PHOENIX – Revised investment return assumptions adopted by the California Public Employees' Retirement System have Gov. Jerry Brown and others concerned that the massive pension fund could be exposing the state and local governments to serious financial risk down the road.
The CalPERS Board of Administration on Nov. 18 adopted a new "funding risk mitigation policy" that would reduce the discount rate - or assumed rate of return on the fund's investments - by a minimum of 0.05 percentage points to a maximum of 0.25 percentage points in years when investment returns outperform the existing discount rate, currently 7.5%, by at least four percentage points.
Brown has been urging CalPERS to quickly address underfunding, and wanted CalPERS lower its investment assumptions more directly.
The nation's largest pension fund, worth nearly $300 billion, was about 77% funded at the close of fiscal 2014.
CalPERS said the new policy was "in large part a response to the maturing of the workforce." For example, CalPERS said in a release, where the ratio of active workers to retirees was over 2-to-1 just a decade ago, the ratio is now 1.6 workers to every retiree, and that downward trend is likely to continue until 20 years from now when the ratio of actives to retirees is expected to be less than one.
"Ensuring the long-term sustainability of the fund is a priority for everyone on this board, and this policy helps do that," said Rob Feckner, president of the CalPERS board. "It makes significant strides in lowering risk and volatility in the system, and helps lessen the impacts of another financial downturn."
Brown quickly released a statement expressing his disapproval of the CalPERS action.
"I am deeply disappointed that the CalPERS board reversed course and adopted an irresponsible plan that will only keep the system dependent on unrealistic investment returns," Brown said. "This approach will expose the fund to an unacceptable level of risk in the coming years."
A state Department of Finance spokesman said Brown is upset that CalPERS' plan would adjust the discount rate much more slowly than the governor wants, with a phased-in approach that experts said could take about 20 years to lower the discount rate a full percentage point.
Feckner responded with his own statement, disagreeing with Brown and further explaining CalPERS' reasoning.
"We respectfully disagree with Governor Jerry Brown's statement that the funding risk mitigation policy adopted this week by the CalPERS Board is 'irresponsible,'" Feckner said. "We took a bold leadership step to reduce risk and volatility in the pension fund to help ensure the long-term sustainability of the system and protect the public employees who serve and have served our great state."
Feckner's response said the CalPERS policy was the result of a more than more than a year of expert analysis.
"It incrementally lowers the discount rate in years of good investment returns, helps pay down the Pension Fund's unfunded liability, and provides greater predictability and less volatility in contribution rates for employers," Feckner said. "It's consistent with the state's goals of helping to pay down debt and we would hope that the Governor would have agreed it is a step in the right direction."
A more aggressive policy would have damaged local governments, Feckner said.
"A more rapid reduction of our discount rate would have caused financial strain on many of California's local municipalities who are still recovering from the financial crisis," he said.
The League of California Cities, in a survey before the policy was adopted, found that 77% of the 115 responding cities support the steps CalPERS is taking to reduce volatility in its investments by lowering the discount rate and gradually raising contribution rates.
"There is strong support at the local level for keeping the CalPERS system fiscally sustainable, and reducing volatility risk in the investment portfolio is a major ingredient in accomplishing that goal," the league's executive director, Chris McKenzie, said in a statement. "These additional costs will likely be the subject of future local labor negotiations."
Jeffrey Snyder, vice president and senior consultant at Cammack Retirement Group in New York, said that lowering the discount rate will clearly have an impact on municipalities.
"Changing the discount rate really impacts the contribution that each entity will have to make to CalPERS," Snyder said. "We know that by raising the contributions you are going to impact municipalities that are already cash-strapped," he said, citing cities such as Stockton and San Bernardino, which have gone bankrupt.
Snyder said that those setting pension policy all over the country face an "iron maiden" in finding the money to fund pension plans while continuing to provide services to taxpayers, and said that his group believes that only a compromise can succeed.
There could be higher taxes, pension obligation bonds, a different plan structure for new employees, or investments in riskier assets that could potentially yield greater returns.
"We don't think that it's going to be one solution," Snyder said. "There's no panacea here."
David Crane, a lecturer in public policy at Stanford University and president of the legislative advocacy group Govern For California, argued that Feckner and union interests behind the CalPERS decision are only using the excuse of hard-pressed municipalities as a pretense to avoid taking action adverse to their own interests but beneficial to California.
Crane was a critic of the state's pension practices and sought changes as an advisor to Gov. Arnold Schwarzenegger's administration.
He said the new CalPERS discount rate adjustment plan is "a Rube Goldberg-ian contraption" designed to distract the public from a problem that is already affecting them.
"It's all about pulling the wool over people's eyes," Crane said.
Cities are already wrestling with pension costs that are a rapidly-growing part of their expenditures but which are extremely hard for them to reform due to the so-called "California Rule," a series of state Supreme Court decisions limiting both the state's and its local governments' options to address pension challenges apart from making higher contributions.
Recent statewide reforms apply only to new employees.
Moody's Investors Service said in a September report that California currently has the highest adjusted net pension liability of any state, with a fiscal year 2013 figure of $189.4 billion. That is about 92.5% of revenues, 17th highest among states and above the 50-state median of 52.8% of revenues, Moody's said.
The rating agency noted that the pension plans were considering actions to reduce volatility in their investments, and acknowledged that it would involve more up-front expenses for the state and local governments.
Crane said California cities are already experiencing a slow degradation of public services as pension costs rise, but that the problem essentially only gets the appropriate amount of attention when a municipality finally declares bankruptcy.
"It's like a frog that's being slowly boiled to death," said Crane, who argued that CalPERS should reduce its discount rate immediately rather than spreading it out over the coming decades.
"It's already hurting," he said.
Former San Jose Mayor Chuck Reed, a Democrat who is a leading proponent for a state ballot measure to require any changes to pension benefits for state and local government workers be pre-approved by voters, warned that California municipalities will find themselves in a very unpleasant spot if the economy takes another dive before CalPERS and other pension plans get some serious reform.
"When the economy turns bad, they're going to have huge unfunded liabilities they can't pay," Reed said. "The state of California isn't going to go bankrupt, but there are thousands of local jurisdictions. And during the next recession, some of those are going to be candidates for bankruptcy," Reed said.
The state's Legislative Analyst's Office, in its annual Fiscal Outlook report released in November, cautioned that the state needs to strengthen its fiscal hand before the next downturn hits.
