How did we get into this mess? Costs got understated in 2 ways. As this slide shows CalPERS raised its discount rate from 1960 into the 1980s as interest rates went up and it became reasonable to discount future liabilities at a higher rate. But when rates started to fall they did not symmetrically reduce their rate assumptions. Because of this CalPERS only accounts for about 60 percent of what an economist would say is the true pension liability. Source: “Understanding the CalPERS discount rate and the Effect on Employer Contributions” CalPERS slide presentation February 6, 2017 slide 4. A way to think of the CalPERS calculation of liabilities this: The amount of pension liabilities is supposed to be the amount borrowed from employees in the form of reduced pay in return for future benefits. However, a provision in the calculation is that the employer will have to pay interest at 7.50% per year until the benefits come due, on average in about 13 years. There is no allowance for the difference in costs between having to pay this rate and having to pay a market rate. Making allowance for this difference would on average increase every $60 of reported benefits to about $100. Since on average there is a little over $40 in assets against every $60 of reported liabilities, changing the reported liabilities to $100 would roughly triple the reported unfunded deficit.

Secondly, when the stock market did well in the 1990s CalPERS allowed politicians to increase benefits while simultaneously cutting contributions --- in some cases to zero for several years. However, when the fund had a couple of single digit losses in 2001 and 2002 it did not symmetrically increase contribution rates. It used various hokey smoothing techniques so that if a plan lost $15 million the sponsors had to increase their contribution by $60,000 the first year, and not so much more the second even as interest compounded on the loss. The consequence is that out of the 60 cents of benefits that have been recognized (out of 100 cents promised) only about 70 percent, or 42 cents, are paid for with assets in the pension fund. Source: “Addressing California’s Key Liabilities: An LAO Report”, Mac Taylor, Legislative Analyst, May 7, 2014, p. 25.

Here you can see the history of contributions to the CalPERS Schools plan as an example: The funding rate was above 13 percent in 1980. It dropped all the way to zero for 4 years at the turn of the century but only got back above 13 percent this year. The consequence of all that underfunding is that there will be big funding increases in the future. Source: CalPERS Schools Pool Actuarial Valuation June 30, 2015 p.25.

You can see CalPERS is reluctantly moving a little closer to th3 3 You can see CalPERS is reluctantly moving a little closer to th3 3.25-4 percent discount rate that an insurance company would apply or that CalPERS itself would apply if Palo Alto wanted to exit the system, by moving from 7.50 to 7.00 percent over several years. Source: “Understanding the CalPERS discount rate and the Effect on Employer Contributions” CalPERS slide presentation February 6, 2017 slide 7.

Even this small rate reduction means that the schools contribution, which would have to rise by 50% over the next three years will actually have to almost double because of the move from 7.50 to 7.00 percent. Source: “Understanding the CalPERS discount rate and the Effect on Employer Contributions” CalPERS slide presentation February 6, 2017 slide 14.

Contributions for CHP, already about 50% of payroll, are projected to rise significantly even with the CALPERS actuarial method, and would rise much more with more realistic discount rate assumptions.

Contribution Rates Double if 5.50% vs. 7.50% Employer Contributions, CalPERS 2015 Risk Analysis 7.50% vs. 5.50% State Tier 1 26.6 vs. 49.2 State Tier 2 26.1 vs. 47.0 State Industrial 18.4 vs. 39.6 State Safety 18.8 vs. 38.4 State Peace Officers 40.3 vs. 79.1 CHP 48.7 vs. 89.6 This assumes 30 year amortization. With 11-12 year amortization as required by Government Code 20229 rates would be much higher --- for example 115 percent for state peace officers and 125 percent for CHP. You can see what would happen if CalPERS moved rates down to 5.50 percent according to their own calculations --- let alone what would happen at 4 percent or lower, information which they have not released to the best of my knowledge. Source: CalPERS State Actuarial Valuaion 2014-15 pp. 61-66

Palo Alto Pensions, 2015 Valuation Now we come to Palo Alto which is representative of the state. If Palo Alto wanted to write a check to CalPERS or an insurance company to cover the benefits already promised, not those accruing after 2015, the check would have to be for 1.791 billion in liabilities minus 736 million in assets in the fund, for a net amount of 1,055 million. Even if the CalPERS 7.50% rate was used the check would have to be for $338 million. For perspective the total payroll for that year was about $93 million. So over time the taxpayer is on the hook for over 10 years of back wages for benefits already promised but not paid for. Put another way, at a state level the deficit is about a trillion dollars by the market measure, vs. a state budget of $125 billion. So on average each of us in California, we owe about the equivalent of 8 years’ taxes just to pay off these benefits contracted for past work. Source: www.pensiontracker.org.