Tag Archives: Joe Nation

Loyalton, CA and the cost of faulty actuarial assumptions

The New York Times has an interesting piece on the pension troubles facing the small town of Loyalton, California (population 769). Loyalton has seen little economic activity since its sawmill closed in 2001. In 2010 the city made a decision to exit Calpers saving the city $30,000. The City Council thought that the decision to exit would only apply to new hires and for the next three years ceased paying Calpers. Four of the the pension plan’s participants are retired and one is fully vested.

In response, Calpers sent the town a bill for $1.6 million – the hypothetical termination liability – for exiting the plan. For years Loyalton operated under the assumptions built into Calpers’ system which values the liability based on asset returns of 7.5 percent. This actuarial value concealed reality. Once a plan terminates Calpers presents employers with the real bill: or the risk-adjusted value of its pension promises based on a bond rate of 3.25 percent.

To see how big a difference that makes to the bottom line for cities, Joe Nation, Stanford professor, has built a very helpful tool that compares the actuarial liability of pension plans with the market value for individual governments in California.

The judge in the Stockton bankruptcy case Christopher Klein characterized the termination liability as presenting struggling towns with a “poison pill” for leaving the system. Another way to look at it is that the risks and costs that were hidden by faulty accounting assumptions based on risky discount rates are coming due as Calpers fails to hit its investment target. The annual costs may start to be shifted, and in the case of termination, fully imposed on local employers.

The four retirees of Loyalton are facing the possibility of drastically reduced pensions. In a town with annual revenues of $1.17 million, Calpers’ bill is far beyond the town’s ability to pay. Negotiations between Calpers and Loyalton are likely to continue. Some ideas floated include putting a lien on the town’s assets or revenues.

 

California’s $500 billion pension shortfall

A new study estimates California’s pension shortfall at $500 billion. Employing a risk-free discount rate, this estimate is far higher than the $142.6 billion estimated by the state. Currently California assume a 7.75 percent discount rate for two plans: CalPERS and CalSTRS, and a 7.5 percent discount rate for UCRP. It’s an amount that is too large to be addressed solely by future benefit cuts. These findings haven’t been received very warmly by State Treasurer Bill Lockyear who says the estimate relies on an overly-low discount rate. Contrary to the Treasurer’s assessment, estimating pension liabilities isn’t about cherry-picking numbers but instead about how to accurately value pension liabilities which are guaranteed by the state of California, and thus should be considered safe and risk-free by beneficiaries.

Such a massive shortfall means bad news for California’s budget and fiscal outlook. The share of pensions in California’s budget will have to triple. Stanford professor, Joe Nation, author of the study and a former Democratic Assemblyman warns that each day the state does nothing it costs $3.4 million.

The study  finds that CalPERS under assumed rate of return of 7.75 percent has an 82 percent chance of its assets falling short of obligations. To meet the problem Nation proposes higher employee contributions, taxes, and reducing plan costs by increasing the retirement age, reducing benefit formulas, and moving to a hybrid Defined Benefit/Defined Contribution system. In addition, he critiques Governor Brown’s proposal. For more, read the study, which contains some very interesting data and analysis.