STUMP » Articles » California Dreamin' of Ever Closing Their Pension Gap » 21 September 2016, 06:13

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California Dreamin' of Ever Closing Their Pension Gap  


21 September 2016, 06:13

Great news everybody!

Calpers CIO Says Funding Gap to Widen for Foreseeable Future

Pension’s net outflows to grow to $9.2 billion in 15 years
Returns lower than 7.5% projection would widen imbalance

The California Public Employees’ Retirement System, the largest U.S. public pension fund, faces a widening funding gap for the foreseeable future as its returns lag behind obligations to retirees, Chief Investment Officer Ted Eliopoulos said Monday.

“The gap grows over time,” Eliopoulos said during a presentation to the Calpers board. “If we return less than 7.5 percent along this path, it gets wider and sooner.”

Calpers, with $301.5 billion in assets, has reported net outflows for five of the past seven fiscal years, including $1.5 billion in the year ending June 30, according to a presentation by Eliopoulos. The gap, a measure of outlays for benefits compared with revenue from contributions and income, is expected to widen to $9.2 billion by fiscal 2031-2032, the final year in the presentation.

The projections are based on annualized returns of 7.5 percent, a target Eliopoulos said is overly optimistic given the current low-interest-rate, low-return environment.

Calpers’ consultant Wilshire Associates projects annualized returns closer to 6 percent, which would require higher contributions to the fund from a combination of public employees and taxpayers. The system also faces a wave of retiring baby boomers with lengthening life expectancy as the number of employees paying into the system has plateaued or fallen, he said.

Selling Assets

Calpers must sell as much as $2 billion of securities a year to help close the gap, Eliopoulos said, a situation likely to raise the risk of not meeting benefit needs if markets decline. As of June 30, Calpers had 68 percent of the money it needs to pay projected health and
retiree benefits.

“A significant drawdown would particularly be painful especially when the current funded status of the fund is at just below 70 percent,” Eliopoulos said. “It’s very difficult in a down market to sell assets to meet these benefits.

Oh wait. That’s not great news.

You know what it is when a pension fund has to sell off assets to meet benefits, and the liability is only growing?

An asset death spiral.


First, let’s check out other posts where I mention the asset death spiral.

My previous explanation on the asset death spiral:

Let me explain the asset death spiral, which is when balance sheet weakness manifests itself in something really serious: a lack of cash flow to cover promised benefits.

Having to liquidate assets to cover cash flows is not necessarily a bad sign — if one has a decreasing liability (which means decreasing cash flow needs in the future).

This is not the case for Chicago. Nor Illinois.

One has to sell off assets when investment returns and pension contributions are too low to cover current cash flow needs. This reduces the asset amount for the pension funds…and if cash flow needs are increasing, you find that one has to liquidate more and more assets… until the fund is exhausted.

I also have a graph showing an asset death spiral for Kentucky:

There’s even a link to discount rates.

From an archived post I wrote in 2010:

- the discount rates don’t change the real, ultimate costs of the pensions. The cashflows are what they are….when they materialize decades down the line.

- what discount rates can do is shift the costs to a different generation of taxpayers…that’s assuming each year the proper payment as per the valuation is made. Which in many cases, it hasn’t been.

- if the discount rate is too low, then current taxpayers may be paying way too much for current public employee services for their future retirement. The lower the discount rate, the higher the obligation looks. Given the incentives, it is not common nowadays to hear of the discount rate being too low.

- if the discount rate is too high, then the cost of current service retirement benefits are being pushed off to later taxpayers who did not benefit from said service. If the rate is too high, then contributions will generally be too low during the time service is provided, and later one finds “unexpected” larger and larger payments required to meet cashflow needs during retirement. This is one of the elements of a public pensions death spiral.

Finally, how a death spiral can accelerate:

We’ve often heard it crowed that investments cover public pension outflows more than contributions do (this is silly, but I don’t want to get into financial philosophy right now.)

But what happens when the investments have negative returns?

If the free cash flows are too low, you end up having to sell while asset values are down.

What are the cash flows involved?

  • Some assets mature (like bonds or private equity being realized) and turn into cash
  • Bonds and preferred stocks can spit out cash flows before maturity (but interest rates, and thus coupons, have been very low)
  • New cash flows in, in the form of contribution
  • Cash coming from the sale of Pension Obligation Bonds (PTUI!)
  • Pension benefit payments going out

When those cash inflows are too low to cover the cash going out, then assets have to be sold to cover the payments.

When the market was going up, this was not much of a problem.

It is a problem when markets go down.

A lot of time there is an overreaction when stocks are going down. You don’t want to sell during a panic. But sometimes, you have little choice.

Then you sell when things are down, you realize that loss, and you miss the opportunity for recovery. Because the pensions have to keep getting paid. So more assets have to get sold… this is how an asset death spiral begins.

Especially if your funded ratio was very low to begin with. I think many will find that vaunted 80% threshold out of reach and try to adjust that threshold downward.

Yeah, I had to throw in the 80%.


It’s not really a mystery how Calpers got here. Basically, the last time there was a surplus (in accounting) for the pension, some bright young (or old) fellows thought it a dandy idea to retroactively boost pensions.

Calpers wasn’t alone in this, by the way, but because it’s the largest public pension plan in the U.S., we really notice it.


Let’s check out a few stories from the LA Times.

The pension gap — It was a deal that wasn’t supposed to cost taxpayers an extra dime. Now the state’s annual tab is in the billions, and the cost keeps climbing.

ith the stroke of a pen, California Gov. Gray Davis signed legislation that gave prison guards, park rangers, Cal State professors and other state employees the kind of retirement security normally reserved for the wealthy.

More than 200,000 civil servants became eligible to retire at 55 — and in many cases collect more than half their highest salary for life. California Highway Patrol officers could retire at 50 and receive as much as 90% of their peak pay for as long as they lived.

Proponents sold the measure in 1999 with the promise that it would impose no new costs on California taxpayers. The state employees’ pension fund, they said, would grow fast enough to pay the bill in full.

They were off — by billions of dollars — and taxpayers will bear the consequences for decades to come.

Let’s just call it what it was (and is): a lie.

I love it when politicians do this little game of confidently proclaiming lies like “no new costs” and then when the extremely forseeable consequences occur just as honestly proclaim: “How were we to know? We’re idiots!”

It’s more that they think the taxpayers are idiots.

Davis, who was elected in 1998 with more than $5 million in campaign contributions from public employee unions, says that if he had it to do over, he would not support the pension improvements.

“If you’re asking me, with everything I’ve learned in the last 17 years, would I have signed SB 400…. no, I would not have signed it,” Davis, now 73, said in a recent interview at his Century City law office.

Oh bullshit. It would have nothing to do with what he supposedly learned in terms of the financial consequences.

The key knowledge he’d use is that even with doing the unions’ bidding, he’d be recalled in 2003. It’s easy to stand for principle when you know you’re not going to win either way.

One of the few voices of restraint back in 1999 belonged to Ronald Seeling, then CalPERS’ chief actuary.

Asked to study differing scenarios for the financial markets, Seeling told the CalPERS board that if the pension fund’s investments grew at about half the projected rate of 8.25% per year on average, the consequences would be “fairly catastrophic.”

The warning made no discernible impression on the board, dominated by union leaders and their political allies.

At least one actuary told them they were insane.

Not that it did any good.

The joy of being an actuary: we’re always there to say “we told you so.” Not necessarily to prevent the disaster, because we have no pull.

The piece is fairly long, and has plenty of nice, juicy details. Including the “fact” that the pensions could be ratcheted retroactively, but it’s UNCONSTITUTIONAL! to cut back any of that excessive boosting.

The second LAT piece is a simple FAQ: Understanding California’s public pension debt
The gap between money available and promises made is huge and growing.

How much is it?
According to the state controller’s office, the unfunded liability of California’s 130 state and local government pension plans stood at $241.3 billion as of 2014, the most recent year for which figures are available.

In addition to pensions, an analysis of state and local government financial reports representing 90% of public workers uncovered $125 billion in unfunded retiree healthcare costs.

This brings the public retirement debt to at least $366 billion.

Yes, at least.

Because if Calpers had to value the whole pension liability at current interest rates, instead of whatever they say they want to discount at, that debt would be a lot more.

Maybe you can see why they want to discourage towns to leave the plan…as long as everyone agrees the Ponzi will work, and you force new participants to join and old ones to stay in…. well, that asset death spiral should be a lot slower. Right?


Here’s the funding ratio for Calpers:

Yes, that’s an old one, but you can see the funding ratio hasn’t much improved since 2013.

In 2013, the measured funded ratio was 75%. The 2015 number is 76%.

Okay, let’s keep the excitement down.

So you want to know what the 500 basis point difference in discount rates is worth? It’s this option:

There’s something odd about the numbers in the public plans database for the ARC, but my point is that Calpers dictates to the participating towns what they must pay into the pension system.


If a town leaves, Calpers can’t come back and keep asking them for more more more.

They can support a 7.5% discount rate, as long as they have that embedded option of asking for more money to pay for past costs.

For what it’s worth, there is a claim that SB 400 didn’t increase costs much, but note:

A recently updated CalPERS chart shows that SB 400 has not had the big impact on state rates that critics might expect.

In a breakdown of the state contribution changes between 1997 and 2014, SB 400 accounts for about 18 percent of the increase. Other benefit changes caused 5 percent of the change.

Most of the rate change, 46 percent, was due to investment gains and losses and changes in demographic assumptions, actuarial methods and contributions. Employee contributions reduced the state contribution about $478 million this fiscal year.

What if you had to value those SB 400 extra benefits with the actual investment experience & assumption changes baked in?

Sure, you can say it has to do with the investments underperforming the prior 8% target, and now underperforming 7.5%. You can say the extra costs were due to changing the discount rate and mortality assumption.

But what if you valued the SB benefits using the current assumptions? Shouldn’t that be factored into the cost of that change?

Just a thought.

More to come, I’m sure. Interesting how quickly a more-than-funded plan can’t recover to full-fundedness even after stock market highs. That gap isn’t going away for a very long time.

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