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Ed Ring | California Policy Center
“The bottom line is that claiming the unfunded liability cost as part of an officer’s compensation is grossly and deliberately misleading.”
– LAPPL Board of Directors on 08/07/2014, in their post “Misuse of statistics behind erroneous LA police officer salary claims.”
This assertion, one that is widely held among representatives of public employees, lies at the heart of the debate over how much public employees really make, and greatly skews the related debate over how much pension funds can legitimately expect to earn on their invested assets.
Pension fund contributions have two components, the “normal contribution” and the “unfunded contribution.” The normal contribution represents the present value of future retirement pension income that is earned in any current year.
For example, if an actively working participant in a pension plan earns “3 percent at 55,” then each year, another 3 percent is added to the total percentage that is multiplied by their final year of earnings in order to determine their pension benefit. That slice, 3 percent of their final salary, paid each year of their retirement as a portion of their total pension benefit, has a net present value today – and that is funded in advance through the “normal contribution” to the pension system each year.
But if the net present value of a pension fund’s total future pension payments to current and future retirees exceeds the value of their actual invested assets, that “unfunded liability” must be reduced through additional regular annual payments.
Without going further into the obscure and complicated weeds of pension finance, this means that if you claim your pension plan can earn 7.5 percent per year, then your “normal contribution” is going to be a lot less than if you claim your pension plan can only earn 5.0 percent per year.
By insisting that only the cost for the normal contribution is something that must be shared by employees through paycheck withholding, there is no incentive for pension participants, or the unions who represent them, to accept a realistic, conservative rate of return for these pension funds.
This is an amazing and gigantic loophole, with far reaching implications for the future solvency of pension plans, the growing burden on taxpayers, the publicly represented alleged financial health of public employee pension systems, the impetus for reform, and the overall economic health of America.
Gov. Jerry Brown’s Public Employee Reform Act (PEPRA) calls for public employees to eventually pay 50 percent of the costs to fund their pensions, this phases in over the next several years. But this 50 percent share only applies to the “normal costs.”
In a 2013, California Policy Center analysis of the Orange County Employee Retirement System, it was shown that if they reduced their projected annual rate of return from the officially recognized 7.50 percent to 4.81 percent, the normal contribution would increase from $410 million per year to $606 million per year.
In a 2014 CPC analysis of CalSTRS, it was shown that if they reduced their projected annual rate of return from the officially recognized 7.50 percent to 4.81 percent, the normal contribution would increase from $4.7 billion per year to $7.2 billion per year.
The rate of 4.81 percent used in these analyses was not selected by accident. It refers to the Citibank Liability Index, which currently stands at 4.19 percent. This is the rate that represents the “risk free” rate of return for a pension fund. It is the rate that Moody’s Investor Services, joined by the Government Accounting Standards Board, intends to require government agencies to use when calculating their pension liability. As can be seen, going from aggressive return projections of 7.5 percent down to slightly below 5.0 percent results in a 50 percent increase to the normal contribution.
Tags: CalPERS, pension
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