Marty: CalPERS falls behind the curve

Marty Richman

Between June 30, 2011 and June 30, 2012, the major stock indexes increased an average of 6.8 percent. Unfortunately, market value of the CalPERS mix represented by plans in San Benito County and the City of Hollister actually lost 0.6 percent. The combined local dollar loss was a modest $850,000 on the previous value of $163 million. However, CalPERS had targeted an average rate of return of 7.5 percent, so the shortfall was significant. And our investment would have made approximately $12 million with that return.
One can justify almost any rate of return if they cherry-pick the date or period of evaluation. A single year’s shortfall does not mean the long-term average is impossible, but this does illustrate the risks of building a retirement system based on forecasts of high return rates. Remember, in a defined benefit plan like CalPERS, the employer takes all the investment risk and they have to make up the difference if the returns fall short.
CalPERS uses rate forecasts of 7.5 percent, which is aggressive; conservative forecasters use 4.5 percent to 6 percent. The difference may not seem like much, but it adds up over many years. Invest $100,000 at 6 percent for 30 years and you get upward of $474,000 in interest; do it at 7 percent and you get upward of $661,000 in interest. The reverse holds true: If you budgeted for 7 percent but only realized 6 percent, you’re going to be $187,000 short.
When market returns were inflated during the bubble years, CalPERS collected low or no retirement contributions from employers. Rather than saving the money for a rainy day, the employers, mostly local governments, usually passed that money directly to the employees by agreeing to pay the employees’ share of retirement funding. The bubbles burst and CalPERS no longer gives free rides, but repealing that generous benefit is one of the sticking points in the county’s labor negotiations.
There are so many variables in CalPERS calculations that most explanations are confusing and forecasts only add uncertainty. However, one recently supplied set of figures, the Hypothetical Termination Liability, freezes all the variables for a moment in time.
The Hypothetical Termination Liability looks at each account on June 30, which is the last day of the fiscal year for most agencies, and calculates how much each would need to meet their future obligations using U.S. Treasury (no risk) yields for investment returns. Year-over-year this can show the direction of the plan. We only have two data points so far, 2011 and 2012, but they do show how compounding gains and losses leverage the surplus and the debt. The basic figures were published in the last CalPERS Annual Validation Reports dated October 2013 as of June 30, 2012.
For simplicity’s sake, I have combined the plans within each local agency to give an overall view and rounded the numbers, but the individual data sets for police, fire, and miscellaneous group plans are available.
Due primarily to the 2011-12 investment shortfall, the county’s unfunded termination liability increased by $78 million, 67 percent, to $181 million and the city’s unfunded termination liability jumped $41 million, 75 percent, to $101 million, even though both did very little net hiring, and limited raises.
The damage was inflicted long ago and many of the culprits are gone, but the pain is just coming to the surface. There is no proof that good times are any more permanent than bad times, or the other way around, skillful investors know that it all comes back to the average, eventually.

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