How would you feel if someone told you they’d just increased your retirement benefit by 50%, took five years off the age you’d have to be when you could retire and collect this benefit, and then told you there would be almost no additional cost because the stock market was roaring? In California, that’s what happened in December 1999. “You” were “ALL PUBLIC AGENCIES,” and their countless thousands of public employees, and “someone” was the biggest public employee retirement system in the state, CalPERS. Click here to read the agency’s 12/23/1999 analysis.
Then how would you like it, two years later, after the market had “corrected,” you were told, via a CalPERS board resolution, that an “exception” had been made to generally accepted actuarial accounting standards, and you could choose to value your savings that had been set aside to pay for your retirement benefits at a value 10% greater than the actual market value of those assets at the time? That’s what happened in June 2001. Click here to read that 6/06/2001 letter.
Did CalPERS comply with the law when they did this?
Today, we’re left to wonder whether those actions violated state law. California Government Code Section 7507 requires that an enrolled actuary notify elected officials of the actual costs of any benefit increase.
Here is an excerpt from Section 7507:
The Legislature and local legislative bodies shall secure the services of an enrolled actuary to provide a statement of the actuarial impact upon future annual costs before authorizing increases in public retirement plan benefits. An “enrolled actuary” means an actuary enrolled under subtitle C of Title III of the federal Employee Retirement Income Security Act of 1974 and “future annual costs” shall include, but not be limited to, annual dollar increases or the total dollar increases involved when available.
The California Policy Center recently re-released a policy brief entitled “Did Your Agency Comply with the Law When Increasing Pension Formulas?” That policy brief provides clear instructions to any local elected official or local activist who would like to gather and view for themselves possible evidence of 7507 violations in their city or county.
The stakes are high. Senate Bill 400, enacted in 1999, increased pension benefit formulas by roughly 50 percent for California Highway Patrol officers. Over the next five years or so, nearly every state agency, city, and county in California followed suit, not only for their police and firefighters, but for all public employees regardless of their job description. The ongoing financial impact of this on civic budgets has been severe, and there is no end in sight.
Back in 1999, pension expenses as a percent of total operating budgets in California averaged around 3 percent. Today they average over 11 percent. Depending on how fast agencies are required to pay down the unfunded liabilities on their pension obligations, and depending on how pension investments perform over the next several years, pension expenses as a percent of total operating budgets in California could rise to over 30 percent.
With rare and incremental exceptions, all attempts so far to reform pensions – and so restore financial sustainability and robust services to California’s public agencies – have been thwarted. Reformers continue to challenge these special interests in court, but progress has been slow and expensive, with no rulings of any significance.
Did CalPERS comply with the law when they offered their agency clients the option to greatly increase pension benefits? Did they comply with California Government Code Section 7507?
Using Pacific Grove as an example of CalPERS’ followup, here’s the “Contract Amendment Cost Analysis – Valuation Basis: June 30, 2000,” in which a CalPERS actuary presented to Pacific Grove’s city officials three distinct values for the assets they had invested with CalPERS. The city officials then had the liberty to choose which one to present to the city council. The higher the value they chose for their existing assets, the lower the cost from CalPERS to pay for the benefit enhancements they were contemplating.
Option 1: “No increase in actuarial value of pension fund assets.”
Option 2: “Actuarial value of assets increased by twice the increase in the present value of benefits due to this amendment, limited to 100% of market value of assets.”
Option 3: “Actuarial value of assets increased by twice the increase in the present value of benefits due to the amendment, limited to 110% of market value of assets.”
In plain English, the CalPERS actuary is inviting the elected officials to pick from three differing calculations of how much money they’ve already set aside to cover future retirement payments. The difference between “actuarial value of assets” and “market value of assets” is what creates this wiggle room. While the pension fund investments may have a well-defined market value at any point in time, in order to avoid having to continually adjust how much needs to be contributed into the fund by the employers each year, a “smoothing” calculation is applied that takes into account the market values in previous years.
Obviously, based on the above three choices, how assets get “smoothed” is a subjective exercise. Otherwise there would only be one option. So guess which option was chosen by the City of Pacific Grove? Evaluating the table on page 4 of the 6/30/2000 CalPERS cost analysis provides hints.
Option 1: Employer contribution will be 25.1% of payroll.
Option 2: Employer contribution will be 20.0% of payroll.
Option 3: Employer contribution will be 6.2% of payroll.
Pacific Grove selected option 3. Is that any surprise? When the pension increase was enacted by the City Council they were told by city government officials that the cost would only be $50,500 per year because they had selected among themselves to give the City Council the lowest cost option. The City Council, as required by 7507, was never shown the actuarial report so they would understand there were 3 different costs. Later on John Moore, a retired attorney and Pacific Grove resident found the CalPERS cost estimate and went to the City Council members and asked them if they would have voted for the increase if they would have seen CalPERS’ “option 1” cost of $800,000 per year. All said they would not have voted for that level of increase because they knew the City could not afford it.
Notwithstanding what information from CalPERS may have been withheld by city officials from their city council, did the entire disclosure from CalPERS comply with California Government Code Section 7507? Despite the presence of disclaimers dutifully included by CalPERS, arguably it did not. CalPERS offered Pacific Grove three alternative valuations for their pension fund assets, and then presented three very different payment requirements depending on which option they chose. The diligent reader will investigate these documents in vain for additional evidence that CalPERS offered Pacific Grove – or any of its other participating agencies – a less ambiguous “statement of the actuarial impact upon future annual costs.”
Even the actuary who wrote the analysis for Pacific Grove hedged his bets. In the “Certification” section on page 5, the actuary wrote, “The valuation has been prepared in accordance with generally accepted actuarial practice except that [italics added], under a CalPERS Board resolution, an increased actuarial value of assets may be substituted for the actuarial value of assets that would have been produced by the current and generally accepted actuarial asset smoothing method described in the annual report.”
What CalPERS did was to offer public agencies the option to “smooth” upwards the value of the assets they’d set aside to cover those enhanced retirement benefits they’d awarded during the stock market bubble. They persisted in these tactics to enable agencies that had not yet enhanced their benefits to do so, in order to “compete” with other agencies and retain employees.
Not only were these asset values smoothed, of course. The payments demanded each year by CalPERS were also smoothly increased. Smoothly and inexorably, with no end in sight.
CalPERS notice to All Public Agencies, 12-23-1999 – “New 3% @ 55 and 3% @ 50 Formulas, and Change in Benefits Cap for Safety Members”
CalPERS notice to All Public Agencies, 6/06/2001 – “New CalPERS Board Resolution Concerning Value of Assets Used in Calculation of Cost of Contract Amendments”
CalPERS analysis for City of Pacific Grove – “Contract Amendment Cost Analysis – Valuation Basis: June 30, 2000
CLEO Policy Brief – “Did Your Agency Comply with the Law When Increasing Pension Formulas?”
California Senate Bill 400, enacted 1999
CLEO Policy Brief – “Coping With the Pension Albatross” – provides links to sources for historical and projected escalation of pension costs as a percent of operating budgets