STUMP » Articles » Pension Quicktakes: California Dreamin -- Let's Boost Pensions! (and more) » 28 August 2015, 07:58

It’s All About California today!

MO MONEY! MO MONEY!

UPDATE: an update posted at Union Watch:

Author’s Note: The original title of this post was “CalSTRS CEO Jack Ehnes Recommends 50% Increase to CalSTRS Pension Benefits.” That was inaccurate. What Ehne’s specifically recommended per the quote immediately below this note was “income replacement of 80 percent to 90 percent to maintain a similar lifestyle in retirement,” in reference to his assertion that presently “the median CalSTRS pension replaced less than 60 percent of final salary for the members who retired last year.” To be perfectly accurate, Ehnes’ is recommending a 50% increase in CalSTRS participant retirement income. While he does not specifically recommend increasing their pension benefit by 50%, in order for teachers to achieve a 50% increase in their retirement income, either some other employer paid form of compensation would have to increase – for example, supplemental 401Ks, fed by either greater teacher salaries or greater employer matching, or both, or something else – or teachers would have to live more frugally in order to save more retirement funds on their own without an increase to compensation. Which is it? While this note constitutes a retraction of the original title, and the author apologizes for the misconceptions that resulted, it is still necessary to wonder why pension fund executives are suggesting that 60% income replacement for a public servant is inadequate, when private citizens may consider themselves extraordinarily lucky to secure a retirement income anywhere close to that amount.

Okay, then that accords with what I write below — people need to save more to increase their replacement ratios. I think independent saving is a good idea, should the DB pension run into trouble.

That said, I also call into question 80% replacement ratio as a target. But that’s for a later post.

Original post continues below:

Ed Ring at UnionWatch points out that Calstrs guy says pensions should be higher:

“The median CalSTRS pension replaced less than 60 percent of final salary for the members who retired last year. CalSTRS recommends income replacement of 80 percent to 90 percent to maintain a similar lifestyle in retirement. Public educators do not receive Social Security benefits for their CalSTRS service.”
– Jack Ehnes, Chief Executive Officer, CalSTRS, Introduction to CalSTRS Comprehensive Annual Financial Report 2014, page 11)

Here we go again – a recommendation for another 50% pension benefit increase. Will it be retroactive this time? That went well last time. Remember SB 400, quietly passed for CHP officers during a robust bull market in 1999, and by 2005 rolled out to nearly every state/local agency in California? No consequences whatsoever.

And, here we go again – somehow getting a CalSTRS pension instead of Social Security is a monstrous sacrifice!

And, of course, the obvious response is “Well, hey – let’s get those guys on Social Security!”

When you say that, all of a sudden they admit
1. How little the SocSec benefit is and
2. How likely that benefit will get cut for the relatively-pension-rich Calstrs people.

Ed says the Social Security benefit would generally be about 25% of final salary if teachers retired at age 68. I tried to check that myself, and looking at the research, it’s hard to tell — because everything I can find gives replacement rates for 40-years-average salary. Even “indexed”, that’s going to be distorted upwards re: replacement rates.

But hey, let’s think about how much Social Security costs: 6.2% for employees and 6.2% for employers (up to the wage cap) — 12.4% of payroll for (taking Ed’s word for it) 25% of final salary at age 68.

Let’s see what Calstrs is actually paying for the plan, hmm?

The ARC is 25% of payroll — note that ARC is growing as the percent of payroll paid is actually level. Calstrs is paying about 11% of payroll.

11% of payroll for 60% replacement ratio? (not that they’re going to get it… in the long run)

Hmmm, 2/3 funding ratio. 2/3 of 60% is still 40%, not too shabby. Of course, if they keep at this low contribution rate, the funding ratio will continue to deteriorate.

So the Calstrs people may keep throwing up the “it would be really nice to have an 80% replacement ratio” stuff, but they really should worry about being able to get the 60%.

By the way, you know what private workers do when they want more retirement income than their employers have agreed to provide?

No, not bitch to the press (well, they may, but it doesn’t get them far). They save their own money. I assume California teachers are bright enough to figure out how to open financial accounts for themselves, and if not, perhaps the union could help them with it.

Oh look. The union does have a lot of help for its members. It even has a calculator to help figure out how much extra one needs to save.

HILTZIK GOTTA HILTZIK

So we saw Hiltzik wasn’t too happy with the ballot proposal for being able to cut pensions, but he wasn’t done yet.

Did you know that closing pension plans magically makes pensions more expensive?

As it turns out, the Journal — and the drafters of the initiative — have the math exactly wrong. The experience of states that did exactly that shows that taking these steps sharply increases pension costs to taxpayers while providing employees with markedly poorer retirement benefits.

The evidence comes from a study by the National Institute on Retirement Security, whose board and advisors comprise officials of public pension agencies and leading academic experts on pension economics. The study examined the experience of West Virginia, Michigan and Alaska, each of which responded to rapidly rising unfunded liabilities in their defined benefit public pension funds by closing those plans and placing new employees in defined contribution plans.

The study found that in most cases the unfunded liabilities in the old plans rose sharply, the employees in the new plans failed to build sufficient nest eggs for comfortable retirement and the cost of pensions went up. West Virginia eventually reopened its defined benefit plan to those new employees, and they piled back in. Alaska has considered doing so, but hasn’t passed the required legislation.

Hmmm, now why would unfunded liabilities rise sharply once a pension plan was closed?

The main problem with closing defined benefit plans is that the demographics within the closed plans change quickly. Without new members coming in, the number of active workers making contributions shrinks. The loss of young members making contributions for years before retirement is especially damaging. California’s giant pension fund, CalPERS, made this point in a 2011 white paper; its findings are confirmed by the experiences of the three states.

Now this highlights one of the big problems with public pensions: when they determine the plan costs, they can make them look cheaper by assuming later participants’ contributions can cover the costs of shortfalls that already exist.

This came up in the Detroit bankruptcy, by the way. By assuming that the payroll would continue to increase (as oppose to getting cut), the pension projections had that future contributions to the pensions would increase.

But they didn’t.

If your prior measurement of pension costs assume greater contributions in the future (and thus we don’t need to cover our current costs right now), obviously that cover goes away when that future base is obviously not increasing.

By the way, you can’t get away with this sort of crap in insurance.

YOU CAN CHECK IN ANY TIME YOU LIKE…

This is the 2011 white paper Hiltzik references, and here’s a post by Ed Mendel at Calpensions on the matter:

How to leave CalPERS without paying huge fee

It may surprise cities that did not switch new hires to 401(k)-style plans because of huge CalPERS termination fees, not to mention the authors of a proposed initiative giving voters power over pensions.

But a CalPERS white paper that surfaced last week describes a “soft freeze” of pension plans that switches new hires to a 401(k)-style investment plan without paying a termination fee.

The March 2011 paper seems to contradict the current California Public Employees Retirement System position: When a pension plan is closed to new members, state law requires that the plan be terminated.

Termination triggers a fee large enough, when conservatively invested in bonds, to pay the pensions promised remaining plan members for decades into the future. The big fee is needed because employers and employees no longer pay into a terminated plan.

In the Stockton bankruptcy, Judge Christopher Klein said a termination fee that boosted the Stockton pension debt or “unfunded liability” from $370 million to $1.6 billion was a “poison pill” if the city tried to move to another pension provider.

Here’s the other deal (though not in the NIRS report, I believe): in Calpers/Calstrs, if you want to leave, they switch the valuation rate from the “oh-so-reasonable” 7.something% down to a superlow “risk free” rate.

Unsurprisingly, that boosts the unfunded liability.

If Calpers/Calstrs had to use that low valuation rate all this time, they’d probably not be in the trouble they are in right now.

And it wouldn’t look so questionable that by stopping accruing more liabilities, the liabilities just-so-happen to cost more.

WE’RE LONG TERM INVESTORS

I told you this would be the story.

Take 1 — Calstrs CIO tells CNBC that pension fund has long-term focus:

The California State Teachers’ Retirement System’s Chief Investment Officer Christopher J. Ailman said on CNBC on Monday that the public pension fund is focused on the long-term amid this “choppy seas” marketplace.

“The market is going to be choppy for a couple more weeks but the key is the U.S. economy is still in good shape,” said Ailman.

The second-largest public pension fund, with over $191 billion in total assets, has “been looking at the emerging markets, but we’re worried about a hard landing in China so we’ve been holding off,” Ailman said.

In the fiscal year ending in June, Calstrs reported that volatile markets drove the fund’s return to 4.8 percent, below the actuarially assumed 7.5 percent return. By comparison, the nation’s largest public pension fund, the California Public Employees’ Retirement System, or Calpers, ended the same fiscal year with a 2.4 percent return.

Take 2 — California officials eyeing stock market plunge, hope it won’t last:

Stock market problems could also be felt in California’s pension funds. When investment returns don’t keep pace with goals set by state officials, taxpayers may need to fork over more money to cover the difference.

For example, in June 2014 lawmakers approved a three-decade plan for patching a $74-billion shortfall in the retirement system for teachers and other school employees. But that effort relies on hitting a 7.5% investment return; last year the fund had 4.8%, and it has had an average of 7% over the last 10 years.

I don’t trust these “averages”, but that’s for a later post.

Again, cash is going out right now.

THE MYSTERY OF THE DECREASING FUNDED RATIO

Calstrs is obviously underfunding its pension fund, but let’s look at Calpers.

Calpers supposedly is making 100% ARC:

…and supposedly have done better than the valuation rate for some years, and yet the funded ratio keeps decreasing.

How does that happen?

Seems to me that staying in the plans have obvious increasing costs: percent of payroll keeps increasing, and funded ratio does not improve. There was a change to the valuation assumptions in 2011, but that does not explain enough (and it was only a 25-bp drop..if you can’t swing that….)

Tell me why exiting costs more, again.

And be careful about the rhetoric around the ballot referendum. If more voters see some of this stuff, they may be just fine with California pensions getting cut on current retirees and employees.