What About Pensions


It is easy to sit down and write about the problems in the public employee pension plans. Hey, there are problems. The numbers are large.

Question 1 – How do you find out about public pension issues?

Answer 1 – You read the paper.

Reporter Johnny Schmuck takes a day to accumulate numbers, quotes, and formulates his opinion. He then writes a story. You read it. You see big deficits. You get mad. Reporter Johnny has a new follower for his agenda.

You never ask, is Reporter Johnny right? Does he know anything about what he is writing? What is his agenda – Yes, he likely has an agenda.

Let me tell you my agenda. Make local government fiscally responsible!

California is a country unto itself. It has an economy that puts it into the top ten in the world – give or take.

California politicians spend more money than they have to spend. This creates structural problems in the budget process. Good years mean more spending and bad years mean more borrowing to keep up the spending trend. Nobody can fix the State Legislature until local governments take the lead.

Here is my Part I solution – Multiple-year budgeting

Local governments must create a three year budget plan. Many numbers are known such as employee salaries. Some numbers are pure guesstimates.

Establish a policy for staff that simply says, “Any proposed change in spending requires a statement from the Finance Director that indicates the impact on the current and future budget years.”

Obviously only one year is binding, the other years are informational.

This is a simple first step.


Via Rough & Tumble

Harrison Sheppard of the LA Daily News reported on December 17

Fiscal storm on horizon - Government officials soon must start acknowledging unfunded benefits

SACRAMENTO - Already grappling with spiraling annual health costs, some of the largest agencies across California are facing a new squeeze as they’re forced to begin fully accounting next year for retiree health-care liabilities.

And for the first time, many will have to acknowledge they have accumulated hundreds of billions of dollars in looming costs with no comprehensive way to pay for it other than by cutting strained budgets.

There it is. You read it in the MSM. “No comprehensive way to pay for it other than by cutting strained budgets.” Add the CalPERS pension deficits and the taxpayer had better start putting their cash under the mattress.

Annual health costs for state and local government retirees are expected to total at least $4.5 billion this year and could soar to almost $31.5 billion by 2019, according to a recent study by government consultant Steve Frates on behalf of the California Healthcare Foundation.

[snip]

At the local level, long-term liability of the Los Angeles Unified School District alone has been estimated at $10 billion, while Los Angeles County government’s liability is estimated at $9 billion.

I wonder, how will the unions sell benefit cuts to their members. Ah, what members? To make these liabilities palatable, many local governments will simply be required to cut staff and thus reduce union membership. Obviously, this is the least desirable action because services will have to be provided with fewer employees.

In a few years we will see government paying for current workers and two retirees. This is the only logical conclusion – See Cal AG Approves Extension of Pension Liability Period


For your reading pleasure, a GASB Press Release

GASB Proposal Would Enhance Disclosure Requirements for Governmental Pension Plans

Norwalk, CT, December 15, 2006—The GASB today issued a proposal that would bring current pension disclosure requirements for governments and governmental pension plans into line with those recently issued for other post-employment benefits, or OPEB. The changes, outlined in an Exposure Draft of a proposed Statement on pension disclosures, would enhance accountability and improve the decision usefulness of financial information provided to citizens, elected representatives, investors, and other financial statement users about pensions in a number of areas.

Specifically, today’s proposed Statement would amend GASB Statements No. 25, Financial Reporting for Defined Benefit Pension Plans and Note Disclosures for Defined Contribution Plans, and No. 27, Accounting for Pensions by State and Local Governmental Employers, by requiring:

1. Disclosure of the current funded status of the plan as of the most recent actuarial valuation date in the notes to the financial statements of pension plans and certain employer governments to be presented in addition to funded status data currently presented as required supplementary information (RSI)

2. Disclosure by governments that use the aggregate actuarial cost method of the funded status and present a multiyear schedule of funding progress using the entry age actuarial cost method as a surrogate; these governments currently do not provide this information

3. Additional note disclosures about actuarial methods and assumptions used in the valuations underlying information reported about the annual required contribution and funded status of the pension plan

4. Disclosure by governments participating in cost-sharing pension plans of how the contractually required contribution rate is determined

5. Presentation by governments in cost-sharing plans of the required schedule of funding progress if the plan does not issue a GAAP-compliant report that includes RSI or if the plan is not included in a publicly available financial report of another entity.

“Today’s proposal reflects our commitment to ensuring that users of governmental financial statements have access to the highest-quality information available to make their decisions,” said Robert Attmore, GASB chairman. “The Exposure Draft would accomplish this by making the improved disclosures introduced in the OPEB standards applicable to all retirement benefits.”

Chairman Attmore also noted that the GASB is concurrently conducting a broader research project to determine whether existing accounting standards for government pensions have been effective. Based upon constituent feedback received and analysis conducted during that research, the Board will determine at a future date whether further changes to the current pension standards are necessary.

The requirements of today’s proposed Statement would be effective for periods beginning after June 15, 2007, with early implementation encouraged.


California Attorney General Bill Lockyer and Treasurer-elect issued Opinion 06-808 on December 1, 2006.

This opinion provides the public with important information about the public employee pension plan.

On page 4 we find some important definitions

In analyzing the question presented, we first must consider the definitions of the relevant terms used therein. With respect to the phrase “extend the payment schedule,” we note that a pension plan develops “surplus” or is “ahead of schedule” when plan assets exceed a scheduled desirable level known as the “accrued liability.”

“Surplus” is also likened to being “super funded”. Many California government entities were “super funded” during the great “phony tech-market”. Governments were so “super funded” that they decided not to continue making all of their contributions to their plan. Those funds ended up being used elsewhere in the local government budget. Now that the money is needed to fund current pension demands, services will likely be impacted.

The plan has an “unfunded liability” or is “behind schedule” when plan assets fall below the scheduled desirable level of assets.

We have heard a lot about this concept. With government financial statements revealing to the public the escalation of pension liabilities and costs, “unfunded liability” is becoming an important taxpayer buzzword. The real question is, are these pension rate increases sustainable, realistic, or necessary?

People understand the importance of keeping their credit card balance down but they are finding that the government is not concerned about this “credit card” called unfunded liabilities.

How is a “surplus” or “unfunded liability” created?

Plans develop surplus or unfunded liability when the actual experience of the plan (such as investment return, salary growth, terminations, disabilities, deaths, and retirements) differ from the experience anticipated by actuarial assumptions. Plans can also develop an unfunded liability or surplus because of changes in anticipated future benefits payable under the plan, such as a legislative change in plan benefits.

The Attorney General correctly notes that plan balance are in continuous flux

Pension plans are almost always “off schedule” because the assumptions are long term averages, not year by year predictors; consequently, the employer’s contribution must be raised or lowered to get assets back to the scheduled desirable level. The period of time that contributions are to be raised or lowered to get the plan back on schedule is called the amortization period. This time period is a matter of policy and can be lengthened or shortened. To “extend the payment schedule” is to lengthen the period for which increased or decreased contributions will be needed to get the plan back on schedule.

A simple dismissal of Billions of Dollars - how nice by the Treasurer-elect. I wonder, is this opinion a conflict of interest as it will make his next job easier?

In California, the pension benefit formula is very simple

…the member’s retirement age, the member’s total years of service at retirement, and the member’s final compensation rate.

On page 5 of the opinion we find a nugget of information. There is a hidden cost in raising pension rates and it is called “retroactive benefits”.

While not an actuarial or legal term, “retroactive benefits” is used here to refer to benefit increases that are authorized by the Legislature to be applied not only to employees’ service rendered after the effective date of the authorizing legislation, but also to the years of past service that employees have already rendered prior to the effective date of the legislation - hence applying “retroactively.”

CalPERS has the following policy to “smooth results”

Most public plans choose a fixed period of time to raise or lower employer contributions to “get back on schedule.” We are informed that CalPERS uses a time period of 20 years to accomplish this purpose for benefit improvements. This is also the most common length of time for all public plans to use.

[A perspective of smooting from Fly At Night - California’s economy is outpacing everyone’s expectations]
Dan Walters — Bee Columnist reports ‘Smoothing’ masks true cost of expanding public pensions

Davis and the Legislature, then as now beholden to public worker unions, ramped up pension benefits - especially those for police and fire “safety” workers - dramatically. The key measure was passed in 1999 by overwhelming votes in both legislative houses as CalPERS, according to a Senate bill analysis, gave assurances “that they will be able to mitigate this cost through continued returns of the CalPERS funds (and) anticipate that the state’s contribution to CalPERS will remain below the 1998-99 fiscal year for at least the next decade.”

Wrong. Within a couple of years, the state was being hit for several billion more dollars to prop up the retirement trust fund, which took sharp hits as the stock market plunged and payouts increased due to the new benefits.

What’s worse, the same CalPERS assurances lured city and county officials into emulating the state’s expanded benefits in negotiations with their own unions, and untold thousands of local workers immediately took advantage of the windfall - pensions of up to 90 percent of pay for some. Soon, however, CalPERS was sending big bills to local governments.

We’ll never know, of course, whether CalPERS actuaries really believed that the expanded benefits could be covered without cost to the taxpayers, or whether their bosses on the board skewed the numbers to provide political cover. Financially, it doesn’t matter; California taxpayers are stuck with billions of dollars in costs, and the state and many local governments are floating bonds to pay for them.

Back to the opinion…

To determine the length of time that employees will work is speculative.

The average period of time, statistically, that all current active workers will remain in employment before terminating, becoming disabled, dying, or retiring, is the “average remaining work period of the employees eligible to receive benefits.” This number will vary depending upon such factors as the current age and composition of the workforce, the nature of the work, and the terms and benefits of the relevant retirement plan.

The opinion correctly puts the impact of a change in benefit rate into perspective

For example, a city may grant improved benefits retroactively to its existing employees as an element of enhanced compensation. A retroactive improvement in retirement benefits not only requires an increase in the city’s future retirement contributions, but also creates a ‘past service liability,’ or debt to the retirement fund, which must be paid.

There is little doubt that pension activists focus on this one component more than any other. The reason is simple, when you change a rate from 2% to 2.7% the average person can easily understand the implications. However, there is more to this story.

“Another reason why actual experience may not match actuarial assumptions is that assumptions are imperfect. This may occur for any number of reasons including fluctuations in market performance, unexpected rates of employee turnover, and unforeseen increases in salary or in purchases of service credits. When the retirement fund experiences such ‘net accumulated actuarial gains and losses,’ contributions must be adjusted to compensate for the difference.

Yes, those speculative investments can come back to create a problem - remember the Tech Bubble?

The conclusion

We conclude that the Board of CalPERS may extend the payment schedule for retroactive benefits beyond the average remaining work period of the employees eligible to receive the benefits without violating the Board’s constitutional duties to provide secure benefits to its members, minimize costs to employers, assure the competency of the assets of the retirement system, and protect the employees’ contractual rights to an actuarially sound retirement system.

Unfortunately the decision is correct. I must wonder, however, if this decision may result in financial statements that are not correct. The unfunded liability is reported on the balance sheet. The expense related to the accumulation of benefits is reported on the income statement.

According to the Attorney General opinion, the government entity can fund the liability beyond the period of employment. This creates a situation whereby the government entity is using dollars that could be attributed to existing employees and services to pay for employees who are no longer employed. Add to this extended payment option the requirement to pay for current employee costs. If those costs are also extended, government could potentially get to the point that they never pay for current costs in the current period.

Using the principle of “conservatism” (accounting definition not the political one) would require the government entity to recognize the actual liability and expense incurred during the fiscal year being reported thus not enhancing the financial statements. The expense should not be the actual contributions paid to the retirement plan (budget funding) but the calculated benefit cost incurred during the period being reported (a difference between budget and financial statement reporting). This concept will likely be debated as being cumbersome and extreme but it is Accounting 1A in theory.

Some selected readings from Fly At Night posts

Like Enron? You Will Love CalSTRS

CalSTRS Education Plan - Taxpayers to Make Up 20.3B Deficit

Another Authority for Public Pension Reform


What About Pensions is all about the world of public and private pensions.

The purpose of this blog is to discuss the impact of public pensions and Other Post Employment Benefits (OPEB) on government budgets. With California’s state and local government unfunded liabilities for pension and other retirement benefits in the BILLIONS of dollars it is time to have a taxpayers discussion on the issue.

Pensions are not free. The rising costs impact employee wages and will eventually impact services.

Private pension plans are also in danger.

Congress and state legislatures talk a good game but they tend to ignore or simply don’t understand the impact of incurring these long-term obligations on future services and tax rates.

Governments and companies do not pay for benefits, workers and taxpayers do!