Cities jolted by a new CalPERS rate increase laid out in their annual pension reports this fall are finding few options for cost relief. Basically, they can pay more now to avoid higher costs later or curb the growth of employees and their pay.
As rising pension costs squeeze funding from government services, a big change could come from a state Supreme Court decision. Two unanimous rulings by appellate court panels allow cuts in pensions earned by current employees in the future.
Appeals of the two rulings have yet to be heard by the Supreme Court. How the high court will rule, and what might follow if the groundbreaking appellate rulings are upheld, is far from clear.
The California Public Employees Retirement System, like many public pension plans, has not recovered from huge investment losses a decade ago. Last year CalPERS only had 68 percent of the projected assets needed to pay future pension costs.
The funding level now is several percentage points higher. Investment earnings in the fiscal year ending in June, 11.2 percent, exceeded the 7 percent target. A $6 billion extra payment for state workers is expected to save $11 billion over two decades.
But a lengthy bull market that began in 2009 after a stock market crash may be coming to an end. And CalPERS is forecasting that its investment portfolio, valued at $340 billion last week, will earn a below-target 6.2 percent during the next decade.
The failure to recover from big investment losses, as CalPERS has done in the past, leaves no cushion to absorb large losses. A downturn could drop the funding level below 50 percent, a red line experts think makes a return to 100 percent unlikely.
“Frankly, if it falls below 50 percent it’s a hole that’s almost impossible to get out of,” Brad Pacheco, CalPERS deputy executive, told the Salinas city council on Sept. 26. “So we needed to inject cash into the system, and that’s one of the reasons they lowered the discount rate.”
The CalPERS investment earnings forecast used to offset or discount the cost of future pensions was lowered from 7.5 percent to 7 percent last December. The resulting employer rate increase for local governments begins next year and won’t be fully phased in until 2024.
CalPERS lowered the earnings forecast from 7.75 percent to 7.5 percent in 2012, triggering the first employer rate increase. A second increase from a reform of actuarial method will be fully phased in by 2019, a third increase for longer life spans by 2020.
Pacheco and Randall Dziubek, CalPERS deputy chief actuary, spoke at a Salinas study session on the recent fourth rate increase. A CalPERS review of investments done every four years could result in a decision on another rate increase as soon as December.
A fifth rate increase is considered unlikely at this point. CalPERS has been holding a series of meetings with local government groups this year to explain the rate increases and to get their views about the upcoming decision on investment allocations.
Some cities in CalPERS have been getting an outside opinion. Actuary John Bartel gave an analysis to a Pacific Grove city council pension workshop on Oct. 3 that differed from the CalPERS Salinas presentation in at least one notable way.
Bartel suggested the former CalPERS policy of delaying employer contribution rate increases added to the current funding shortfall. CalPERS had been spreading the recognition of investment losses over 15 years and paying them off with a 30-year “rolling amortization.”
The policy “smoothed” employer rates, avoiding sudden big increases that would strain or shock local government budgets. Rolling amortization is a kind of annual refinancing that pushes debt into the future, and theoretically might never pay it off.
Bartel praised CalPERS for adopting a new policy in 2013 that phases in a rate increase over five years and in 30 years will pay off the debt or “unfunded liability” from below-target investment earnings.
“The old minimum (rate) was not sufficient to pay the unfunded liability,” Bartel told the Pacific Grove council. “The new minimum will be once it kicks in.”
(The CalPERS chief actuary, Scott Terando, told the board last month he is considering a change that would pay off new debt from investment losses in a shorter period, perhaps 20 years. He said some employers want to pay down more quickly, saving money in the long run.)
Other causes of the CalPERS shortfall mentioned by Bartel and the CalPERS Salinas presentation are investment losses, lower earnings forecasts, generous retroactive pension increases around 2000, and a maturing pension system.
As retirees outnumber active workers, more investment funds must be used to pay annual pensions. Replacing losses in the massive investment fund requires larger contribution increases. More of the debt is owed retirees, leaving less time to replace losses.
One way mentioned to cut long-term costs is extra payments to CalPERS, like the $6 billion for state workers, or on a smaller scale a lump sum annual payment rather than monthly payments, like Salinas this year.
Another way to cut or manage pension costs and lower reportable liabilities is setting aside money to make future CalPERS payments. Bartel estimated that more than 100 local governments have set up prefunding trust funds with several private firms.
The CalPERS board voted last year to seek legislation allowing it to create a prefunding pension trust fund for employers. But the proposal stalled when employers would not agree to get union agreement before contributing to the fund.
Bartel said Pacific Grove is facing “crazy high” employer rates, well over 100 percent of pay, because the safety plan has a small number of active workers and a comparatively large number of retirees.
Some said it’s the expected result of merging the city fire department with Monterey a decade ago, which will save money in the long run. A Pacific Grove initiative in 2010 capping payments to CalPERS was overturned by a court as a violation of employee vested rights.
The CalPERS actuary, Dziubek, told the Salinas Council CalPERS is recommending that employers begin talking to unions about having employees hired before a cost-cutting pension reform in 2013 pay half of the pension normal cost.
Employees hired after the reform on Jan. 1, 2013, earn a lower pension formula and are required to pay half of the normal cost of a pension, covering the pension earned during a year but not the unfunded liability from previous years paid only by the employer.
Pension reform legislation was limited to new hires because of the “California rule” now before the state Supreme Court. Under a series of previous court rulings, the pension offered at hire becomes a vested right under contracrt law that can’t be cut unless offset by a new benefit.
More cost-cutting pension legislation seems unlikely. A dozen cities unsuccessfully urged the CalPERS board last month to analyze suspending annual cost-of-living adjustments and giving current workers lower pensions for work done in the future.
The Salinas city manager, Ray Corpuz Jr., said his four-point pension strategy is faster payment of debt, considering a prefunding trust, outsourcing some jobs and services if possible, and urging all employees to pay more of their pension cost.
“But in order to make this sustainable, organized labor, the employers, PERS, the Legislature and the courts have to kind of work together,” Corpuz said. “Otherwise we will have a catastrophic economic future that nobody wants for this state and certainly for this city.”