Okay, maybe not everybody.
But first, thanks to my referrers:
That NYT article on Calpers and it’s odd way of valuing has gotten everybody talking. And talking even in a negative way is better than being ignored.
I’m broadly classifying the comments as in agreement with the points of view being expressed in the NYT, and others thinking the piece is crap (for whatever reason, but you’ll see there is a common thread.)
I am indebted to Mary Williams Walsh in the New York Times for exposing the situation.
We have seen in so many situations that mass concealment games are often exposed by minor events. And so it was in the US where a tiny fund — the Citrus Pest Control District No. 2, serving just six people in California — decided it wanted to shift from a pension plan to the US equivalent of Australia’s accumulation funds.
It seemed a simple task because the actuaries had stated that the fund had a surplus, so conversion came at no cost. Accordingly, the Citrus fund people went along with the group managing its plan, Calpers, to get a payout figure. The six-member fund then discovered to its horror that it was not in surplus as the actuaries had declared but rather had a shortfall of $500,000.
Here in Australia, the official actuaries reckon the promises we have made to public servants result in a deficit of about $250 billion.
But anyone who looks closely at the real figures knows that the truth is somewhere around a deficit of $500bn to $600bn — and its growing at $6bn a year.
In addition, it is doubtful whether the actuaries have taken into account some of the recent rorts that favour young, newly-acquired dependants.
The market worth of the pensions held by some of the advisers to the government on superannuation is more than $10m — that’s why I call them the $10m club. One day we will face the truth but the $10m club will try and conceal it for as long as possible.
Then Megan McArdle at Bloomberg Review had this to say:
Effectively, Calpers itself is illustrating why, from the taxpayer’s perspective, public pensions should set their discount rates more conservatively. It’s only really safe for penionsers to bet on high returns as long as you assume that taxpayers will bail out the fund if those returns don’t materialize. Accountants would call that an off-balance-sheet asset. The rest of us would call it taxpayers’ wallets.
It’s easier to say who’s losing than who’s winning. The losers are future taxpayers and pensioners. Because the funny thing is that even using aggressive discount rates, public pensions are often badly underfunded. Except that’s not very funny. But it’s certainly remarkable. For example, Calpers, which uses a 7.5 percent discount rate, has a funding level of about 75 percent. It is currently contemplating lowering that discount rate all the way to 6.5 percent, but only over two decades.
It’s hard to believe that 20 years was chosen for mathematical reasons. After all, the wave of boomer retirements, which will be the greatest stressor our national retirement systems have ever seen, should be well over by 2035. Rather, one suspects it was chosen because Calpers doesn’t dare change it faster. Changing it faster would mean big increases in current contributions.
And states are probably not going to pony up the trillions of dollars that Robert Novy-Marx and Joshua D. Rauh have suggested they actually need to make their pensions whole.
Well, exactly. As I had opined, this second number proves pension critics have been right all along. When taxpayer money is on the line, CalPERS is a big spender. Only the finest and highest pension formulas will do for its public workers. They deserve it. Don’t worry. It will all pay for itself, which is what CalPERS argued in the Legislature when it was championing the 1999 pension legislation that started the ensuing pension-spiking spree.
But when its own money from its own investment pool is at stake, the agency suddenly gets very conservative. In 2011, it was using the 3.8-percent rate-of-return number. Lately, according to the Times article, it is using a measly 2.56 percent rate of return. The lower the return, the higher the unfunded pension liabilities, or debt. Using the “official” numbers, CalPERS has a big debt problem. Using the “market” numbers it has a potential catastrophe on its hands.
On Tuesday, Service Employees International Union 1021 members “shut down the San Joaquin County Board of Supervisors evening work session on public safety, demanding higher wages,” according to a Stockton Record article. They’re unhappy with a 6 percent proposed raise over the next three years.
Here’s the rolling-on-the-floor-laughing moment. The lead union negotiator was quoted as follows: “The county has the money to solve this, but instead, they choose to put that money into its pension fund.” Well, yeah, the county has to put in money to prop up the underfunded pensions union workers will receive. It’s still going to their compensation. This county is home to Stockton, which recently emerged from a bankruptcy due in part to the garish pension formulas and “Lamborghini-style” health plan it gave to employees.
There’s a quasi-serious term called the “Viagra Effect.” Public employees are retiring at such early ages that many of them are hooking up with young new spouses. So if Bob the firefighter retires at 50 with a $225,000 a year payday and then marries 32-year-old Mary, the actuaries have to figure out how the taxpayer-backed system is going to pay that amount until Mary joins Bob in that big firehouse in the sky. CalPERS statistics, by the way, show that the best-pensioned employees (cops and firefighters) live the longest — well into their 80s.
They really do think that somebody, somehow, later will pay the money … decades down the line, say… money they’re finding too difficult to scrap together now.
Some unions are wising up that the money that’s going to magically appear later…may not actually appear. That’s why you’re seeing unions in New Jersey suing to have the state throw in the money now that they said they were going to pay.
But two issues keep coming up:
- many unions think “BUT YOU PROMISED” is some kind of magical phrase that means the pensions will be paid in 20-30 years, even though their pension plans are 70% funded now and they can’t make ARC
- the law is such that judges keep ruling that underfunding the pensions is not the same as not paying the pension benefits (though, ultimately, that’s what will happen)
It doesn’t matter what the law says anyway. Judges can rule that governments need to spend money, but it can be really difficult to get governments to pay out.
THE ACTUARIES CHAT
We’re having a nice little discussion at the Actuarial Outpost. I’m going to pull out comments from people who are not me, because I will be putting my own comments at the end of this post. This is not exactly about agreement/disagreement, and not everybody in this thread are pension actuaries (though some obviously are.)
I mark off user names in bold and put their comments below that. These are in the order in which they appear, but I’ve removed any posts by me.
This is when i wished people knew the difference between different types of actuaries. This hurts us all.
You’re absolutely right, but I hope you realize that it is the traditional pension actuarial practice that damages our collective brand name, not the NY Times, nor the Economist, nor P&I, nor Bill Sharpe.
Dr T Non-Fan
If it’s any consolation, a similar story is on the front page of the Sunday LA Times.
Interesting, atleast the actuary there did do one adverse scenario, I mean, it fell on deaf ears, but, there was something.
Why aren’t pension actuaries required to do this all the time??
I think it depends on the context.
Any actuary giving on opinion on reserves is sort of forced into a single number, even if a range is more representative.
It’s a little long for this forum, but here’s my response to the paper on financial economics:
Response to Financial Economic Principles Applied to Public Pension Plans
In reading the Working Paper prepared August 31, 2016, I view with interest the audiences for this effort.
The paper notes that the Principals with interest in public pension plans include “public employees, taxpayers, users of government services, and bondholders.” Absent from this list are those whose livelihood and political authority (power) is substantially affected by the presence or absence of such plans, and whose rewards from the plan are dependent on others who might not be principals. Yet those are the parties with the most influence on the policy positions of the plans.
….. [it’s pretty long, so I’m cutting the rest – also, it’s what the next poster is responding to]
Dr T Non-Fan
Not sure about the rest, but this is the primary issue.
Also, in the case of CA Bill 400, lawmakers themselves were direct beneficiaries of the pension they were voting on.
I’m not sure how innumerate (if a continuous scale exists) one can be not to realize that a [b]tiny increase[/b] in benefit from 2% to 3% of salary [per service year] is a [b]50% increase in the payments[/b], and that is a lot.
It goes on for a while. The whole thread is at 251 comments as I write this. I assume it will continue going (because I will be posting in there).
I had noted Yves Smith’s complaints about the article, but somebody on that Actuarial Outpost thread pointed out that the comments are a lot of fun, and so I’ve dug through some of those:
September 18, 2016 at 8:35 pm
Thanks. I know the Illinois 100 billion dollar liability is based on everyone retring today so I too wondered what they were up to.I also dont think Illinois has counted in the benefit of teir 2 which is terrible in paying off teir one. I think its all aimed ar destroying public service and the Times fell for it.
Ah yes, the old “it only means that if everybody retires tomorrow” lie. I’ve seen that lie/ignorance on display more and more often. What I wrote before:
In no actuarial method that I know of do we assume that everybody is going to retire tomorrow in setting the value of that liability. There is a set of assumptions, one of which is the distribution of ages at which people will retire.
Now, those assumptions can be wrong, but nobody uses the “everybody retires tomorrow” assumption unless something really bizarre is happening.
It’s not quite the same, but it would be equivalent to “everybody dies tomorrow” assumption for an actuary valuing life insurance reserves or “everybody is in a car accident tomorrow” for an actuary setting personal auto reserves. It’s absurd… and would make the funded ratio look much, much worse.
Back to the comments…
September 19, 2016 at 5:41 pm
Dear Susan Webber,
I am the “rube” who didn’t do their homework. According to your post I am also “clueless”. In response I will refrain from making ad hominem attacks and references to animal fecal matter.
First I would like to point at that the MISCELLANEOUS PLAN OF THE CITRUS PEST CONTROL DISTRICT #2 OF RIVERSIDE COUNTY is useless as there is about a two year lag in the information. I’ve included a link to an article on us from May so you can become more acquainted with our situation. Please note that CalPERS estimated that we would owe $90,000 to terminate.
Your blog post also did not address that it took CalPERS 4 months to calculate our termination valuation from the date of our exit, and then added $11,000 worth of interest, calculated at 7.5%, before we even received the bill.
For the sake of clarity, our plan did not have six employees. At the time we had one employee with 5 retirees receiving benefits from CalPERS. If you believe that it was unwise to switch to a 401K benefit plan because of the fees associated, then I would encourage you to contact the City of La Quinta to confirm that they owe CalPERS ~$6 million to stay in CalPERS.
Lastly, I hope you can take time to reflect on how hard people work to put food on the table rather than insult them.
The unnamed person links to this news article:
Leaving CalPERS could cost agency one-third of its budget
Yeah, that’s a large impact. Yves Smith responds in the comments.
September 20, 2016 at 1:10 am
Bottom line is that when an employer leaves, CalPERS has to come up with enough money to stuff in a mattress to guarantee all future liabilities for that employer are covered. No future contributions and no room to risk trying to get 7.5% return.
Who else but the employer should come up with it? Certainly doesn’t make sense to take it out of funds contributed by other employers(taxpayers) to cover their employees. I agree that in this case, CalPERS is handling it correctly.
Indeed. I will repeat this at the end, but everybody is missing the point about the complaints over the exit value. (Not Megan McArdle, who explained the situation well, but most of the other people)
No, we’re not accusing Calpers of fraud. We’re not even saying that Calpers is making supersecret calculations it’s not sharing with participating employers. We’re not saying that the exit value is incorrectly calculated.
We’re saying there’s a huge disparity between the exit value and the valuation if you stay in the plan… and that disparity has no good reason for being that large. We’re saying that the going-concern valuation needs to be a lot closer to the exit value.
The NYT seems determined to do the equivalent of birtherism with public pensions, implying that there is some conspiracy in the way they do their accounting. The paper ran a major business section article today headlined, “a sour surprise for public pensions: two sets of books.”
The “surprise” should hardly be a surprise to anyone familiar with public pension systems. Pensions calculate liabilities based on the expected rates of return for the assets they hold. This calculation tells governments how much they should expect to put into the fund each year on order to meet their obligations to their retirees. If they do their projections correctly (this is not an issue raised in the piece) then this should be the number that governments are most interested in.
However, the piece highlights “the second set of books.” This is market value of pension funds assets and liabilities. This is where the pensions would sit today if they wanted to cash out of the system, which is exactly the situation described in the piece. The market value would make a pension look considerably worse, since they would have to use a lower discount rate (typically the interest rate paid on either Treasury bonds or municipal bonds) to assess the liability of the funds.
The fact that the latter would show a worse situation for pensions is hardly a secret, nor is it particularly hard to determine the larger liability, at least to a close approximation. If anyone has a knowledge of the projected stream of payouts for a pension, it is a simple matter to throw this up on Excel spreadsheet and apply a different discount rate to it.
In other words, this is a great non-scandal, just like President Obama’s real birth certificate.
Did Sid Blumenthal also start the whisper campaign re: pension accounting?
Again, way to miss the point.
MY BROAD TAKES
I’m repeating some of what I wrote above. I’m not going to use any math, so don’t worry.
I don’t have an issue with the exit value. I have an issue with the “going concern” value.
The inherent value of what was promised shouldn’t depend on:
-who did the promising or
-how they plan on fulfilling the promise (the funding patterns, etc.)
The promised amounts are what they’re worth. Calpers is recognizing this with their exit value. But they’re not recognizing it with their “going concern” value.
That said, there’s the embedded option that the promise won’t be fulfilled…that’s what they’re implicitly doing with showing a liability value a lot less than the exit value.
If these valuations were broken into the two parts, I would be just fine with that approach to valuation.
Official Pension Value = Full Value of Promise – Probability-weighted value of promises defaulted on
Show the two parts.
More and more public employee unions are recognizing that the second part of that equation is not zero. For the longest time, they acted like it was zero, but as we see more downward adjustments of pensions for current retirees of various cities and states, others know they need more money in their funds right now.
Another point many people miss is that the plan being detailed in the NYT piece is of people who are all retired. (Or, rather, at the time they were considering the exit decision, there were 5 retired people and one just about to retire)
There are no new employees in the plan.
So why would the employer need to be putting more money in if it were fully-funded? If the employees are all retired, you know what benefit is going to be paid. You know the actuarial present value of the annuity….. if you have the discount rate, mortality, etc. set.
So how many years, how many decades, was Calpers expecting to be making up experience shortfalls? Would the district possibly be making additional contributions even after all the retirees died? (Okay, probably not that last one. I think.)
At the very least, when someone retires, all the uncertainty about base benefit amount is gone. The uncertainty over when the retiree will start getting payments is gone. The liability should be paid up as of that date, right? Shouldn’t you be treating that as an exit?
The actuarial valuation loses credibility when you give extremely different pension valuations depending on whether you can claw back more money from the district 20 years from now. Why not reduce that variability?
As McArdle wrote, Calpers is taking twenty years to try to lower the discount rate to 6.5%… and that’s still contingent on good investment results. If the results are bad, they keep the discount rate at whatever value and not lower it. They don’t want to recognize that the promises are worth more.
Obviously, Calpers will not be changing how it calculates exit values, nor should it. Everybody has been focusing on that part, when it’s really about what the going concern value is.
So my proposal is that Calpers splits out that value into two parts, and do a calculation of probability of default (or, in the way they like, the value of being able to try to claw back more money in the future…. call it the intergenerational inequity value. Which I will explain next week (I hope)).
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