Pension Crisis

Huge Pension Fund Makes Example of Tiny California City

CalPERS strikes back against small towns and agencies trying to leave its system.

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Ken Lund/flickr

California state government observers have wondered in recent months why the California Public Employees' Retirement System (CalPERS), the nation's largest state pension fund and one of Wall Street's most muscular financial players, has taken such a hamfisted approach toward one of California's tiniest and least-powerful cities. There's a rational, albeit troubling, reason for its approach.

After the Sierra County city of Loyalton (pop: 862) could no longer afford its monthly payments to CalPERS to pay the pension benefits for its one employee and four retirees, the City Council voted in 2013 to pull out of the pension fund. In response, CalPERS slapped it with a $1.66 million "termination fee"—far more than the city's annual budget. That means that, as recent news reports reveal, Loyalton's retirees will soon have their pension benefits slashed by 60 percent, which is a massive hit for a small number of people.

CalPERS is sending a message to other cities that want to leave the fund: agencies will pay dearly if they attempt to loosen CalPERS' grip on their finances. The pension fund is taking a similarly hard line with some agencies in Southern California.

"The CalPERS Board of Administration in March voted to cut the pensions of close to 200 retirees from the East San Gabriel Valley Human Services Consortium," reported the Los Angeles Times this month. That agency, known as LA Works, folded in 2014. On July 1, "CalPERS sliced the pension checks for the consortium's retirees by 63 percent." The Timesalso pointed to the Niland Sanitary District in Imperial County, which is currently negotiating with CalPERS over exit terms.

Every city's payment for the "defined benefit" pensions that CalPERS administers is based in part on financial assumptions. The most important of these: the fund's assumption that it will earn 7 percent on its investments (down from 7.5 percent). It calculates the fees that cities and other agencies have to pay based on benefit formulas and these assumptions about investment earnings.

As soon as an agency decides to leave the pension fund, CalPERS places its investments in what it calls the Terminated Agency Pool, or TAP. For agencies in the TAP, CalPERS assumes a rate of return of around 2 percent.

As I explained last month, this highlights a dirty little secret: The pension fund is bullish about the stock market when the public's money is at risk, given that any shortfalls in investments ultimately are backed by California taxpayers. But when agencies leave the fund, CalPERS can no longer rely on taxpayers and future returns for those dollars. Its own money is at risk, so it then assumes a minuscule rate of return. That assumption increases dramatically what a local agency owes CalPERS.

CalPERS could have negotiated a deal for Loyalton, says Dan Pellissier, a former aide to Republican Gov. Arnold Schwarzenegger and well-known pension reformer. He points to California law that states the CalPERS "board may negotiate with the governing board of the terminating agency" regarding the "terms and conditions of the termination" from the pension fund.

"CalPERS offered to negotiate payment options under the government code that you cited, but Loyalton said they couldn't make those payments either," CalPERS spokesperson Amy Morgan told me. "That is when they were moved into the terminated agency pool."

But CalPERS also confirmed that "the negotiations were based on what the city could afford on the $1.6 termination liability cost that they owed, not the discount rate." There's obviously no way that a city that said it couldn't afford its modest annual payment (reportedly around $3,500 a month) in the 7.5 percent fund could begin to afford the higher payments based on 2 percent earnings.

This is par for the course for CalPERS "negotiations." When the city of San Jose tried to extricate its small pension plan for council members from CalPERS and move to a 401(k) system, CalPERS hit back. CalPERS had calculated the city's liabilities at around $900,000 for that fund, but CalPERS wanted San Jose to pay around $5 million to exit.

"CalPERS does everything it can to keep the rats from leaving the sinking ship," former Mayor Chuck Reed told me. "And they treat you like rats, too."

Reed says CalPERS could have come up with a deal to let San Jose pay off the remaining pensions without adding new members. The pension fund has claimed that it isn't statutorily allowed to do so, but that's an open question. Moreover, CalPERS itself could push for a legislative change. "They do not want to help," Reed said. "Clearly, they do not want people to leave."

The point of the termination pool is to deal with agencies that become defunct. Loyalton still has an annual budget and government-owned assets such as a city hall. It's a different story with LA Works and those handful of agencies that actually have dissolved. Those sorts of situations are what termination pools were designed to address.

Even when agencies actually go out of business, there's room for a settlement. CalPERS' termination pool has a surplus of $111 million, so it's 200 percent funded. The idea is to have extra funds to cover shortfalls. LA Works would appear to have a good argument that this is an appropriate use of some of those funds.

"Upon termination, CalPERS becomes the guarantor of benefits for all members and beneficiaries whose benefits are paid from the TAP and has no future ability to obtain funds from former contracting employers," wrote CalPERS CEO Marcie Frost, in a letter last month to the state Senate. She was responding to Sen. John Moorlach (R–Costa Mesa) who harshly criticized the disparity between the assumed rates in the two investment pools.

But Frost's rebuttal bolsters what pension reformers have been arguing. The TAP makes investments in "low-risk, U.S. government-issued securities" as a way to "minimize funding risk" because CalPERS then becomes the guarantor of all benefits. These are the investment assumptions CalPERS uses when it wants to be sure that it doesn't lose any money.

"If you felt that 2 percent is the interest rate, you should be basing it on that rate the whole time," Moorlach told me, rather than basing it on 7.5 percent and then lowering it to 2 percent once an agency wants to leave the system. "I've paid what you charged me. You've undercharged me. That's your problem," he added.

The bigger problem, of course, is that if CalPERS tried to move the entire system to a sustainable basis—i.e., one that is priced like a private fund that didn't rely on public subsidies and future bull markets –it would need to increase dramatically what it charges member cities and agencies. Those public agencies already are slashing services to pay their current, escalating bills.

CalPERS' "number one strategy is to preserve the defined benefit and get more employees into defined-benefit plans," Pellissier said. So the fund "absolutely" is making an example of Loyalton to keep other cities from getting the wrong idea.

In the meantime, a reasonable negotiated settlement with Loyalton and other exiting agencies would quietly preserve the relatively small pensions of a handful of employees. However, it could also send the message to other cities and agencies that leaving CalPERS might be a doable alternative. Given its current union tilt, the pension fund certainly can't allow that idea to gain traction.

This column was first published by the California Policy Center.

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  1. Ponzu scheme!

    If the cities were smart they would inform their retirees to cash out as much as they could form Calpers and then the city refuses to pay. Qthey get a bill from Calpers and do what cities do, just refuse to pay.

    1. *Ponzi scheme that is.

      1. I thought Ponzu might have been a demon, which would have been fitting, but it’s actually a citrus-based condiment from Japan.

        1. Not only does this dummy fuck up his own point, he makes everybody hungry for Japanese food way before a reasonable lunchtime. Thanks a lot, lc.

          1. Raw fish and strange pickles. No thanks.

            1. Raw Fish And Strange Pickles was my nickname in grad school.

              1. Whoa! Fat 540! I’m gettin’ agro on this kicker! Stomp that pickle revert!

              2. Yes, that’s what she told me.

          2. Couldn’t have done it without glitchy Reason screens bouncing and trying to force advertisements on my iPad.

            1. That ain’t nuthin’. I was on the toilet w diarrhea, & trying to power off my Kobo caused it to wipe all the book files thereon.

              1. You wiped with your Kobo? I usually use toilet paper…

        2. That’s just it, citrus-based: the deal is a lemon.

  2. This story must be phake newz! After all, this is California! It’s run by Democrats, so we know it’s a worker’s utopia! And it’s a Big Government agency, so you know they would never screw over retirees!

    1. Loyalton went for Trump. Explains everything.

  3. As I explained last month, this highlights a dirty little secret: The pension fund is bullish about the stock market when the public’s money is at risk, given that any shortfalls in investments ultimately are backed by California taxpayers. But when agencies leave the fund, CalPERS can no longer rely on taxpayers and future returns for those dollars. Its own money is at risk, so it then assumes a minuscule rate of return. That assumption increases dramatically what a local agency owes CalPERS.

    CalPERS should be glad courts would likely toss suits due to standing issues — because I don’t see how this would survive a fraud claim. Unless they can point to what investments they change specifically to slash the assumptions, this looks like fraud to me.

    1. “But Frost’s rebuttal bolsters what pension reformers have been arguing. The TAP makes investments in “low-risk, U.S. government-issued securities” as a way to “minimize funding risk” because CalPERS then becomes the guarantor of all benefits.”

      “Upon termination, CalPERS becomes the guarantor of benefits for all members and beneficiaries whose benefits are paid from the TAP and has no future ability to obtain funds from former contracting employers,” wrote CalPERS CEO Marcie Frost

      It was in the article. Sounds like they move anyone trying to escape from CALPERS into all treasuries rather than a higher returning but more volatile mix of stocks & bonds. Their rationale is that they have no ability to collect on any shortfalls between estimated fund returns and actual returns ceases once an employer exits CALPERS, so they refuse to take on any of that risk. Instead, they just stuff the retirees in treasuries (very low risk, very low return). Definitely a pretty uncaring move, but not entirely irrational. Predicting future returns is extremely difficult, and being off even 10 basis points can result in a shortfall or excess of millions when you’re covering pension liabilities for tens of thousands of workers. This is one of the most important reasons all private companies have moved away from defined benefit and into defined contribution (401k) plans.

      1. If the taxpayer backstop was removed, the entire fund would be managed exactly as the termination pool is managed.

        1. If the taxpayer backstop was removed, the employees would demand a defined contribution plan rather than entrust their retirement to shady and incompetent CALPERS managers.

    2. I don’t see how this would survive a fraud claim.

      The judge’s pension is based on fraud. Therefore it would survive a fraud claim rather easily, unless it were tried in a jurisdiction where the judges’ pensions are not based on similar frauds.

    3. Agreed; it does smell like fraud. As well as bad faith. Loyalton should sue the CalPERS board personally for punitive damages. It could probably find a libertarian or conservative foundation to support the lawsuit.

  4. What does the commentariat think about odds of Feds bailing out CALPERS when Dems recapture power next time ?

    1. I think the Dems will at least float trial balloons for it. If they don’t I imagine their union overlords will start squeezing their tiny balls.

    2. I think it still won’t cause me to vote for Team Red.

      1. Red is the colour of the Left. We need to get our colours straight once again.

    3. Solid 75% of doing so. Their fundraising is based largely there.

    4. Way before CalPERS needs help, we will see examples in New Jersey, Illinois, Pennsylvania, Kentucky, etc., etc., etc.

  5. CalPERS exists solely to serve the public employees of California! Except for those who decide not to be wholly owned property of CalPERS, who are to be crushed utterly and without remorse.

    1. Californians exist to serve the public employees, peasant.

  6. The only way out of the mafia is in a bag.

  7. Loyalton? You can’t make this stuff up!

  8. Sierra County and Loyalton are Trump country. Who cares about them?!?! That’s the attitude in this state. Geographically California is red state. But it’s ruled by only four or five counties, where all the population is. As long as it’s only the little counties that get shoved down the wood chipper, the big counties don’t care. Fuck them.

    1. Geographically California is red state. But it’s ruled by only four or five counties, where all the population is

      Sounds just like New York State. If we could just kick NYC out it would be SO much better.

  9. Sounds like King John’s scutage.

  10. Perhaps if you spent alittle time on the fore story to the retirees being screwed it would be more accurate reporting. The self serving council members wanted to throw their funds to a friend in the 401k business and not be part of CalPERS anymore. They knew the consequences of pulling out of CalPERS. In addition, they gave everyone a huge raise and spent ridiculous sums of money on painted rocks. You need to go back a few years in this story to see how it all went down. CalPERS administers our pension fund and they do pretty well when everyone budgets their retirement obligations and actually pays them. It is the duty of the local entity to put the curbs out when negotiating contracts. This town knowingly set out to screw their retirees and shame on them and any others who think it’s ok to not put contract money into the fund. Those city leaders who did this to their own retirees should be arrested and sent to jail for contract violations. I value having a retirement plan and don’t understand why all Californians can’t have the same.

    1. “I value having a retirement plan and don’t understand why all Californians can’t have the same.”

      Well, yeah. Everyone likes having other people’s money. The reason everyone can’t do it is that no money would enter the system without some sheep outside the system to fleece. See Margaret Thatcher’s quotation on socialism, which I’ll provide since you may not be familiar with it.
      Margaret Thatcher ? ‘The problem with socialism is that you eventually run out of other people’s money.’

    2. Why? See the first post: Ponzu, uh, I mean, Ponzi scheme.

      See, e.g., http://www.dailyherald.com/art…..701019945/

      This is Illinois, but the point remains

      “…said Heffez’s pension stands to earn him $17.3 million over his lifetime, based on actuarial tables and under the state’s current pension law. … Heffez…worked at the university for 29 years and…contributed $768,611 to his retirement plan, an amount he’ll make up in less than two years of retirement….”

      This is what these schemes promise and they simply cannot afford it. That’s what, a guaranteed 22% return on his contribution?

      That’s why all Californians can’t have the same. It’s a Ponzi scheme.

      1. I think I did the math wrong there. It seems more like an annualized 13.25% (I’m assuming 25 years to get to the $17.5MM total payout).

        Another way to look at that, if he had personally invested $768,611 in one fell swoop, 8% annually results in a total of $5.3MM, 7% results in $4.2MM, 5% results in $2.6MM, and 3% results in $1.6MM.

        Since the state is the one actually getting those returns, the state is just handing him between $12.2MM and $15.9MM over the returns it can earn with his money, for doing absolutely nothing.

        Yes, that is a Ponzi scheme.

      2. When a municipality negotiates a pension plan, part of the money is contributed by the employee – that would be the $768,611 and part is contributed by the employer – usually on a greater basis than does the employee.
        So, the figure you are looking at is but a part of what the pension fund is supposed to get, before putting it into investments – some of which have been ongoing for 29 years.
        The only “taxpayer” money that has been used by any of these pension plans is that which is part of the normally budgeted payments for employee benefits – and frequently, if investments have returned more than anticipated, not even that much.
        This whole pension “trouble” began when the financial markets had their “meltdown” and all these municipalities had to pony up the full share of the contributions for their employees, because the investments weren’t covering it, and they would have to pull the money from places they were spending it on vote-buying schemes.

        1. “The only “taxpayer” money that has been used by any of these pension plans is that which is part of the normally budgeted payments for employee benefits – and frequently, if investments have returned more than anticipated, not even that much.”
          Bullshit. Any shortfall in the fantasized return has to be (and has been) paid by the taxpayer.

          “This whole pension “trouble” began when the financial markets had their “meltdown” and all these municipalities had to pony up the full share of the contributions for their employees, because the investments weren’t covering it, and they would have to pull the money from places they were spending it on vote-buying schemes.”
          IOWs, your earlier statement is a lie and how much did it take to buy your vote with the pension promises paid for by the taxpayer?

    3. “I value having a retirement plan and don’t understand why all Californians can’t have the same.”

      You have identified one problem already. “It is the duty of the local entity to put the curbs out when negotiating contracts.” Defined benefit pensions allow politicians to pay lavishly with future promises rather than actually come up with the funding to pay what they owe now. That’s not just a problem in a couple little towns; it’s a problem everywhere. So long as everyone is pooled in CalPERS, the system can continue for a while, but it’s not sustainable. When it collapses, it will take down everyone, unless they are bailed out by the Feds, which would create an even bigger “too big to fail” scheme. The union leaders, if they care about their members at all, must be counting on a bailout.

      1. Well, these local entities sit at the bargaining table with the unions they do business with. When it’s done they all sign contracts. Then they are suppose to each put their money in the budgets. The employees get their pay deduction and the local entities put up ART. No money is put in the budget to equal the negotiated contract. Thus the breech of contract. If you sign a contract you’d best honor it.

        1. JenniferHu|8.25.17 @ 7:39PM|#
          “Well, these local entities sit at the bargaining table with the unions they do business with.”
          So the politicos sit at the table with the unions who promise them votes if they get good eals for the union members and ‘do business’ with them? How convenient!

          “When it’s done they all sign contracts. Then they are suppose to each put their money in the budgets. The employees get their pay deduction and the local entities put up ART. No money is put in the budget to equal the negotiated contract. Thus the breech of contract. If you sign a contract you’d best honor it.”
          Good. Let the politicos who signed those contracts honer them out of their own pockets.

    4. You do have a good point, which is that the consequences of pulling out of CalPERS were probably known all along. As libertarians, who say that we believe in contractual agreements, we should acknowledge that aspect of the story.

      1. “You do have a good point, which is that the consequences of pulling out of CalPERS were probably known all along. As libertarians, who say that we believe in contractual agreements, we should acknowledge that aspect of the story.”

        As libertarians, we should protect the taxpayers from politicos buying votes with our money.

    5. Except that that’s not actually the “fore story:”

      In 2012, the Loyalton City Council decided to withdraw from CalPERS because its last employee with a guaranteed pension had retired.[13] The city had been fully paying its required annual contribution of $30,000 and had only four remaining pensioners.[13] CalPERS then demanded $1.6 million from the city.[13] CalPERS publicly uses actuarial present value to calculate member contributions but when a member withdraws it utilizes a non-public calculation to define unfunded liabilities.[14] Loyalton has not yet paid the bill so CalPERS is charging 7.5% annual interest and had sent a final demand letter in September 2016.

      Rural mountain town of 750 schemes to screw over one of the nation’s largest and most powerful investment funds is not a narrative that goes own with ease. Got some evidence that the local city council was working diligently to screw over their friends and neighbors?

      1. Yes, but did CalPERS do anything that wasn’t spelled out ahead of time in legal agreements with the city? I’m asking — I don’t know one way or other.

        Don’t we libertarians always say that contracts are binding?

        1. Yes, but did CalPERS do anything that wasn’t spelled out ahead of time in legal agreements with the city?

          That I honestly do not know. I’m simply pushing back against JenniferHu’s accusation that this is not CalPERS being ruthless dicks but is in fact the city council members of this tiny, tiny, tiny little town (where obviously everyone in town knows each other) doing some shady deal and somehow taking advantage of the poor, na?ve rubes at CalPERS.

          She feels like a paid shill to me, so I wanted to get that out there.

          I deal with construction contracting, and many, many times I have relieved some poor na?ve subcontractor who got in over his head with provisions he didn’t understand and account for (and I have been a subcontractor in that same boat and gotten such consideration from Generals). If the details of the situation are as they have been represented, CalPERS are being jerks even if they are enforcing the letter of the contract.

          1. Agree they’re being jerks. They are desperate for money, and will do whatever they can to get it.

            1. They are desperate for money, and will do whatever they can to get it.

              Indeed. Which is pathetic considering the size of the fund.

        2. Yes the CalPERS contract is very clear. The failing is they do not inform retirees soon enough that the retirees agency is in default. They claim they are not obligated to do this but do let the retiree know 90 days before their checks are impaired. Retirees do not have representation, these agencies know this, and can not band together to get relief from the defaulted or defunct agency. They do not have time to get after the agency legally for selling them out. The defaulting agencies do not tell their retirees at all so they are safe from suits.

          1. So, in answer to S=C’s question, you have no evidence, is that correct?

        3. Mike Laursen|8.25.17 @ 2:57PM|#
          “Don’t we libertarians always say that contracts are binding?”

          Contracts signed between politicos buying votes from the other side of the table?
          No. Simply, no.

      2. Well I did read an interview with the current mayor who indicated just what I wrote that the previous armature city representatives knowingly sold out their few remaining retirees. In fact, they promised those retirees they would make up the difference in their pay after they did not continue their payments. But that to did not get honored by the city leaders. All of them pointing their fingers at CalPERS as they move on to the bank themselves with their new raises.

      3. The city leaders of Loyalton at the time did in fact scheme to mess with the few remaining retirees. Not CalPERS. They knew full well the consequences of their actions. Their intentions were to get out of CalPErS and they could have if they had just waited for the last retirees from CalPERS to die. Just got impatient with their plan.

  11. CalPERS is desperate to grab funds wherever it can.

    1. Full disclosure: I am the proud winner of a CalPERS “scholarship” of, like, $50, in my Senior year of high school. That was way back when CalPERS had no funding problems.

      1. And I should probably disclose that back in the day I worked for the company that managed the construction of the CalPERS building in downtown Sac. They almost single-handedly carried our company for a little while. Still don’t like them, though.

  12. Well, California.
    Secession should take care of this little misunderstanding.

    1. Just remember your social security and Medicare go with succession. In addition who will run the new country? Another dilettante. People are sheep and it will all just stat over.

  13. CalPERS is a PONZI scheme.

  14. any government or quasigovernment agency in that stinking state is corrupt to the core. And act like bullies.

    reminds me of the slogan for a smallish local pseudo-Mexican restaurant in the area, Taco John’s. “Once we getchya, we gotchya”.

    their offerings were a whole lot more palatable than CALPERS, though…..

  15. Unions were invented to undermine the achievements of honest men and establish socialism.

    1. Well they actually were designed to give voice to the downtrodden enslaved people (children included). They enabled a pooled voice against “the man”. It is most unfortunate that the power entrusted to some leaders has been misunderstood and misused. Shame on them and us for allowing that. These leaders must also be toppled to bring our voice back.

      1. JenniferHu|8.27.17 @ 3:43PM|#
        “Well they actually were designed to give voice to the downtrodden enslaved people (children included).”

        You can try to sell that happy horseshit to lefties who are dumb enough to believe it.
        Read “Meet You in Hell” on the Homestead Strike; the union was founded to keep the well-paid well-paid and keep the laborers poor.

  16. Money quote: “I paid what you charged me. You undercharged me. That’s your problem.” That is it, in a nutshell. In fact, the people paying into public pensions, public services requiring significant infrastructure, and many other public goods have not been paying the actual costs as those expenses are incurred. THe result is financial deficits driven by the decisions of innumerate idiots and numerate cowards who cannot do math or fear the political reaction to truth.

    All over the country we have been eating seed corn for a couple generations. Sooner or later it is going to come to an end. Whether it is a slow, quiet deterioration or a resounding collapse is yet to be seen, but it is going to end one way or another.

    What are we going to do then? There is no fixing the systems we have ruined. We will have new systems. Choose wisely. There are not going to be many chances to get it wrong without dire consequences.

    1. Truer words have never been spoken.

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