motivated by pure selfish politics, but there is no excuse for someone in Chiang’s position to advocate for its passage. He should know better.

It is possible the deal might not even be legal.  It can be construed as the equivalent of a pension obligation bond, which would be unconstitutional based on a 2003 case.

The administration does not care.  Meeting the June 15th budget deadline is all they care about…that, and papering over an unsustainable pension plan rather than negotiating for structural improvements requiring higher employee contributions.

To make matters worse, the rate the state wants to charge Calpers smacks of a sweetheart deal.  The duration of the loan will likely be eight years, yet a rate approximating short-term US Treasuries may be used (estimated by the LAO to be less than 1%) .  Something approaching the 10-year yield of 2.25% would be a far better match.

But that would make Chiang’s optimism more suspect. He is anticipating a long-term savings of $11 Billion, provided Calpers hits its a targeted return of 7%, overwhelmingly considered way too high by the investment community.

A major market correction would completely destroy his assumptions and make the unfunded liability worse.

You don’t play games when guaranteed benefits are on the line.  Calpers is already doing just that.  It takes an aggressive investment strategy to hit 7%, which translates to higher risk. Chiang and Brown would be raising the ante.

In other words, it is an attempt to bet their way out of the pension time bomb, just as  gambling addicts double their bets in the face of a losing streak.

 

 

 

 

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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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