Tag Archive for: CalPERS

Are Government Pensions Funds in Crisis Again?

If ever there were a case of Chicken Little, it’s the endless squawking over the imminent implosion of public employee pension funds. In California, ever since pension benefits were enhanced, retroactively, starting in 1999, critics have been claiming a pension apocalypse was imminent. But no matter what happens, pension funds muddle through.

The modern era of pensions began in the 1984, when pension system guidelines were revised to permit them to purchase equities without limit. By 1999, on the strength of a nearly 15 year run of unbroken equities growth, California’s pension systems were fully funded with surpluses. With their confidence undiminished after the internet bubble popped and stocks tanked, pension system managers blithely continued to advocate pension benefit enhancements. By 2005 those benefit enhancements had rolled through every agency in California, and by then the markets were recovering as well. Then came the crash in the fall of 2008. To cope, the pension systems began to use creative accounting. Collectively these gimmicks obscured growing problems.

For example, asset “smoothing” made it possible to hide recent drops in the value of invested assets by reporting the average value of those assets over previous years. As the funded status – the difference between total invested assets and the amount the fund actually needs to pay current and future pensions – worsened, pension systems began to require so-called “unfunded contributions,” which were catch up payments necessary to reduce the growing amount of underfunding. But by negotiating repayment terms analogous to negative amortization mortgages, agencies were allowed to make low payments in the early years of the amortization term, which frequently meant the underfunded amount wasn’t even being reduced. Then when those payments become burdensome, agencies would refinance the new, now even larger unfunded liability, to get that unfunded payment down again.

Gimmicks abounded. Pension funds in the early 2000s used an estimated rate-of-return per year of around 7.0 percent, which was obviously too high, since the funding status of pension systems continued to worsen. But by maintaining the fiction of a higher than realistic rate-of-return, pension systems could underestimate the size of their pension liability, and claim there was enough money in the system. If they acknowledged that returns might be lower, they would need more assets to make up the difference.

The consequence of this was pension systems quietly ended up with an unfunded payment that came to dwarf the “normal” payment. If a pension system is fully funded, the only contribution required each year is the “normal” payment, which is the amount of money that has to be invested in order to pay whatever amount of future pension benefits were earned in that year. This is the essence of pension finance. You estimate the present value of future pension benefits, and make sure you have that amount invested today. When you don’t do that, you end up with an unfunded liability. In California today, in almost every one of the pension systems set up for government retirees, the unfunded payment that agencies have to make to the pension systems is now more than the normal payment. But guess what? The only portion that public employees have to themselves help pay through payroll withholding is the normal payment. Taxpayers pick up everything else.

If all this complexity is tedious, join the club. An innumerate legislature, a powerful public employee union lobby, and inadequate pension system oversight has put us where we are today. Pension systems that remain only 70 percent funded, with taxpayers footing far more than their share.

So are we today at just another Chicken Little moment? After all, the pension systems have bent but they never broke. This is thanks to the PEPRA reforms of 2013, the GASB reforms of 2015, along with agencies picking up unfunded contributions that slowly grew into the monster they are today, which allowed them time to raise taxes and cut services so they could make those higher payments.

Taking all this into account, it is not unreasonable to consider government pensions resilient enough to take whatever is coming next. Nonetheless, with today’s uncertain outlook for stocks, bonds, and real estate, it is timely to have another look at the financial health of California’s pension systems. Since CalPERS is the 800 pound gorilla in California’s pension jungle, a look at its finances may be illustrative.

The first chart shows the funding status of CalPERS by year, starting with the fiscal year ended 6/30/2007 and continuing through 6/30/2020, the most recent year for which financial statements are available. As can be seen, CalPERS has only been around 70 percent funded for over six years. It is also evident that 2013 was a pivotal year for the fund, because in that year, the value of the total invested assets actually declined, from $283 billion on 6/30/2012 down to $281 billion on 6/30/2013. The funded ratio prior to 2013 had stayed over 80 percent, but subsequently fell down into the 70s and still has not recovered.Something else that should be noted from this first chart is the relentless growth of the pension liability. Between 2012 and 2013, as total investment assets shrunk in value, the present value of future pensions increased by over 10 percent, from $340 billion to $375 billion. Overall, during the 14 years reported here, while assets increased in value by 181 percent, liabilities increased by 223 percent. The combination of absolute growth in the total pension liability and a diminishing funded ratio has a compounding impact on the amount of the unfunded liability. As of 6/30/2020, CalPERS was facing an unfunded liability of $163 billion. Taxpayers are on the hook for 100 percent of this debt.

While complete financial statements for CalPERS – and most public employee pension systems – lag about 18 months behind their close dates, every month CalPERS offers an update on the value of their invested assets. Reviewing the latest available report reveals the risks they have begun to take in order to prevent their funded ratio from further deteriorating.

The next chart, below, provides a snapshot of CalPERS investments as of August 31, 2022. Their total assets have swollen to $446 billion. That’s good performance, implying an annualized return over the 14 months since 6/30/2020 of over 9 percent. But what’s in these numbers?Here is where CalPERS position may be more precarious than ever. Consider each category of assets, including some you would not have spotted ten years ago. Public equity refers to listed stocks, and with the market in turmoil, the direction of these investments is uncertain. “Income” refers mostly to bonds with fixed yields, and as interest rates go up, the value of previously purchased bonds must fall, since for them to remain marketable the yield from their fixed payment has to rise to a competitive level. “Real assets” refers to real estate investments, which, like publicly traded stocks, is in uncertain territory. But what about the other categories?

Here is where even greater risk to the CalPERS investments may reside. Private equity and private debt refer to investments in companies that are not yet listed. These investments lack the liquidity of publicly traded stocks and bonds, and the financials of these companies are not as transparent. Private equity may also include hedge fund investments which are even more volatile.

And then there is “Other Trust Level” investments, where CalPERS has deigned to commit over $16 billion. In the footnotes to CalPERS Trust Level Quarterly Update, decipher this description: “Trust Level Financing reflects derivatives financing and repo borrowing in trust level Synthetic Cap Weighted and Synthetic Treasury portfolios.” Good luck with that. This is pre-financial crisis speculative behavior, the sort that almost brought down the entire financial system. To further put this in context, “Leverage” refers to money CalPERS borrowed in order to make additional investments, hoping those investments would earn more than they paid to borrow the money.

A financial blogger operating under the pseudonym “QTR” (Quoth the Raven), with thousands of subscribers on Substack, warned last week what could happen to U.S. pension funds, writing “The fact that these funds were unable to post the returns that they needed during arguably the most euphoric bull market in history is extremely concerning.”

If CalPERS is any example, indeed they could not. During the period from 2007 t0 2020, CalPERS went from 87 percent funded to 70 percent funded. Because annual pension benefit payments to government retirees in California are required to match inflation once the purchasing value of a pension falls to within 75-80 percent of its purchasing power upon retirement, inflation is going to drive the amount of the total pension liability up faster than the 6.4 percent it averaged over the past 14 years. CalPERS, and the other pension plans, are chasing a greyhound, and the engine is overheating.

California’s pension systems, to the extent they have matched CalPERS in diverting billions of dollars into private debt and equity, hedge funds, derivatives, and other highly speculative financial instruments, and financed these adventures with borrowed money, are stretched as far as they can go. California’s legislature needs to investigate the asset mix of state and local government pension systems and honestly appraise the exposure. Are they facing margin calls? Do they face liquidity risk?

As for the financial experts running California’s pension systems, they need to back away from speculative investments, deleverage, and tell the union lobbyists and their captive legislators the truth: We can no longer use creative accounting and high-risk investment strategies to perpetuate the perception of system stability.

This article originally appeared in the California Globe.

Post-Coronapocalypse Pension Reform Checklist for California

In a perfect world, California’s state and local public employees would receive exactly the same retirement benefits as federal employees. They would receive a modest defined benefit, a contributory 401K, and they would participate in Social Security.

Unfortunately, in California, while some state and local public employees are offered 401Ks, and many participate in Social Security, all of them rely inordinately on a defined benefit pension. Far from being modest, even the most minimal examples of defined benefit plans for California’s state and local government workers provide roughly twice the value of the typical defined benefit offered federal workers. And where there’s twice the value, there’s twice the cost.

In reality, however, twice the cost would be a bargain. It’s much worse than that, and very little has been done. In 2013, the PEPRA (Public Employee Pension Reform Act) legislation lowered pension benefit formulas in an attempt to restore financial sustainability to California’s public employee pensions. But these revisions, which resulted in defined benefit formulas only about twice as generous as the federal formulas, only applied to new employees.

California’s Pension Systems Were Crashing Before the Coronapocalypse

Two years ago, and after more than eight years of a bull market in the stock market indexes, CalPERS, which is by far the largest pension system in California, had already announced that contributions from participating agencies were going to roughly double. They posted “Public Agency Actuarial Valuation Reports” that disclosed the details per agency.

At the time, in partnership with researchers at the Reason Foundation, the California Policy Center used these reports from CalPERS to summarize the impact on 427 cities and 36 counties (download full spreadsheet). As shown on the table below, two sets of numbers are presented – payments to CalPERS for the 2017-2018 fiscal year, and officially estimated payments to CalPERS in the 2024-25 fiscal year.

The most important distinction one should make when reviewing the above data is the difference between the “normal” and the “catch-up” payments. The so-called “normal contribution” is the amount the employer has to contribute each year to maintain an already fully funded pension system. The “catch-up” or “unfunded contribution” is the additional amount necessary to pay down the unfunded liability of an underfunded pension system.

As can be seen in the example of Millbrae (top row, right), by 2024, the “catch-up” contribution will be nearly six times the amount of the normal contribution. But in the PEPRA reforms, new employees are only required to contribute via payroll withholding to 50 percent of the “normal” contribution.

A separate California Policy Center analysis, also published two years ago, attempted to estimate how much total payments statewide would increase if all of the major pension systems serving California’s state and local public employees were to require similar levels of payment increases. The analysis extrapolated from the consolidated CalPERS projections for their participating cities and counties and estimated that in sum, California’s state and local government employers would have paid $31 billion into the 87 various pension systems in 2018, and by 2024 this payment would rise to $59.1 billion.

As noted at the time, and now more than ever, this was a best case scenario.

A Financial Snapshot of CalPERS Today

The next chart, below, depicts financial highlights for CalPERS – either officially reported or projected – in a format which ought to be publicly disclosed, every quarter, in this format, from every state and local public pension system in California. The first two columns depict data as reported by CalPERS for their most recent two fiscal years, ended 6/30/2018 and 6/30/2019. The final column, which consists of CPC estimates (not provided by CalPERS), shows how their financial condition could appear three months from now.The first thing to note from the above chart is the fact that CalPERS was only 70 percent funded (“funded ratio,” bottom line) in June of 2019. The next thing to note, and this is crucial, is that the actuarial estimates of the total pension liability lags behind one year. That is, the $504.9 billion reported “actuarial accrued liability” is reported as of 6/30/2018, even though that figure is used to report the funded ratio as of 6/30/2019.

Take a deep breath, because the significance of this delay requires further discussion. From page 122 of CalPERS most recent CAFR, here are the trends for the actuarial accrued liability: 6/30/2009 = $294B, 2010 = $308B, 2011 = $328B, 2012 = $340B, 2013 = $375B, 2014 = $394B, 2015 = 413B, 2016 = 436B, 2017 = $465B, and 6/30/2018 = $504B. Based purely on the trend, is there any reason to believe this liability will not exceed $550 billion by June 30, 2020, two years later? Why isn’t that estimate being made?

There’s more. Why are actuaries permitted to have an entire extra year to complete their estimate of the total pension system liability, when changing single variables will cause the estimate to massively fluctuate? Sure, it is a complex exercise, and at some point an official calculation, based on all known data, should be reported that amends a preliminary estimate. But if, for example, you vary the earnings projection downwards from 7.0 percent to 6.0 percent – which needs to be done sooner not later – using calculations provided by Moody’s Investor Services, the amount of the CalPERS liability soars from $550 billion to $621 billion. You don’t split hairs when you’re being scalped.

And what about the employer contribution (second row of data)? Why did it go down from $20 billion in 2018 to $15 billion in 2019? From the “Basic Financial Statements” in the CalPERS CAFRs for the last few years, here are the totals for payments by employers: 2015 = $10.2B, 2016 (page 38-39) = $11.0B, 2017 = $12.4B, 2018 (page 40-41) = $20.0B. With the payment for FYE 6/30/2019 back down to $15.7B, the trends suggest that the large payment of $20.0 billion in 2018 was an anomaly. But assume that much money will come again from employers in 2020. But based on historical trends, probably not more than that. Yet.

Where does this put CalPERS?

All of this discussion is to explain the reasoning behind the figures in column three on the above chart. What might be materially different? What estimate isn’t best case? Does anyone believe CalPERS will actually break even in the return on their invested assets between 6/30/2019 and 6/30/2020? Does anyone believe the most accurate estimate of the total liability belongs anywhere south of $550 billion, particularly when they’re still using a discount rate that’s too high? And yet this puts CalPERS in what is arguably the worst shape it’s ever been, at 64 percent funded as of this June.

This paints a very grim big picture. CalPERS is on track to collect over $20 billion from taxpayers in the current fiscal year, and CalPERS, while the biggest pension system, only manages just over 40 percent of the state and local government pension assets in California. This suggests that the total taxpayer contribution to California’s state and local government pension systems in 2020 is already up to around $50 billion. And it isn’t nearly enough.

Steps to Reform CalPERS and all of California’s pension systems

1 – Admit the long-term rate of return projection is too high for calculating the value of pension liabilities. Move it down to 6 percent. Increase the required “normal contribution” accordingly, and, in turn, increase the share required from active employees via withholding.

2 – Once a more reasonable long term rate of return projection is adopted by the pensions systems, the goal of pension reform should be to stabilize pension system payments at some maximum percent of total personnel costs. With cooperation from union leadership, agree on what that maximum percent should be, then determine how to spread benefit reductions in an equitable manner between new hires, current employees, and retirees.

3 – For all state and local government employee pension plans in California, start providing consolidated quarterly financial summaries (without gimmicks), using the above chart as an example. Include a footnote indicating how much of the total employer contribution is for the unfunded liability vs the normal contribution.

4 – If a pension system falls below 80 percent funded, agree on an escalating series of remedies to be implemented to bring the funded ratio back up. They would include suspension of COLA, prospective further lowering of the annual multiplier for active workers, retroactive lowering of the annual multiplier for active workers, reduction of the retiree pension payment, and increasing the required payment to the pension plan by active workers via withholding.

5 – Pressure the California State Supreme Court to swiftly hear and rule on the cases Alameda County Deputy Sheriff’s Ass’n. v. Alameda County Employees Retirement Ass’n (filed 1/8/2018), and Marin Ass’n of Pub. Employees v. Marin Cnty. Employees Retirement Ass’n (filed 8/17/2016). These cases may provide clarity on the “California Rule,” which currently is interpreted as prohibiting lower pension benefit accruals, even for future work.

6 – With or without a decisive ruling (or any ruling) on the California Rule, work with government union leadership to revise pension benefits. If union leadership is uncooperative and the courts fail to offer an enabling ruling, than as a last resort, to bring the unions back to the negotiating table, lower salaries, current benefits, and OPEB benefits.

7 – In the long run, move towards a system modeled after the federal system. This would be a logical next step, following in the footsteps of PEPRA. It would create three basic tiers of public sector workers in California, the pre-PEPRA workers (who may submit to lower benefit accruals for future work), the post-2013 hires who are subject to the PEPRA reforms, and new hires starting in, for example, 2021, who would enjoy retirement benefits similar to what Federal employees receive.

The Ripple Effect of Unreformed Pensions

There are two problems with a bullish outlook today. First of all, the great returns of the past few years may have been unsustainable, a super bubble. And then that super bubble was not popped by a pin, but rather by a wreaking ball, the Coronapocalypse. There are tough economic times ahead.

In a severe downturn it is conceivable that annual taxpayer contributions to California’s public employee pensions systems will not merely soar from around $50 billion in 2020 to $60 or $70 billion within a few years. They could go even higher. For example, over the total three year period through June 2020, it is quite possible that CalPERS will collect more from taxpayers – $65 billion – than it will have earned in investment returns – $52 billion.

This is the new reality of public sector pensions in California. And because taxpayers have been increasingly on the hook to bailout these pensions, taxes have increased, services have been cut, and there has been a gradual wearing away of trust by citizens in their local governments. This is why, for the first time in decades, more local taxes and bonds were rejected by voters in March 2020 than were approved. Absent pension reform, this backlash has just begun.

So-called “crowding out” of other public services in order to pay for pensions doesn’t just impel an insatiable drive for higher taxes. It also works its way into higher fees, building fees in particular. Infrastructure investments such as connector roads and parks for new housing subdivisions used to come largely out of municipal operating budgets. It was a fair trade – the city builds the roads, the builders sell the homes, and the new residents pay taxes. But now, all of those costs are paid for by the builders and passed on to the home buyers. The rising cost of pensions can be directly tied to the unaffordable cost of homes.

Pensions for state and local government employees in California are literally three to five times as costly as Social Security, and at least twice as costly as the Federal Retirement System. Ultimately, this disparity divides Americans and undermines what it means to be an American citizen. Why should public employees care if Social Security is inadequate, if they don’t depend on it? Why should they care if all public benefits offered private taxpayers is diluted, or if citizenship itself becomes less meaningful, if their membership within the public sector is the primary source of their security?

America is entering difficult economic times. Maybe one good thing to come out of this will be a willingness on the part of public sector union leadership to make common cause with all of California’s workers, and agree to reasonable concessions on pensions that will help everyone living in this great state.

This article originally appeared on the website California Globe.

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CalPERS is Investing in Chinese Companies

On October 1st, 2019, the People’s Republic of China celebrated its 70th anniversary. The centerpiece of their festivities was a massive military parade down the streets of Beijing, and the centerpiece of that parade was China’s newest intercontinental ballistic missile, the Dongfeng-41. This missile travels at a speed of Mach 25, carries multiple nuclear warheads, and can reach the United States in under 30 minutes.

California’s public employees will be pleased to know that their retirement funds have invested in companies controlled by the Chinese military, which manufacture parts for the DF-41 missile, along with a range of aircraft, unmanned aircraft systems, and airborne weapons.

For that matter, these pension funds not only invest in Chinese companies (and index funds, tracked by mutual funds, that are heavily weighted with Chinese companies) directly involved in manufacturing military equipment and surveillance equipment, they also invest in Chinese companies involved directly or indirectly in human rights, labor rights, and environmental protection violations all over the world.

California’s largest public employee pension fund, CalPERS, provides a case in point. In search of the elusive and eternal 7 percent annual return, CalPERS nonetheless foregoes investments in Iran, Sudan, assault rifles, tobacco products, and thermal coal. But CalPERS continues to invest in Chinese companies.

A review of what is still the most recent report on CalPERS investments, dated 6/30/2018, show there is no summary wherein their international investments are subtotaled by country. A keyword search under “China” turns up 172 companies, partnerships, etc., nearly all of which (by virtue of their name) are probably based in China, with a total market value of $3.1 billion. This is obviously understating the total, since, for example, one of the listed companies, “Bank of Chongqing Co Ltd,” is almost certainly a Chinese company, but along with many others, is not within that total.

Roger Robinson, president and CEO of RWR Advisory Group, a Washington DC based risk consultancy, is an expert on U.S. investments in China. When reached for comment, he posed the following question, “Why would CalPERS hold in their investment portfolio Chinese and Russian companies either actively, or passively via index providers, that have been sanctioned by the U.S.?

Robinson, who earlier served as chairman of the congressional U.S./China Economic and Security Review Commission, elaborated on the risks facing pension funds that invest in China. “Doesn’t being sanctioned represent an asymmetric material risk to the share values and corporate reputations of these companies, and if so, are California’s public employees being properly protected as investors?”

Concerns about U.S. investment in China is spreading. Earlier this year, according to a press release from his office, U.S. Senator Marco Rubio (R, Florida) “requested information from MSCI, Inc. (MSCI) regarding the company’s controversial decision to add Chinese companies in its equity indexes. MSCI indexes are listed on U.S. stock exchanges and available to retail investors. The MSCI Emerging Market Index includes 24 countries with emerging economies, including China. Specifically, Rubio requested information regarding whether MSCI examined the potential for funding Chinese companies involved in the Chinese government and Communist Party’s military, espionage, human rights violations.”

Because mutual funds that collectively manage direct investments totaling several trillion dollars will mirror the selection and weighting of companies in the MSCI index, their decision to increase their holdings in Chinese companies offers a tangible benefit to those companies. It translates directly into increased U.S. investment into China by any pension system that includes MSCI tracking funds in their portfolios.

In response to a request for the total value of CalPERS investments in Chinese companies, CalPERS did not answer, offering an innocuous non-reply “CalPERS is a global investor, with holdings in approximately 49 countries. Our Annual Investment Report reflects all investments at the end of the most recent fiscal year.”

While there is a legitimate moral argument for constructive engagement governing investment policies, even with a nation as problematic as China, that argument becomes strained when examining certain companies that are part of the CalPERS investment portfolio.

A blistering report published by Bloomberg Businessweek in Sept. 2018 highlights abuses committed by China Communications Construction Co., which CalPERS owned shares in as of 6/30/2018. The in-depth article recounts fraudulent bidding practices, corruption, environmental violations, mistreatment of workers, national security concerns, and even a role in building Chinese military bases on reefs in disputed areas of the South China Sea. Bloomberg writes, “There’s no shortage of companies, including American ones, that have been accused of bribery and environmental damage when operating abroad. Yet the number and scope of allegations involving CCCC set it apart.”

Another Chinese company where CalPERS owns shares is China Aerospace International Holding, a subsidiary of China Aerospace Science and Technology Corp., which is operated by the People’s Liberation Army, and China Unicom, a company which, according to the Washington Post, helped build and operate North Korea’s internet network.

When contacted regarding its Chinese holdings, the following response came from CalPERS: “CalPERS has a fiduciary duty to ensure retirement benefits for our members after a career in public service. To that end, we will pursue and explore all legal investments that help us further that goal.”

While investing in China remains legal, it may be argued that these investments, at the very least, challenge CalPERS divestment principles. On page 15 of their Total Fund Investment Policy, human rights violations are an important focus.

When asked about how ongoing and escalating human rights violations by the Chinese regime in Xinjiang, Tibet, Inner Mongolia, Hong Kong, and within Central China could be reconciled with their divestment principles, the response from CalPERS was “CalPERS believes engagement with the companies we own is the most fruitful way to enact change. In limited cases, divestment decisions have been mandated by legislative action and by the Board in accordance with our policies.”

A troubling article published in Epoch Times in July 2019 exposed allegedly deep ties between the Chinese regime and the Chief Investment Officer at CalPERS, Yu Ben Meng. The article claims that Meng’s position as deputy CIO at China’s State Administration of Foreign Exchange (SAFE), which he occupied from 2015-2018, “have provoked controversy about the operations of the largest public retirement fund in the United States.”

SAFE  is responsible for managing over $3 trillion in foreign reserves controlled by China. According to Investopedia, “Its mandate includes the study and implementation of policy measures for the gradual advancement of the convertibility of the renminbi (CNY), China’s official currency.” Apart from the Chinese military, maybe, it’s hard to imagine an organization more central to the global strategy of the Chinese regime than SAFE. Meng’s role as deputy CIO with SAFE almost certainly put him in regular contact with the most powerful people in China.

CalPERS did not react favorably to a question about Meng’s role with SAFE. When asked “Is it plausible to assume that when the Chinese hired Mr. Meng to occupy a high ranking position with SAFE from 2015-2018, that the Chinese government relied on his loyalty to the Chinese regime,” the response was:

“Your suggestion is patently absurd, and frankly, offensive. Ben Meng is a United States citizen born in China. He is globally respected investor, serves as a member of the CFA Institute’s Future of Finance Advisory Council, and is an associate editor for the Journal of Investment Management. Mr. Meng has a Ph.D. from University of California, Davis. In addition, he not only has master’s degree in financial engineering from University of California, Berkeley, but has also taught at the Haas School of Business where he was the recipient of the Cheit Award for Excellence in Teaching. Mr. Meng was hired by CalPERS after a rigorous recruitment for the CIO position and was found to be the most qualified and best-positioned candidate to lead the investment office and to help ensure the security and sustainability of the CalPERS fund.”

This is indeed a touchy subject. But what happens if constructive engagement with China fails? What if the momentum of history finds the United States in another cold war, this time with China?

Here, quoted from People’s Daily (use Google translator), is Meng’s reaction in 2017 to working again in his native China, after moving to the U.S. at age 25, “In a person’s life, if there is an opportunity to work for the motherland, this responsibility and honor is unmatched by anything.”

This Chinese “motherland,” as reported earlier this month by NPR, is now “The U.S.’s top intelligence threat.”

Nathan Yu, an investigative reporter for Epoch Times who has covered communist China for years, had this to say when asked if Yu Ben Meng might have a conflict of interest as chief investment officer of CalPERS. “He was part of the Thousand Talent Plan which is operated by the Chinese regime, but we don’t have proof that he has ties to the Chinese Communist Party other than what is available to the public.” As reported in June 2018 by the South China Morning Post, “China’s “Thousand Talents” programme to tap into its citizens educated or employed in the US is a key part of multi-pronged efforts to transfer, replicate and eventually overtake US military and commercial technology, according to US intelligence officials.”

CalPERS did not respond to multiple follow up requests to disclose whether or not Yu Ben Meng has ever received a security clearance from the Chinese regime, or was ever a member of the Chinese communist party. In a follow up email, their statement read “We have no additional comments, other than what we’ve said: Ben is a U.S. citizen and an investor respected globally for his skill and integrity.”

Yu elaborated on the risks of investing in China, highlighting both a financial and moral hazard. “There are so many uncertainties when you go to China to invest. Most investors have not thought through the circumstances in China. It is a country without any transparency. A country that puts the communist party above the law. If there is ever serious instability going on in China against the ruling communist party they will use whatever means available to control the investments and financial markets. If anything like that happens it is a big risk to all the investments from the US in China.”

On the moral hazard of investing in China, Yu had this to say. “Of course it empowers the Chinese regime to have the money flowing in. The investment from the US to China empowers the Chinese regime and helps the regime to continue its human rights violations and persecution of religious groups. Investors really need to think about the values behind their investments. When Americans invest in China it violates our values and empowers the values we’re against – we empower the forces against transparency and rights of personal happiness. The Chinese regime has no respect for the right to pursue happiness.”

An August 2019 article in the Atlantic offers a sobering assessment of China’s intensifying espionage offensive against the United States. But the writer concludes with a caution against overreacting, pointing out “China is both a rival and a top trade partner. The economic and research relationship between the two countries benefits them both. At the same time, Chinese immigrants and visitors to America risk being unfairly targeted if U.S. officials fail to find the right balance.”

The challenges and controversy facing CalPERS is certainly bigger than who they’ve hired to be their CIO. There are gaping contradictions in their investment policies, which exclude nations like Iran and Sudan, yet favor nations like China which are just as repressive to their citizens, and pose a far greater threat to the security of the United States.

The risks and hazards of U.S. pension funds investing in Chinese companies, directly or indirectly, is not going away. In August of this year, U.S. Senator Jeanne Shaheen (D, New Hampshire), joined with Senator Rubio in a bipartisan effort to pressure the Federal Retirement Thrift Investment Board, which manages pension assets for federal employees, to “reverse a decision that is set to channel billions of US dollars into funding Chinese companies that they say support Beijing’s military, espionage and domestic security efforts.”

It’s worth asking Mr. Meng, along with all of his deputies in the CalPERS investment office: When are you going invest tens of billions in equity positions in California’s infrastructure projects? When are you going to accept lower rates of return, so you don’t have to chase emerging markets that include China, which is arguably the biggest security threat the United States has ever faced? And when are California’s public sector unions, to whom you answer, going to establish investment rules that benefit an American “belt and road” initiative, instead of furthering the strategic objectives of a murderous regime halfway around the world?

This article originally appeared on the website California Globe.

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How Much Will YOUR City Pay CalPERS in a Down Economy?

When evaluating the financial challenges facing California’s state and local public employee pension funds, a compelling question to consider is just how much more will they demand from their clients in the next economic downturn?

It’s noteworthy that CalPERS still hasn’t issued their actuarial analyses for the period ending 6/30/2018, even though a year ago, the 6/30/2017 analyses were available. Could it be related to the fact that the DJIA index on 10/01/2018 was 26,447 and as of midday 10/01/2019 it sits at 26,599? Between 6/30/2018 and 6/30/2019, did CalPERS have a bad year? And what does that mean?

What is alarming in the case of CalPERS and other public sector pension funds is the relentless and steep rate increases they’re already demanding from their participating employers. Equally alarming is the legal and political power CalPERS wields to force payment of these rate increases even after municipal bankruptcies where other long-term debt obligations are diminished if not completely washed away.

Until California’s local governments have the legal means to reform pension benefits, rising pension contributions represent an immutable, potentially unmanageable financial burden on them.

San Marino’s Payments to CalPERS Will Nearly Double by 2025

The City of San Marino, a small Southern California town with barely 13,000 residents, nonetheless offers a typical case study on the impact growing pension costs have on public services and local taxes. Using CalPERS own records and official projections, the City of San Marino paid $3.0 million (not including employee contributions) to CalPERS in their fiscal year ended 6/30/2017. That was equal to 32% of the base salary payments made in that year. By 2025, the City of San Marino is projected to pay $5.1 million to CalPERS, equal to 46% of base pay.

Can the City of San Marino afford to pay an additional $2.1 million per year to CalPERS, on top of the $3.0 million per year they’re already paying? They probably can, but at the expense of either higher local taxes or reduced public services, or a combination of both. But the story doesn’t end there.

The primary reason required payments to CalPERS are nearly doubling over the next few years is because CalPERS was wrong in three critical estimates: how much their pension fund could earn, how much would be paid to retirees, and how much their client agencies had to pay to stay current or catch up. They could still be wrong.

Annual pension contributions are are split into two categories:

(1) How much future pension benefits were earned in the current year, and how much money must be set aside in this same year to earn interest and eventually be used to pay those benefits in the future? This is called the “normal contribution.”

(2) What is the present value of ALL outstanding future pension payments, earned in all prior years by all participants in the plan, active and retired, and by how much does that value, that liability, exceed the amount of money currently invested in the pension fund? That amount is the unfunded pension liability, and the amount set aside each year to eventually reduce that unfunded liability to zero is called the “unfunded contribution,” or, in plain English, the catch-up payment.

Both of these annual pension contributions depend on a key assumption: What rate-of-return will the pension fund earn each year, on average, over the next several decades? And it turns out the amount that has to be paid each year to keep a pension system fully funded is extremely sensitive to this assumption. The reason, for example, that CalPERS is doubling the amount their participating employers have to pay each year is largely because they are gradually lowering their assumed rate of return from 7.5% per year to 7.0% per year. But what if that isn’t enough?

If the Rate-of-Return CalPERS Earns Falls, Payments Could Rise Much Higher

It isn’t unreasonable to worry that going forward, the average rate of return CalPERS earns on their investments could fall below 7.0% per year. For about a decade, nearly every asset class available to investors has enjoyed rates of appreciation in excess of historical averages. Yet despite being at what may be the late stages of a prolonged bull market in equities, bonds, and real estate, the City of San Marino’s pension investments managed by CalPERS were only 74% funded. As of 6/30/2017 (still the most recent data CalPERS currently offers by agency), the City of San Marino faced an unfunded pension liability of $29 million.

As it is, using CalPERS own estimates, by 2025 the City of San Marino is already going to be making an unfunded contribution that is nearly twice their normal contribution. Another reason for this is because CalPERS is now requiring their participating agencies to pay off their unfunded pension liabilities in 20 years of even payments. Previously, in an attempt to minimize those payments, agencies had been using 30 year payoff terms with low payments in the early years.

Nobody knows what the future holds. The following chart shows how that might play out in the City of San Marino. Notice how at a 4% rate-of-return projection, in 2018-19 the City of San Marino would have had to pay CalPERS $10.1 million; at 3%, $11.8 million.

San Marino is a wealthy community. The median household income of $147,960 is more than twice the median for California of $67,739 (ref. City-Data.com, figures for 2016). But with total municipal expenses of $26.2 million in the fiscal year ended 6/30/2017 (ref. San Marino CAFR, page 10), even San Marino’s budget can be stressed by pension expenses. CalPERS has projected the city’s pension contribution will rise to $5.1 million by 2025, which is 19 percent of total expenses.

At what point do these payments become too burdensome? What if investment returns settle down to an average of only 6 percent per year – can San Marino afford to pay CalPERS the resulting estimate of $7.0 million per year? What about at an even lower 5 percent return – can San Marino afford to pay CalPERS an estimated $8.5 million per year? And what about the employees? Will they start to pay more via payroll withholding? In 2017-18, employees only contributed $767,000 out of $3.8 million.

What about the rest of California?

How would a downturn affect all of California’s public employee pension systems, the agencies they serve, and the taxpayers who fund them? In a CPC analysis published in 2018, “How to Assess Impact of a Market Correction on Pension Payments,” the following excerpt provides an estimate:

“If there is a 15% drop in pension fund assets, and the new projected earnings percentage is lowered from 7.0% to 6.0%, the normal contribution will increase by $2.6 billion per year, and the unfunded contribution will increase by $19.9 billion. Total annual pension contributions will increase from the currently estimated $31.0 billion to $68.5 billion.”

That’s a lot of billions. And as already noted, a 15% drop in the value of invested assets and a reduction in the estimated average annual rate-of-return from 7.0% to 6.0% is by no means a worst case scenario.

To-date, meaningful pension reform has been thwarted by powerful special interests, most notably pension systems and public sector unions, but also many financial sector firms who profit from the status quo. Ongoing court challenges, along with growing public pressure on local elected officials, may eventually offer relief. For these reasons, raising taxes and cutting services in order to fund pensions may eventually become a false choice.

This article originally appeared on the website of the California Policy Center.

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REFERENCES

CalPERS Annual Valuation Reports – main search page
CalPERS Annual Valuation Report – San Marino, Miscellaneous Employees
CalPERS Annual Valuation Report – San Marino, Miscellaneous, Second Tier
CalPERS Annual Valuation Report – San Marino, Miscellaneous Employees (PEPRA)
CalPERS Annual Valuation Report – San Marino, Safety Employees, Fire, Second Tier (PEPRA)
CalPERS Annual Valuation Report – San Marino, Safety Employees, Police (PEPRA)
CalPERS Annual Valuation Report – San Marino, Safety Employees, Fire, First Tier
CalPERS Annual Valuation Report – San Marino, Safety Employees, Fire, Second Tier
CalPERS Annual Valuation Report – San Marino, Safety Employees, Police
CalPERS Annual Valuation Report – San Marino, Safety Employees, Police, Second Tier

Moody’s Cross Sector Rating Methodology – Adjustments to US State and Local Government Reported Pension Data (version in effect 2018)

California Pension Tracker (Stanford Institute for Economic Policy Research – California Pension Tracker

Transparent California – main search page
Transparent California – salaries for San Marino, 2018
Transparent California – pensions for San Marino 2018

The State Controller’s Government Compensation in California – main search page
The State Controller’s Government Compensation in California – San Marino payroll, 2018
The State Controller’s Government Compensation in California – raw data downloads

California Policy Center – Resources for Pension Reformers (dozens of links)
California Policy Center – Will the California Supreme Court Reform the “California Rule?” (latest update)

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The Coming Impact of Pension Payments on California’s Cities, and How Reforms Could Happen

AUDIO: Part One – Employer contributions to pension systems for state/local workers are set to double in the next six years, best case. Ways agencies are trying to increase taxes and cut services to find the money – 10 minutes on 1440 AM KUHL Santa Barbara – Edward Ring on the Andy Caldwell Show.

AUDIO: Part Two – A discussion of how California’s pension crisis began, what potential reforms could make pensions financially sustainable, and the organizations that could successfully push these reforms – 10 minutes on 1440 AM KUHL Santa Barbara – Edward Ring on the Andy Caldwell Show.

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Pricing A Taxpayer Bailout of California’s Pensions

Last month both of California’s largest government employee pension funds, CalPERS and CalSTRS, released their portfolio earnings numbers for the most recent twelve months. In a statement released on January 24th, “CalSTRS Calendar Year-End Investment Returns Show Slight Gains,” CalSTRS disclosed “Investment returns for the California State Teachers’ Retirement System (CalSTRS) ended the 2011 calendar year posting a 2.3 percent gain.” CalPER’s statement released on January 23rd, was titled “[CalPERS} Pension Fund earns 1.1 percent return for 2011 calendar year.”

These funds, and the rest of California’s many local government employee pension funds, are still clinging to long-term rate of return assumptions of between 7.5% and 7.75% per year. So how much would taxpayers be on the hook for if rates of return stay this low?

The first step towards determining this would be to estimate the average pension paid out to a state or local worker in California, based on recent retirees who have worked a full 30 year career. Despite the claim that “The average CalPERS pension is $2,220 per month” (made yet again in the final paragraph of their above-referenced press release), for a more accurate figure, one must look at the average pension awarded recent retirees, based on a full 30+ year career. The problem with the low figure used by CalPERS and others is that it includes people who retired decades ago when salaries and pension benefit formulas were much lower, and it includes people who may have only worked a few years for the government. Since we will be multiplying this average pension by the number of full time state and local government workers in California, we have to assume a full career when calculating the average pension, since for every worker who only worked 10 years, for example, two additional retirees will also be in the system who have themselves also only worked 10 years. To calculate the cost of a full-career pension, you have to add all three of these part-career retirees together. Here is what these pensions really average, based on CalPERS Annual Report FYE 6-30-11 (page 153), and CalSTRS Annual Report FYE 6-30-11, (page 149):

CalPERS average final salary for 30 years work, retiring 2010: $82,884
CalPERS average pension for 30 years work, retiring 2010: $60,894  –
Pension equals 73% of final salary (average of 25-30 year and 30+ year stats)

CalSTRS average final salary for 30 years work, retiring 2010: $88,164
CalSTRS average pension for 30 years work, retiring 2010: $59,580  –
Pension equals 68% of final salary (average of 25-30 year and 30-35 year stats)

If one extrapolates the CalPERS and CalSTRS data to the many independent pension funds serving local agencies – many of these are quite large, such as the one for Los Angeles County employees – it is probably conservative to peg the average pension going forward for full-career government workers in California at at least $60,000 per year, and at least 70% of final salary.

The next step in figuring out how much state and local government worker pensions could cost California’s taxpayers in the future is to establish the sensitivity of pension contribution rates to changes in the rate of return of pension funds. CIV FI has explored this question repeatedly, with a good summary in the July 2011 post entitled “What Percent of Payroll Will Keep Pensions Solvent?” Using the same financial assumptions as were used in that analysis, here is how the required pension contribution rates – expressed as a percent of payroll – change in response to lower earning rates for the pension funds. This is based on pensions averaging 70% of final salary, and assumes 30 years working, 25 years retired, and salary (in real dollars) eventually doubling between hire date and retirement date:

If the pension fund’s return is 7.75%, the contribution rate is 22% of payroll.
If the pension fund’s return is 6.75%, the contribution rate is 28% of payroll.
If the pension fund’s return is 5.75%, the contribution rate is 37% of payroll.
If the pension fund’s return is 4.75%, the contribution rate is 48% of payroll.
If the pension fund’s return is 3.75%, the contribution rate is 63% of payroll.

What the above figures quickly indicate is not only that the required payroll contributions go up sharply when projected rates of investment return come down, but that the lower the rate of return goes, the more sharply the required contribution rises.

To complete this analysis, one only needs to multiply the number of full time state and local government employees in California by the average payroll for these employees, and multiply that result by the various required contribution rates. Using 2010 U.S. Census data for California’s State Employees and for California’s Local Government Employees, one can quickly determine that there are 339,430 state workers earning on average $68,880 in base annual salary, and there are 1,185,935 local government workers earning on average $69,399 in base annual salary.

To sum this up, there are currently 1,525,365 full time (not “full-time equivalent,” which would be an even higher number, but those part-time employees may or may not have pension benefits) state and local government employees in California. They earn, on average, $69,284 per year in base pay. Here is how much pensions will cost for these workers each year based on various rates of return:

If the pension fund’s return is 7.75%, the state pays $23 billion to pension funds each year.
If the pension fund’s return is 6.75%, the state pays $29 billion to pension funds each year.
If the pension fund’s return is 5.75%, the state pays $39 billion to pension funds each year.
If the pension fund’s return is 4.75%, the state pays $51 billion to pension funds each year.
If the pension fund’s return is 3.75%, the state pays $66 billion to pension funds each year.

It is interesting to note that both CalPERS and CalSTRS failed to even achieve a 3.75% return in calendar year 2011, the lowest amount used in these examples and the lowest amount that can even keep pace with inflation.

When one takes into account the fact that only about five million households in California pay net taxes, the impact of the pension con job Wall Street brokerages have enlisted the support of public sector unions to foist onto taxpayers is even more dramatic. Because if, during the great deleveraging that likely will consume this economy for at least another decade, California’s pension funds only deliver 3.75% per year, instead of 7.75% per year, that will translate into $8,600 per year in new taxes for each and every taxpaying California household.

Government Pensions Increasing Hedge Fund Investing

In less than five years California will have over 10 million residents who are over the age of 55 (ref. U.S. Census, California Demographics). If every one of these people were to receive a pension equivalent to what the average public employee in California can now expect after working full-time for no more than 30 years, it would cost taxpayers nearly $700 billion per year. To put this in perspective, $700 billion is 40% of California’s entire gross domestic product.

When spokespersons for California’s public sector unions claim that pension reformers are “trying to destroy the middle class,” they should be asked this question: How on earth can any system of retirement security – not even including health insurance benefits – possibly expect to consume 40% of the entire economic output of the state or nation in which such benefits are being provided, and yet remain financially sustainable? Universal and equitable retirement security in America will never be realized by offering everyone the deal that public sector employees currently receive. Their benefits must be reduced. But instead, government worker pension funds are making riskier investments.

Public sector pension funds rely on investment returns to make up for the shortfalls in taxpayer revenues. But can investment returns really hope to sustain public sector pensions when there are as many people drawing pensions out of the fund as there are people (and taxpayers) contributing money into the fund? That tipping point, where there is as much money going out as there is going in, has not yet been reached, since most pensioners in the system currently are drawing benefits that were calculated when pensions formulas were far less generous. For example, a teacher who retired in 1985 and is still alive will receive today a pension of barely $30,000 per year. A teacher of the same seniority retiring in 2010 after a 30 year career will receive a pension on average of $70,000 per year. This same sort of disparity applies across all public sector disciplines, and is the reason there is still more money going into public sector pensions than is being paid out. Once these pension funds start selling as many securities as they are buying, even more downward pressure will apply to stock prices than already applies.

As documented in “What Percent of Payroll Will Keep Pensions Solvent?,” for every 1.0% that the rate of return for a pension fund falls, the required contribution into the pension fund must increase by about 10% of payroll. This means, for example, that if CalPERS lowers their projected rate of return from 7.75% per year down to 6.75%, the contributions their members (or taxpayers) will have to invest in CalPERS every year will rise from (for example) 20% of payroll to 30% of payroll. It is difficult to overstate just how dire the pressure is on public sector pension funds to claim they can continue to earn 7.75% per year.

One way that public sector pension funds are trying to maintain their rate of return is by investing in hedge funds. These virtually unregulated funds utilize manipulative tactics to extract larger than market returns – often at great risk. But to beat the market, someone else has to lose. Public sector pension funds investing in hedge funds are encouraging a phenomenon – market manipulation – that is driving value investors and small private investors out of the market altogether. As reported in the Wall Street Journal on October 18th in an article entitled “Traders Warn of Market Cracks,” the dominance of program trading and other manipulative tactics is taking taking liquidity out of a market that is already in trouble:

“One surprising element of the fall-off in liquidity is that one key set of players actually appears to be more active in recent months: so-called high-frequency traders. These hedge funds use computer models to trade at a rapid pace. In recent years they have replaced brokerage firms as the go-betweens when investors trade stocks. But with so many other players stepping back from the market, the liquidity that high frequency traders are providing isn’t creating much of a cushion, traders say. In fact, some say they may be making matters worse.”

Yet public sector pension funds have to invest in hedge funds. They have to be high-risk players, exploiting the tactics that value investors would never consider and small investors could never afford – and THIS is the reason they claim they can outperform the small investors – because without these high-risk, manipulative, barely-legal, market-killing, short-term acts of desperation, they would already have to admit they cannot possibly earn 7.75% per year. And their actions only postpone that admission.

Here are some examples of how much money is now being poured into hedge funds by public sector pension funds, as documented in Private Investor Online:

“The New Jersey Division of Investment, which manages the state’s $71.6 billion in public pension assets, could put as much as $10.7 billion in hedge funds if it moves to a full 15% allocation. That would make the New Jersey fund the second largest hedge fund investor among P&I’s top 200 pension funds.

Another large pension fund looking to increase its hedge fund limit is the $108 billion Texas Teacher Retirement System, Austin.

Another Lone Star State fund, the $18 billion Texas County & District Retirement System, Austin, in March increased its target allocation to hedge fund as part of a new asset mix, confirmed Paul J. Williams, investment officer.

After two years of study, Connecticut Retirement Plans & Trust Funds, Hartford, finally moved its first $200 million into hedge funds, investing $100 million each in funds of funds with Prisma Capital Partners and Rock Creek Group.

The State of Wisconsin Investment Board, Madison, which oversees $83.3 billion, last year began to search for single and multistrategy hedge fund managers to run a total of $1.4 billion, as part of the rollout of its new hedge fund allocation;

The $154.7 billion Florida State Board of Investment, Tallahassee, early last year invested $250 million each directly in three activist hedge funds, but did not create a dedicated hedge fund allocation with a 6% target until June. Investment staff is at work getting the first 2% or $2.2 billion invested directly in single and multistrategy funds.

Colorado Fire & Police Pension Association, Greenwood Village, took its absolute-return investments down to zero in 2009 from 5%. The fund set a new 11% absolute-target and restructured the allocation to invest about 70% in hedge funds and 30% in commodities.

After nearly six years of study, three of the five pension fund systems within the $113.4 billion New York City Retirement Systems finally made large first-time hedge fund investments last month.”

Distilling all this arcana yields chilling realities. The public sector unions who claim Wall Street is to blame for our economic challenges are actually collection agents for Wall Street, at the same time as they are a corrupting influence on Wall Street. Year after year, they pour hundreds of billions of dollars of taxpayer’s money into some of the seamiest investment vehicles ever invented, bankrupting our cities and states to collect their tithe. At a time when assets are deflating everywhere, when the federal government is issuing 10 year notes at under 3%, the public employee pension funds are claiming they will continue to earn 7.75% on their money. They are essentially lending money at 7.75%, a grossly over-market rate, and forcing the smaller, private investors in the market to cover the difference.

If the market crashes again, and it might, look no further than your local public employee pension fund campus, that beachhead of Wall Street at its worst, to find an avid culprit. Public sector pensions are not sustainable, and the notion that they are is Wall Street’s last, biggest con.

Public Safety Compensation Trends, 2000-2010

Today’s Wall Street Journal published an article by Phil Izzo entitled “Bleak News for Americans’ Income,” where, citing U.S. Census Data, it was reported that U.S. median household income – adjusted for inflation – fell by 7% over the past ten years. In constant 2010 dollars, the average household in the U.S. saw their income drop from about $54,000 per year in 2000 to just under $50,000 today.

When debating what level of compensation is appropriate and affordable for public safety personnel, the average income of private sector workers is an important baseline. It provides context for determining whether or not the premium paid to public safety employees – for the risks they take – is exorbitant or fair. The trend of the past ten years is also an important baseline when making this comparison. For example, if the level of risk, the value we place on safety and security, and the degree of training required for public safety personnel have all elevated over the past decade – and they have – does this justify their pay increases exceeding the rate of inflation? Even over this past decade, when ordinary private sector workers have seen their total pay and benefits decrease by 7% relative to inflation?

Here then, also relying on U.S. Census data (ref. 2010 Public Employment and Payroll Data, State Governments, California, and 2010 Public Employment and Payroll Data, Local Governments, California, along with 2000 Public Employment and Payroll Data, State Governments, California, and 2000 Public Employment and Payroll Data, Local Governments, California), are the rates of base pay and pension obligations for California’s public safety personnel in 2000 (adjusted for inflation and expressed in 2010 dollars), and 2010, starting with Firefighters:

Several points on the table above bear explanation. These numbers reference firefighters who, typically, work 24 hour fire suppression shifts, and do not include administrative personnel. These work schedules usually involve three 24 hour shifts on duty, followed by six days off. If a firefighter works more than three out of every nine days, they receive overtime, which is included in these numbers. Worth noting is that when adjusting for vacation, the average mid-career firefighter in California works two 24 hours shifts every seven days, earning overtime for whatever extra days they work beyond that. Not included in these figures are any current benefits, including health insurance, or funding set-asides to cover retirement health insurance. We published a complete work-up of the total compensation of firefighters in August 2010 in a post entitled “California Firefighter Compensation.” In that analysis, the total compensation of the average Sacramento firefighter was estimated at $180,000 per year.

It is also important to explain the rationale behind the higher estimated pension costs (as a percent of salary) between 2000 and 2010. It was around 2000, and for several years afterward, that the “2.0% at 50″ benefit for public safety personnel was changed to the current “3.0% at 50″ formula – retroactively. The so-called “2.0% at 50″ formula meant that a firefighter was eligible to retire at any time after turning 50 years old, and would receive a pension equivalent to the number of years they worked, times 2.0%, times the salary they earned in their final year working. The “3.0% at 50″ formula increased this benefit, logically, by 50%. A firefighter now can retire any time after turning 50 years of age with a pension equivalent to the number of years they worked, times 3.0%, times the salary they earned in their final year working. The numbers shown on this table and the others, which represent the funding requirements per year expressed as a percent of salary, reflect the 50% increase required. These percentages assume 30 years working and 25 years retired, and they assume CalPERS will continue to earn 7.75% per year on their investments – 4.75% after adjusting for inflation. These are very conservative numbers, and indeed, most government agencies already set aside more than this into public safety pension funds. For much more on these calculations, refer to our analysis “What Payroll Contribution Will Keep Pensions Solvent?,” posted in July 2011, as well as the many links referenced as footnotes after the text and before the reference tables.

Here are pay and pension trends between 2000 and 2010 for California’s police officers:

And here they are for California’s correctional officers:

Here is a summary of this data: During the decade between 2000 and 2010, a period when, adjusting for inflation, household income for private sector workers fell by 7.0%, California’s firefighters saw their pay and pension benefits (after adjusting for inflation) increase by 33%, police officers saw their pay and pension benefits increase by 28%, and corrections officers saw their pay and pension benefits increase by 19%.

The next table attempts to quantify these costs in terms of their impact on California’s taxpaying households. While there are 12 million households in California, once you eliminate the nearly 50% of households who pay no net taxes, and the 15% (estimate) of households whose primary income comes from a government job, you’re down to about 5 million households. Corporate taxes, which presumably could cover some of these costs, are passed onto consumers in the form of higher prices. And these costs do not include anything other than pay and pensions – none of the other payroll overhead.

The above figures, all extrapolated from the data presented on the previous charts or from the U.S. Census Bureau’s tables linked to earlier, show salary and pension costs for California’s nearly 200,000 public safety personnel, expressed in billions. The first figure, $21.8 billion, is the estimated amount currently expended per year for base pay (including overtime) plus pension funding. The second figure, $25.2 billion, shows how much that amount will increase if CalPERS lowers their pension fund return on investment projection from 7.75% to 5.75%. The third figure, $17.4 billion, is how much base pay and pension funding for public safety employees would cost taxpayers in California if their base pay and pension benefits had merely kept pace with inflation, instead of escalating at a rate between 19% (correctional officers), 28% (police officers), or 33% (firefighters) greater than the past decade’s inflation. Finally, the fourth figure, $16.2 billion, shows how much taxpayers would pay to fund public safety base pay and benefits in California if, instead of increasing their pay and benefits during a period when everyone else was getting paid less, they took 7% cuts to their pay and benefits – i.e., did not see their income rise quite as fast as the rate of inflation.

Between 2000 and 2010, not only public safety personnel, but all state and local employees in California saw increases to their pay and benefits that exceeded the rate of inflation. The reasons for the decline in real income in the private sector are many and complex; globalization, increased productivity and overcapacity, the obsolescence of middle-management and skilled jobs – lost to office automation and robotic manufacturing – unsustainable and maxed debt accumulation, over-regulation, under-regulation, and of course, insufficiently progressive taxation and insufficient taxes on wealthy individuals and corporations – or is it the lack of a universal flat tax and excessive taxes on everyone? It depends on who you ask. But for the five million households in California who do pay taxes, it is fair to wonder what level of compensation is equitable for public safety personnel, and why their compensation has increased by double-digits (after inflation) during a time when private sector incomes have gone down.