March 18, 2011
By Ed Mendel

Actuaries got another rebuff this week when the labor-friendly CalPERS board voted to leave its earnings forecast unchanged, much like a CalSTRS board action in December that did not lower its forecast as far as actuaries recommended.

A lower earnings forecast raises pension costs for state and local governments struggling with budget cuts during a deep recession. But another rate increase also might fuel the drive for pension reforms that increase worker costs and cut their benefits.

“I was afraid we were going to throw gasoline on the fire in the public pension debate,” Neal Johnson of the Service Employees International Union told a CalPERS committee after a key vote.

(A new statewide Field Poll found voter support for pension reforms urged by the Little Hoover Commission: caps, higher worker contributions, later retirement ages, and lower pensions for new hires and the future un-worked years of current workers.

(The poll also found support, among Democrats and Republicans, for replacing the current system with a “hybrid” that combines a lower pension with a 401(k)-style plan now common in the private sector.

(More voters now think public employee pensions are too generous, the poll found, a reversal from two years ago. The leader of a labor coalition, Dave Low, said public employees have been “beat up” in the media and will begin getting their message out.)

In split votes, 10-to-3 at CalPERS and 8-to-3 at CalSTRS, the support for lowering the forecasts mainly came from appointees or members of the administration of former Gov. Arnold Schwarzenegger, who cut pension costs after a lengthy battle.

The exception among the advocates of a lower California Public Employees Retirement System forecast was the representative of state Treasurer Bill Lockyer. “Reasonable minds can differ,” said Steve Cooney, who did not push for support.

Schwarzenegger opposed a CalPERS “smoothing” plan for a three-year phase in of the cost of huge losses in the market crash. He said the state was “using our kids’ money” to gamble that investment earnings will grow faster than pension obligations.

A Pew Center for the States study last year that found a “$1 trillion gap” in state pension funding nationwide said one of the factors is “failing to make annual payments for pensions at the levels recommended by their own actuaries.”

But the earnings forecast discussions and a legislative hearing on the Little Hoover report this month suggest there is a lot of flexibility in pension payment rules, leaving plenty of room for judgment calls and manipulation.

Scharzenegger objected to CalPERS smoothing that, among other things, spread investment gains and losses over 15 years, well beyond the usual three to five years, and briefly doubled the actuarial “corridor” for valuing assets.

This week CalPERS actuaries recommended lowering the earnings forecast from 7.75 to 7.5 percent a year. Experts expect slower growth during the next decade, and CalPERS adopted a more conservative CalPERS asset allocation to reduce risk.

The consensus prediction of the experts, 7.4 percent, only covers the first decade. Actuaries said they used an optimistic assumption of 8.5 percent earnings in the following period.

The resulting average of 7.95 percent was lowered by administration expenses, 0.15 percent, and preserving a cushion for error, 0.30 percent, built into the current rate. That produced the 7.5 percent forecast recommended by the actuaries.

Replying to a question from a board member, Dan Dunmoyer, advocating a lower forecast, the CalPERS chief investment officer, Joe Dear, said CalPERS has never earned a two-decade average as high as 8.5 percent in the past.

The CalPERS chief actuary, Alan Milligan, told the board that leaving the forecast at 7.75 percent would be “reasonable and prudent.” He said all that would be lost is the previous cushion for error.

An embattled CalPERS, which released more details of a bribery-related investment scandal this week, could have issued a news release with this headline after the vote to leave the earnings forecast unchanged:

CalPERS HELPS SHRINK STATE BUDGET GAP

The new budget proposed by Gov. Brown assumed the earnings rate would be dropped to 7.5 percent and on that basis penciled in a $4.1 billion payment to CalPERS, up $400 million from the current year.

About $200 million of the increase was in the general fund, which has a $25 billion deficit, and the rest was in special funds such as transportation. CalPERS is not scheduled to set the new state rate until May or June.

Local governments would have been hardest hit by a lower earnings forecast because personnel costs are a large part of their budgets.

A Huntington Beach official told a CalPERS committee the city’s rates would go up $2 million, adding to an $8 million shortfall. An Orange official said the rate increase would be $2.5 million for that city.

The board of the California State Teachers Retirement System voted in December to cut its earnings forecast from 8 to 7.75 percent, short of the 7.5 percent recommended by its actuaries.

There was no immediate impact on state and local government costs. Unlike CalPERS and most California public pension funds, CalSTRS cannot set employer contribution rates, needing legislation instead.

But teacher unions urged the board to go no lower than 7.75 percent. They said a lower forecast could reduce benefits, apparently referring to annuities, the purchase of service credits to boost pensions and other member impacts listed in a staff report.

While making the case for pension reform, the Little Hoover report said the 10 largest California public pension funds, with 90 percent of all assets and members, had a combined shortfall of $240 billion.

The report said all of the funds were below the 80 percent funded level “considered the low threshold for a stable system.” But one of the three major credit rating agencies, Fitch, said in a pension report last month that a lower level is adequate.

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