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The Great State Pension Pinch

After years of promising plush pensions, CalPERS is asking agencies to pay more to assure those promises will be kept
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How do you run a $330 billion pension fund when many of the variables you use to calculate its future are question marks?

This is the central question surrounding CalPERS (California Public Employees’ Retirement System), the nation’s largest pension fund and the retirement plan for hundreds of Truckee/Tahoe firefighters, police officers, and special district employees.

Most of the area’s special districts and local governments are members of CalPERS, with a few exceptions like the Truckee-Donner Recreation and Park District, which has its own separate retirement fund. The Tahoe Truckee Unified School District uses both CalPERs and CalSTRS (California State Teachers’ Retirement System) as pension funds.

More than 1.8 million Californians rely on CalPERS for retirement benefits, and 1.4 million have health benefits through the fund, according to CalPERS. The system is governed by a 13-member board, of which six are elected, three are appointed, and four are “ex officio” members — meaning they are automatically seated on the board by virtue of holding another state office. Last year, CalPERS paid out $20.3 billion in benefits to nearly 650,000 beneficiaries throughout the state, according to CalPERS.

The pension fund’s long-term fiscal health has long been a looming question. Those questions have returned to the spotlight in recent months as CalPERS has downgraded its forecasted income from investments and begun asking special districts, counties, and towns to make up the difference. CalPERS had been assuming it would make an annual 7.5 percent return on its investment. It has now reduced the return estimate to 7 percent, subtracting billions of dollars from the fund’s forecasted growth. Because of the decreased investment income, special districts and local governments have to pay more into their pension plans to make up for the multi-billion-dollar gap.

While many Truckee/Tahoe municipalities and special districts say they are well positioned to handle the increases, they say it will mean a doubling of pension payments for many special districts, and hundreds of thousands of dollars of added expense for individual local special districts like fire departments and public utilities, and millions more at larger organizations.

Placer County is expecting a $36 million increase in annual payments to CalPERS by 2021. Today, the county pays $59.7 million to the fund per year, and that is projected to rise to $96.9 million by 2021, according to Placer County Deputy CEO Kate Sampson. The county’s overall annual budget is $796.5 million.

In another stark example, the City of South Lake Tahoe is expected to see its CalPERS payments rise from $4.8 million this year to $9.8 million in 2021. According to a sharply worded budget and staff report written by South Lake Tahoe’s city manager and finance director, “The increased payments will severely impact the city’s net fund balance and restrict the city council’s discretionary budget. The result will be 23 percent of the city’s general fund revenue sent to CalPERS by 2022 … the inability of CalPERS to accurately estimate benefit costs and obtain a reasonable rate of return on investment for public agencies and their employee beneficiaries is astounding.”

Other Truckee and North Tahoe agencies that Moonshine Ink spoke with for this article said that while the increased payments are significant, they will not threaten service levels or require any serious cutbacks.

“It is significant enough that we are paying close attention to it and seeing if we can pay off portions of it in some way, but not significant enough to affect the district’s services or capital investment,” said Blake Tresan, general manager of the Truckee Sanitary District.

The sanitary district expects its payments to CalPERS to double in the next five years, adding about $400,000 in expenses to its budget.

However, some special districts like the Truckee Fire Protection District reported a pension funding percentage that is more than 10 points above the CalPERS average, and say they have a strong fiscal position for dealing with the increases.

“We have no debt in the organization, we spend carefully and we have a reserve fund,” said Bill Seline, Truckee Fire Protection District chief.

But employees are asking more hard questions: What if these downgraded investment return figures are not enough to fix the fund? What if another recession further reduces investment income to CalPERS and blows up the formulas CalPERS uses to calculate its future? What if investments flounder and an already underfunded state pension system has to make up even more ground?

With ironclad pension promises to hundreds of thousands of state workers, the payments still have to go out. How they will be paid for will be determined by the fickle future of stock market, private equity, and real estate asset performance.

The Pension Problem

The state pension fund has not always struggled for solvency, In fact, according to a review of CalPERS documents tracking the fund’s performance, as recently as the late 1990s pensions were declared to be “superfunded” and a range of higher-value pensions and suspended payments were enacted across the state.

From the CalPERS side, that is perhaps the most accurate criticism of the trail of miscalculations that have put the pension plan in a position where it now has to make up serious ground. In the good times, the pension plan spent those paper gains on plusher pensions and suspended payments. In the bad times, the pension plan has been too slow to react and enact painful new payment calculations that would re-balance the fund.

“CalPERS ‘superfunded’ status only lasted about three years,” the City of South Lake Tahoe staff report said. “CalPERS advisories to employers that benefit enhancements ‘would not cost anything’ was grossly negligent, in fact from a mathematical perspective, it was absurd.”

Today, CalPERS sits at an estimated 68 percent funded (or an estimated 32 percent unfunded). And that is using a lower, but still optimistic, 7 percent investment return calculation. CalPERS is now counting on 62 cents of every pension dollar to be funded by investment returns, according to CalPERS.

Part of this new reality is attributable to the recent Great Recession, which erased nearly a quarter of the market value in state pension funds. And part of it is a sobering new reality that economic growth is slowing and future investment returns are expected to be more modest.

The other half of the problem is that longer expected life spans have thrown off pension calculations. Under the most generous pension plans, CalPERS members could retire at 50 years old with nearly their entire salary paid for the rest of their lives. Pension reforms no longer allow retirees to begin collecting pensions at 50 years old.

Pension Reform Addresses New Reality

Depending on who you ask, the pension problem is either catastrophic or well on its way to being solved.

Former Democratic Assemblyman and Stanford University professor Joe Nation, using conservative estimates of the fund’s investment growth, has calculated that the CalPERS total pension debt is nearly $1 trillion.

But CalPERS argues against that, saying that significant pension reforms are already kicking in, investment returns have never fallen to the levels that Nation uses, and employees and employers are paying more into the system.

“PEPRA [Public Employee Pension Reform Act] already is bending the pension cost curve — and will keep doing so with greater impact every year going forward,” said CalPERS in an open letter posted on its website.

PEPRA is the label for the new pension plans instituted across the state. In an effort to structurally fix CalPERS moving forward, the state and CalPERS members lowered pension payout formulas, increased retirement ages, capped pensions, and added more employee contributions to the pension plan. In essence, the pensions plans are now a more calculated promise to a new generation of workers.

Investment returns, life expectancies, and other factors that have been used to calculate the solvency and funding of CalPERS have all shifted and continue to shift. While there is now a unified effort to fix CalPERS, members worry that the changing demographics and moving-target investment landscape give no assurances that this time CalPERS has calculated correctly.

As a wave of state and local government retirees starts drawing pensions — some of which promised six-figure income for the rest of the employees’ lives — how the stock market, bond market, and private equity markets perform over the next several years is critical to the $330 billion state pension fund.

A Fraction of the Whole

Jeremy Popov, administrative services manager for the Truckee Donner Public Utility District, says it is important to understand that CalPERS is made up of many small pieces.
“I look at CalPERS as a honeycomb system. We are just one small part of a very large system,” Popov said.

While the public utility district’s portion of the pension plan is funded above the state average, it will see increases of 11 percent in contributions this year and an average of 13 percent each year over the next five years.

Other organizations are in similar situations. The Town of Truckee is seeing a 35 percent increase in contributions this year, a total of more than $500,000 the town is required to contribute to CalPERS.

“So far in our five-year model we have not had to have budget cuts in any department, but we have lost the opportunity for value-added projects,” said Kim Szczurek, administrative services director for the Town of Truckee.

While special districts have their own separate financial positions within the larger fund, they have little or no control of payment sizes or investment return calculations. CalPERS has total control of these calculations, as well as over the investment choices of the fund, and simply notifies partner agencies of the new contribution levels, according to multiple conversations with numerous special districts around Truckee/Tahoe.

A Benefit as well as a Burden

Of course, pensions are not just a cost. They are a valuable benefit that aids in recruitment of talented public safety personnel and help Truckee/Tahoe families make ends meet. In some cases, they even ensure a higher level of public safety for residents and visitors, according to local members.

“You can’t just talk about the costs in a vacuum, you have to talk about the benefits,” said Bill Seline, Truckee Fire chief. “I don’t think anyone wants a 60-year old running into burning buildings, taking people down stairs, or cutting fire line in a wildfire.”

A fire department is different than other special districts, but Seline said the pension plan has done what it is supposed to do — kept the fire department staffing at the right mix of experience and new blood in an arena that often requires peak physical conditioning.

“Pensions are valuable in that perspective — to keep that fresh, vibrant workforce,” Seline said.

For the Truckee Donner Public Utility District, pensions make a difference in attracting the right talent to the organization.

“Public water and power tends to pay less than the private side, but what compensates for that is the retirement plan,” said Steven Poncelet, public information and strategic affairs manager for the district. “That is why we have been able to attract and retain employees, which has been a benefit to the district.”

Pensions are one piece of a puzzle of compensation that assures there are firefighters to respond during an emergency, electricity line crews to answer when a winter storm knocks out power, or snowplow drivers to clear roads. In a region battling high housing prices and soaring costs of living, it is these benefits that help communities retain the middle class critical to the culture and identity of a town.

More Risk in Search of More Return

If you step back a few decades and take a long view of the CalPERS fund, you’ll see a distinct trend of increasing risk.

Part of that can be attributed to the current dramatically lower U.S. treasury yields. Today, a 10-year U.S. Treasury yield sits at just above 2 percent. In the early 1960s, when CalPERS was just beginning to diversify the fund, this nearly risk-free investment yielded almost twice as much. By the 1970s, that yield had climbed to as high as 14 percent.

To make up for that declining yield in U.S. bonds, CalPERS has piled into higher risk assets like U.S. stocks, private equity, and real estate. While the risk in the fund is similar to other diversified investment portfolios, it is a higher level of risk than the fund has historically had, which leaves it susceptible to volatility.

“Unless they are willing to take a lot more risk, the economic landscape is such that you can’t expect to make investments in medium-risk investments and expect those same returns,” Szczurek said.

The Future

While special districts and municipalities across the state feel the pain of increased pension payments, they can find comfort in one simple fact — with the increased payments to CalPERS they are finally addressing the looming pension problem.

If things go right, the economy could stay strong, investment returns may come in at, or above, forecasts, and local government may begin paying down the unfunded portion of the pensions they have promised.

Of course, a less rosy picture is also just as plausible. The economy could endure another recession, throwing off the CalPERS investment forecasts and shrinking tax revenue for special districts and municipalities across the state. That double whammy of increasing pension payments and shrinking revenue would hit special districts, cities, and counties much harder, and throw the state’s pension fund into deeper trouble.

During the last economic recession, cities like Stockton declared bankruptcy. A judge’s ruling opened up the possibility that the city’s payments to CalPERS could be reduced in bankruptcy, as they might be for any other troubled creditor.

Despite those concerns, long-term prospects for CalPERS are beginning to brighten as long as the state can weather the short-term pain of paying the most generous pensions that were handed out when the economy was booming. Deep structural reforms to retirement ages, pension contributions, and payout formulas as outlined in PEPRA should put the pension plan on solid footing once the employees that have those re-structured pensions reach retirement age, according to an examination of PEPRA reforms and interviews with local special district managers.

Until that time, the potentially painful question marks surrounding state pensions will have to be resolved one by one.

“It is going to take a highly collaborative process to fix CalPERS,” said Szczurek.

 
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October 11, 2018