A small but affluent Orange County city, with a current staff of only a half dozen employees, would have to pay about $3.6 million to leave CalPERS, the giant state pension system estimated two years ago.

Villa Park officials say the city, population 5,800, is unlikely to leave CalPERS because of the big exit cost. But last week the city council directed staff to prepare a “notice of intent” to terminate the pension plan for consideration at a meeting Sept. 23.

The notice would trigger an updated CalPERS estimate of the “unfunded termination liability” ($3.6 million as of June 30, 2012) needed to pay pensions promised 30 city employees: seven active, 13 retired and ten transferred or separated.

Both Mayor Rick Barnett and Councilwoman Deborah Pauly talked about doing a public service by airing the large cost for terminating the pensions of a small city staff that does not include police and firefighters, services provided through the county.

“I almost feel like just handing this to a reporter and saying, ‘Look at this. This for a city the size of Villa Park, the size of staff of Villa Park. Take this and multiply it for another city and see where we really are.’ I mean, Geez Louise, remarkable,” said Pauly.

Villa Park, with a median household income of $153,000, is not one of the cities hit hard by a pension squeeze. Retirement costs are 15 to 20 percent of the general fund in Los Angeles, San Diego and San Jose, taking money from other services.

The Villa Park general fund budget spends $2.7 million this year and has a $1.3 million reserve. The CalPERS employer rate for Villa Park is 22.7 percent of pay, far below some police and firefighter rates of 50 percent of pay or more.

Pauly said the current Villa Park employer payment to CalPERS is about $110,000 this year, little changed since 2009-10 as employee contributions increased from 1 percent of pay to 6 percent of pay, covering much of the increased cost.

Mayor Barnett, a bankruptcy attorney, said he also has pushed the pension issue with the county authority that provides firefighter services. At the council last week, he gave a 10-minute criticism of pensions (1:42 on video) making these and other points:

  • Pensions are a fiscally irresponsible blank check. Most revenue comes from unpredictable investments, and costs are increasingly unpredictable as technology improves longevity. The private sector is phasing out pensions to avoid debt and risk.
  • Pension systems conceal massive debt to avoid political pressure for change. Investment earnings forecasts (7.5 percent annually for CalPERS) are too optimistic. Debt calculations and installment payments and are manipulated.

Barnett suggested that the termination notice contain “whereas” clauses stating that pensions are an unsustainable and unjustified taxpayer burden, a breach of fiduciary duty to city residents and the result of unconstrained public employee union lobbying.

“I think what’s going to come out of this more than anything is public recognition of this problem, so that it can get some attention,” he said. “It’s a huge problem. It’s bankrupting cities all over the country.”

Later in the council discussion Barnett compared pensions to a “Ponzi scheme,” where money needed to pay earlier investors comes from new investors. Leaving CalPERS would close the Villa Park pension plan to new members.

Gov. Brown made the Ponzi comparison when the California Public Employees Retirement System said employer costs could be increased by his proposed federal-style hybrid plan, combining a small pension with a 401(k)-style individual investment plan.

“When I read the PERS analysis they say if you close the system of defined benefit (pensions) and don’t let any more people in, then the system would become shaky — well, that tells you you’ve got a Ponzi scheme,” Brown told a legislative hearing in December 2011.

Brown disagreed with the CalPERS analysis, saying the pension plan would not need to be closed. But the Legislature rejected the hybrid when most of the other parts of the governor’s 12-point pension reform were approved two years ago.

The notice of intent to terminate being considered by Villa Park would begin a process that, if carried out, gives CalPERS some rare but brief power under current state law.

State court decisions are widely believed to mean that the pension offered on the date of hire can’t be cut unless offset by a new benefit of comparable value. Even retroactive pension increases made after decades on the job can’t be cut.

But if a government employer cannot pay all of the debt owed for a terminated plan, the CalPERS board has the power to evenly cut the pensions of current workers and retirees to an amount covered by what the city was able to pay.

Determining the debt owed for pensions promised current workers and retirees, some of which are obligations likely to continue for more than 50 years, is important for other reasons.

When a plan is terminated, CalPERS becomes responsible for paying the promised pensions. The brief power to cut pensions ends when the termination transfer is completed.

CalPERS cannot go back to the government employer or employees and get more money (the Ponzi angle), if long-term investment and demographic forecasts miss the mark and funding falls short.

There may be a possibility that CalPERS could, if the shortfall is not too large, dip into the pension funds of other employers to continue making the pension payments. But that might invite legal and moral challenges.

So, the debt owed for a terminated CalPERS plan balloons, driven by an earnings forecast based on a low risk-free bond rate, not the higher forecast for the diversified portfolio of an active plan still getting adjustable employer-employee contributions.

The latest CalPERS Villa Park actuarial valuation as of June 30, 2012, uses a 2.98 percent risk-free bond earnings forecast to calculate a hypothetical termination debt of $3.6 million, well below the regular 7.5 percent forecast for investments.

As the valuation explained, the CalPERS board in August 2011 adopted a more conservative policy. The Villa Park hypothetical termination debt for the previous year was $2.3 million based on an earnings forecast of 4.82 percent. (See chart below)

“With this change, CalPERS increased benefit security for members while limiting its funding risk,” said the valuation.

Two other cities, Canyon Lake and Pacific Grove, reportedly wanted to leave CalPERS but did not because of high termination costs. Could cities close plans to new hires and continue CalPERS contributions as usual for employees already in the plan?

There would be little immediate savings for employers. And if under current law or policy there is a way for employers to close their CalPERS plans without terminating, they apparently are not pursuing it.

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Originally posted at Calpensions.