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CalPERS Response to Stanford Policy Brief on Public Pension Funds
April 6, 2010
Stanfords Institute for Economic Policy Research released a policy brief Going For Broke: Reforming Californias Public Employee Pension Systems that relies on outdated data and methodologies out of sync with governmental accounting rules and actuarial standards of practice. The report fails to take the following into account:
Investments
* Over the past 20 years, we have earned an average annual investment return of 7.9 percent which includes the past two years when we suffered significant investment losses due to the Great Recession. Thus, our assumptions, from actual experience, have proven valid, relative to the 7.75 percent discount rate.
* The study appears to use the yield of the 10-year Treasury bond as the risk-free discount rate to estimate the present value of liabilities. The duration of the 10-year bond is around 8 years and well below the estimated duration of the CalPERS liability in the study. It would be more appropriate to use the yield of the 30-year Treasury bond as the risk-free discount rate for purposes of such a comparison.
* CalPERS does not believe that using a risk-free rate as suggested in the study is appropriate since the fund can earn a premium over the risk-free rate with high certainty by investing in a diversified portfolio with an acceptable level of risk.
* The study relies on data when the system had $45 billion less in assets than it has today. CalPERS assets are valued at $206 billion a gain of more than $45 billion since the market downturn.
* Additionally, its findings are based on a mathematical model that uses current interest rates, which are very low and make liabilities appear to be much higher. That method is inconsistent with the Governmental Accounting Standards Board and current actuarial standards.
* The study recommendations are based on bond returns over the past 25 years of 7.25 percent for investment grade corporate bonds, which are only 0.66 percent lower than CalPERS total return of 7.91 percent but with much lower volatility. CalPERS experts believe that this reasoning is flawed. Prospective returns on bonds are much lower today since yields are at an historic low and the return to bonds will equal the current yield to maturity which is around 4 percent for most broad band indices. Also bonds could be more volatile than the past if economic conditions are more uncertain as in the recent period.
* CalPERS is taking steps to modify its asset allocation approach and better allocate assets according to their macro risks and fundamental characteristics. This could result in addressing inflation and interest rates as macro risks.
* It ignores our diversified investment portfolio that has been time-tested during our 78 year history. If CalPERS had followed the recommended approach in the study, we would have given up billions of investment earnings, that have helped finance pensions rather than tax dollars.
Actuarial/Benefit Formula Related
* The study misstated some of the benefit formulas in Table 3 and seems to suggest that CalPERS violate the California Constitution by using surpluses to "reduce state debt." Pension raids were determined to be unlawful during the Wilson Administration.
* To adhere to some of the changes suggested in the report, CalPERS would be violating actuarial standards of practice and undo 50 years of governmental accounting rules in favor of an approach that would be "zero" risk.
* Funded status should not be viewed as a long-term irreversible trend. A pension funds funded status whether a liability or surplus is constantly changing, depending on current economic circumstances. It is a snapshot in time that can change dramatically over a fairly short period of time due to the health of the overall economy. Funded status snapshots are useful in showing how far or how near one is to full funding. Experts agree that a funded status of 80 percent is the mark of a very healthy plan. CalPERS notes that the Stanford Report acknowledges that using the data selected, CalPERS was more than 80 percent funded.
* Benefit formulas are not set by CalPERS. They are determined through the collective bargaining process, between the employer and the employee representatives. CalPERS recently held the California Retirement Dialogue, and information on the various viewpoints on benefit formulas is available here.
Future Steps
* CalPERS regularly evaluates its assumed rate of return every three years. At our May investment committee meeting, the Board will hold a workshop on capital market assumptions, finalize those assumptions in September, hold an asset-liability workshop in November, and take final action on an asset mix in December. In February, the Board will take the final step in the process by setting the actuarial assumed rate of return/discount rate. These meetings are open to the public and CalPERS is committed to obtaining all viewpoints on these issues. We invite the authors of the study to participate in the discussions.
okay they say the Standford methodology is flawed. Sure, they could be wrong,but how wrong? I am not in the bus. I count on a myriad of sources to fashion an opinion. if they calpers ala above, are correct well, okay and if not?what does it mean at the end of the day?
okay they say the Standford methodology is flawed. Sure, they could be wrong,but how wrong? I am not in the bus. I count on a myriad of sources to fashion an opinion. if they calpers ala above, are correct well, okay and if not?what does it mean at the end of the day?
I wish to avoid huge quote pyramids, so I will address various points in your post.
First, as I said earlier, CalPERS has a hole. Its just not as big of a hole as the Stanford study concluded. The Stanford study is methodologically incorrect. The fact that they don't have a dog in the race does not validate their methodology, nor does it invalidate the methodology of CalPERS.
I am not sure what the exact stated level of funding CalPERS is relative to their liabilities, but the typical state plan is funded at about 70%-75% of liabilities, and if I recall correctly, they are not far from the average, unlike say Illinois or New Jersey. With $220 billion in assets, a hole of $110 billion - which is close to the number Brett Arends quoted earlier - would put CalPERS at 66% funded.
The problem with pension forecasting is that returns are structurally cyclical. If you study financial history, you see long periods - 10 to 20 years - of high returns followed by long periods of low returns. We are now in a period of low returns. If, as you implied, there is a wave of unexpected retirements after a significant decline in asset prices, then the models off which pension plans work will not accurately capture the net present value of liabilities. It is impossible to forecast return volatility with precision. Very few people predicted that the stock market would fall 50%, and even fewer foresaw a decline of 30% in home prices. Likewise, almost no one predicted a 70% increase in the stock market off the bottom in March 2009. If, say, 10% of California government employees decided to retire in the next three years with full pension, then you will have a problem. But that is true of any defined benefit plan.
To answer your question, is this a problem? The answer is "yes." But to what extent, I'm not sure. Simply put, any unfunded pension plan will eventually be a problem. And almost all state plans are unfunded. But it is not a $500 billion problem, and it is not necessarily a today problem. But at some point, if the fund is continuously underfunded, the contributions are going to have to go up.
I have not seen the Milken Institute study, so I cannot comment on whether or not their conclusion is correct. They may be, I don't know. If asset markets get pounded, which is possible, and there is a wave of retirees over the next five years, then contributions could rise dramatically. If, however, markets do well, which is also possible, and there is no wave of retirees, then the problem isn't too worrisome.
I can comment on the Brietbart piece. Of course, Andrew Brietbart definitely has a horse in this race, and he is, in my opinion, misconstruing the issue.
All pension plans use smoothing. All of them. They do it in the private as well as the public sector. And the reason for this is simple - markets are volatile. If the market rises 40% one year, then it would appear that the pension plan is more funded than it really is. Corporations used to raid over-funded pension plans when markets shot up. Likewise, if the market tanks 30%, then the plan looks much worse than it really is, which would cause significant contributions from the shareholders or the taxpayers. But you don't want to be continuously raising and lowering taxes year in, year out, and you don't want companies at the mercy of the vicissitudes of the manic depressive stock market. So plans smooth out their return assumptions. The typical plan smooths out returns over a 5 to 10 year time period. California went from a 3 year to a 15 year time period. Three years is too short IMHO and 15 years is above standard practice (though probably a better proxy). So Brietbart references the actuary saying that losses will be deferred to future years and future contributions will go up. No kidding! The plan is underfunded! It is inevitable that contributions will go up sometime. So is it better to do it now when the economy is on its back or in the future when things will be better? This is why politicians should not have lowered contributions when times were good. But they can't help themselves. They want to lower taxes and look like good tax-cutters. Likewise, they promise too much to government employees, masking the true costs to future taxpayers (and shareholders for private companies, i.e. GM, Chrysler) in the future.
There are several public pension plans that are in serious trouble. I remember reading several years ago that West Virginia was 17% funded, though I'm not sure what it is today. There is no way they will be able to meet those obligations without massive tax hikes or, more likely, benefit cuts. As I understand it, the city of San Diego is also fucked. I expect them to declare bankruptcy some time in the future.
Having just read the Pension and Investments piece from the Milken Institute, I completely agree with the conclusions of the authors in general for public pension plans. Eventually, I think public pensions will move towards defined contribution plans, i.e. similar to 401ks, and away from the current defined benefit plans. Or maybe there will be some combination of both, where the worker is required to put at least part of his money into an annuity. This really should happen as it shifts the risk from the taxpayers to the worker. Also, public employees will have to contribute more on their own and retire later. They should also change the laws for how pension benefits are calculated in some states. For example, I believe in New York, a worker's pension is calculated based on the last year's average compensation, including overtime. This leads to workers trying to work as much overtime as possible in their final year to pad their benefits. That's abusive and egregious and should change.
The problem with pension forecasting is that returns are structurally cyclical. If you study financial history, you see long periods - 10 to 20 years - of high returns followed by long periods of low returns. We are now in a period of low returns.
I do believe this, this is the end of an era, we are in for 5 years or so of weak econ. tidings. The fed ( who appear clueless, really and out of ideas) downgraded their outlook again, we may dip under 8.5% unemployment...may...by 2012. Compounding that, I don' think anyone no matter the political stripe has any idea what we are in for or how to change course to make the best of this, in short we are out of fixes, cash and credit ( as is the g-20). A huge readjustment is coming, the likes of which I am not sure even depression era folks would see as a much of an improvement.
The problem with pension forecasting is that returns are structurally cyclical. If you study financial history, you see long periods - 10 to 20 years - of high returns followed by long periods of low returns. We are now in a period of low returns.
Which is why pensions need to be restructured to guarantee nothing more than market returns, not absolute returns.
I am still wondering how increasing risk adjusted yields on bonds, CDs and mortgages does not translate into higher financing costs for CA's existing debt, lower property tax revenues and a reduced supply of CDs.
I kind of thought so. I suspect a return to affordability will cause housing prices to decline in a nearly straightline.I am still wondering how increasing risk adjusted yields on bonds, CDs and mortgages does not translate into higher financing costs for CA's existing debt, lower property tax revenues and a reduced supply of CDs.
it already has on CA bonds at least.
which will last far beyond when you and I have passed.
http://www.usmessageboard.com/economy/143594-california-economy-4.html#post3016999
on their own? I don't think so.....
Why not? For this not to be true, then the population of California has to permanently start declining, or the global economy has to enter into perpetual contraction.
BTW, if anyone wishes to argue why any of this from CalPERS is wrong, please feel free to elaborate.
CalPERS Response to Stanford Policy Brief on Public Pension Funds
April 6, 2010
Stanfords Institute for Economic Policy Research released a policy brief Going For Broke: Reforming Californias Public Employee Pension Systems that relies on outdated data and methodologies out of sync with governmental accounting rules and actuarial standards of practice. The report fails to take the following into account:
Investments
* Over the past 20 years, we have earned an average annual investment return of 7.9 percent which includes the past two years when we suffered significant investment losses due to the Great Recession. Thus, our assumptions, from actual experience, have proven valid, relative to the 7.75 percent discount rate.
* The study appears to use the yield of the 10-year Treasury bond as the risk-free discount rate to estimate the present value of liabilities. The duration of the 10-year bond is around 8 years and well below the estimated duration of the CalPERS liability in the study. It would be more appropriate to use the yield of the 30-year Treasury bond as the risk-free discount rate for purposes of such a comparison.
* CalPERS does not believe that using a risk-free rate as suggested in the study is appropriate since the fund can earn a premium over the risk-free rate with high certainty by investing in a diversified portfolio with an acceptable level of risk.
* The study relies on data when the system had $45 billion less in assets than it has today. CalPERS assets are valued at $206 billion a gain of more than $45 billion since the market downturn.
* Additionally, its findings are based on a mathematical model that uses current interest rates, which are very low and make liabilities appear to be much higher. That method is inconsistent with the Governmental Accounting Standards Board and current actuarial standards.
* The study recommendations are based on bond returns over the past 25 years of 7.25 percent for investment grade corporate bonds, which are only 0.66 percent lower than CalPERS total return of 7.91 percent but with much lower volatility. CalPERS experts believe that this reasoning is flawed. Prospective returns on bonds are much lower today since yields are at an historic low and the return to bonds will equal the current yield to maturity which is around 4 percent for most broad band indices. Also bonds could be more volatile than the past if economic conditions are more uncertain as in the recent period.
* CalPERS is taking steps to modify its asset allocation approach and better allocate assets according to their macro risks and fundamental characteristics. This could result in addressing inflation and interest rates as macro risks.
* It ignores our diversified investment portfolio that has been time-tested during our 78 year history. If CalPERS had followed the recommended approach in the study, we would have given up billions of investment earnings, that have helped finance pensions rather than tax dollars.
Actuarial/Benefit Formula Related
* The study misstated some of the benefit formulas in Table 3 and seems to suggest that CalPERS violate the California Constitution by using surpluses to "reduce state debt." Pension raids were determined to be unlawful during the Wilson Administration.
* To adhere to some of the changes suggested in the report, CalPERS would be violating actuarial standards of practice and undo 50 years of governmental accounting rules in favor of an approach that would be "zero" risk.
* Funded status should not be viewed as a long-term irreversible trend. A pension funds funded status whether a liability or surplus is constantly changing, depending on current economic circumstances. It is a snapshot in time that can change dramatically over a fairly short period of time due to the health of the overall economy. Funded status snapshots are useful in showing how far or how near one is to full funding. Experts agree that a funded status of 80 percent is the mark of a very healthy plan. CalPERS notes that the Stanford Report acknowledges that using the data selected, CalPERS was more than 80 percent funded.
* Benefit formulas are not set by CalPERS. They are determined through the collective bargaining process, between the employer and the employee representatives. CalPERS recently held the California Retirement Dialogue, and information on the various viewpoints on benefit formulas is available here.
Future Steps
* CalPERS regularly evaluates its assumed rate of return every three years. At our May investment committee meeting, the Board will hold a workshop on capital market assumptions, finalize those assumptions in September, hold an asset-liability workshop in November, and take final action on an asset mix in December. In February, the Board will take the final step in the process by setting the actuarial assumed rate of return/discount rate. These meetings are open to the public and CalPERS is committed to obtaining all viewpoints on these issues. We invite the authors of the study to participate in the discussions.
CalPERS Response to Stanford Policy Brief on Public Pension Funds
uhm toro, I said this 2 pages ago bro. and one must add that they ALL knew it was smoke, it was good for the unions, calpers and the pols. and it sux a mo[p for everyone else, the forecasts were always ahead of what any reasonable fin. guy would have told them to expect, that was MY point.You are really clueless about how bad this pension situation is.
In California's case, past pension underfunding means reduced funding of current programs. This explains why pension costs rose 2,000% from 1999 to 2009, while state funding for higher education declined over the same period.
California's $500-billion pension time bomb - Los Angeles Times
Gray Davis bought votes from state workers by grossly increasing pension benefits. It has snowballed to the point where real services have been cut to cover this abuse.
I've worked for years in the pension business, and CalPERS is NOT underfunded by $500 billion. The study was done by four Stanford students. Pension fund consultants - firms that do this for a living - do not come to this same conclusion. So why do you believe the inexperienced students who use an absurdly low discount rate and not the professionals who have spent their careers advising on these matters?
I believe the main reason why CalPERS contributions have risen so much is for the same reason why so many states have seen contributions increased - during the latter years of the 1990s, returns were so strong, politicians reduced contributions because they assumed that the strong returns would continue, making themselves popular with voters because they were seen as giving voters a "tax cut" when in fact they should have been retaining contributions. Now, because returns have been low, the folly of political decisions have come back to haunt the states.
I have no doubt that politicians - particularly Democrat politicians - have overpromised retirement benefits in an effort to get re-elected, and there has to be pension reform. But hysteria without contextual understanding is no way to approach an issue.
*shrugs shoulders*..I for one am not hysterical so much as pissed...I am also stuck in a state of what(?)...schizophrenic miasma?...I am part of the problem so to speak, but, I have to make a living.
The problem with pension forecasting is that returns are structurally cyclical. If you study financial history, you see long periods - 10 to 20 years - of high returns followed by long periods of low returns. We are now in a period of low returns.
Which is why pensions need to be restructured to guarantee nothing more than market returns, not absolute returns.
What conclusion do the pros come to? $400B? $300B? $200B $100B?
Are any of those less cause for concern?
I settled at 200 billion. considering there is a 50 Billion shortfall that HAS to be made uo in the next year, well, I think that tells the tale...we are screwed.
The problem with pension forecasting is that returns are structurally cyclical. If you study financial history, you see long periods - 10 to 20 years - of high returns followed by long periods of low returns. We are now in a period of low returns.
Which is why pensions need to be restructured to guarantee nothing more than market returns, not absolute returns.
That's why I think eventually public pensions will become defined contribution plans, at least in part, whereby workers earn market returns.
You are really clueless about how bad this pension situation is.
In California's case, past pension underfunding means reduced funding of current programs. This explains why pension costs rose 2,000% from 1999 to 2009, while state funding for higher education declined over the same period.
California's $500-billion pension time bomb - Los Angeles Times
Gray Davis bought votes from state workers by grossly increasing pension benefits. It has snowballed to the point where real services have been cut to cover this abuse.
I've worked for years in the pension business, and CalPERS is NOT underfunded by $500 billion. The study was done by four Stanford students. Pension fund consultants - firms that do this for a living - do not come to this same conclusion. ....
I have no doubt that politicians - particularly Democrat politicians - have overpromised retirement benefits in an effort to get re-elected, and there has to be pension reform. But hysteria without contextual understanding is no way to approach an issue.
I really have no dog in this hunt, but the resuts released from Stanford's Public Policy program are not only the results by four students:
The state of California's real unfunded pension debt clocks in at more than $500 billion, nearly eight times greater than officially reported. ....
the finding from a study released Monday by Stanford University's public policy program, confirming a recent report with similar, stunning findings from Northwestern University and the University of Chicago.
I would be curious to know the opinions of pension fund consultants, and how they vary with those of the Stanford U, Northwestern U, and U of Chicago reports, but you have not provided evidence that it exists.
The key problem for CA is losing population share and more importantly the young and well educated. Most telling is that bio-tech has generally moved away from CA to MA. The shift from PCs to laptops to tablets means that we are approaching old technology status in computers. By the end of this decade IT will seem as high-tech as plastic extrusion does now, remember that scene from "The Graduate"? As to better returns in the future that presupposes both a bond and real estate crash from where we are now. How a 40% decline in the property tax base and much higher borrowing costs is good new for CA escapes me.
You are really clueless about how bad this pension situation is.
In California's case, past pension underfunding means reduced funding of current programs. This explains why pension costs rose 2,000% from 1999 to 2009, while state funding for higher education declined over the same period.
California's $500-billion pension time bomb - Los Angeles Times
Gray Davis bought votes from state workers by grossly increasing pension benefits. It has snowballed to the point where real services have been cut to cover this abuse.
I've worked for years in the pension business, and CalPERS is NOT underfunded by $500 billion. The study was done by four Stanford students. Pension fund consultants - firms that do this for a living - do not come to this same conclusion. So why do you believe the inexperienced students who use an absurdly low discount rate and not the professionals who have spent their careers advising on these matters?
I believe the main reason why CalPERS contributions have risen so much is for the same reason why so many states have seen contributions increased - during the latter years of the 1990s, returns were so strong, politicians reduced contributions because they assumed that the strong returns would continue, making themselves popular with voters because they were seen as giving voters a "tax cut" when in fact they should have been maintaining contributions. Now, because returns have been low since then, the folly of these political decisions have come back to haunt the states. This happened repeatedly throughout the country, not just in California.
I have no doubt that politicians - particularly Democrat politicians - have overpromised retirement benefits in an effort to get re-elected, and there has to be pension reform. But hysteria without contextual understanding is no way to approach an issue.
Scuze moi, but I am not going to accept your opinion over Stanford's study and the University of Chicago. They studied the data; you haven't.
