CalPERS cuts state payment

For the first time in five years, the state's contribution to employee pensions will fall as the California Public Employees' Retirement System enacts a plan aimed at smoothing out the impact of stock market fluctuations.

On Wednesday, trustees unanimously approved trimming the state's pension contribution by 4.7 percent to $2.43 billion for the coming fiscal year.

CalPERS is hoping the plan will fend off calls from Gov. Arnold Schwarzenegger and other Republicans to replace traditional retirement plans that guarantee set benefits with 401(k)-style investment accounts.

"I'm hoping this gives the governor and the administration some relief where they can say we're trying to solve the problem and help the employers in the long run," said Rob Feckner, president of CalPERS, the nation's largest public pension plan with $182.9 billion in assets.

Over the years, the state's annual pension contribution has swung wildly - from $1.2 billion in 1998 to $156.7 million in 2000 to $2.55 billion this year.

No one shrieked over volatility as the roller coaster clacked upward during the 1990s stock market boom. But now that it's screaming downhill, government leaders from California to Florida are howling about the burden of skyrocketing pension contributions and widening shortfalls.

The Wall Street run-up generated investment gains that allowed state and local governments to skip pension plan payments for several years. While everyone knew it wouldn't last forever, no one expected the end would be the worst three-year stock market decline in decades.

"It was a much steeper decline than we would have anticipated," said Ed Derman, deputy chief executive officer of the $125 billion California State Teachers' Retirement System.

"There's nothing we can point to that is similar," said Ken Kent, vice president of pensions for the American Academy of Actuaries. "To have a market go down three years in a row, even the smoothing can't help mitigate the dramatic increase in costs."

Healthy pension fund surpluses disappeared even as governments saw revenue from sales and income taxes dwindle. Yet states, school districts and counties were forced to dramatically boost pension contributions to make up for stock market losses.

Nationwide, about three-quarters of the country's largest state and local public pension plans were underfunded by 2003, according to a survey released last September by the National Association of State Retirement Administrators and the National Council on Teacher Retirement.

The report also reveals how quickly the funding level for 117 plans eroded - from a 100.9 percent surplus in fiscal 2001 to 96.3 percent in 2002 and 91.1 percent the following year. That means retirement plans were then 8.9 percent short of the cash needed on hand to cover retirement benefits in 20 to 30 years.

It's unknown whether the situation has improved since more recent figures are not available.

This volatility cannot be completely avoided, pension experts say, because the performance of public pension funds is inextricably linked with business and economic cycles. That was not always so.

In the late 1980s, funds started pouring money into stocks to ensure there would be enough money to cover a massive surge in retirees - the product of a graying baby-boom generation and longer life expectancies.

The strategy paid off during the Wall Street boom. At CalPERS, for example, assets soared from $38.2 billion in 1987 to $172.5 billion in 2000 as the fund racked up 14 consecutive years of investment gains.

"Everybody was making money with equities. You could negotiate improvements to your benefits, and it didn't cost you anything," Kent said. "It's very hard to say, 'Let's get real conservative.' Those excess returns should have been banked."

Instead, employer contributions were lowered or postponed. But the bear market socked CalPERS with a combined $19.9 billion in losses in fiscal 2001 and 2002 and put most government pension plans in a financial hole.

Locally, the Citrus Heights Water District saw its CalPERS contribution rate grow over two years from zero to 10.66 percent of payroll for its 26 employees. That's $98,200 for a district with a $6.5 million annual operating budget.

"Any increase in costs has an effect on (water) rates," said David Kane, assistant general manager of the Citrus Heights Water District. "It caused our directors to try to keep our hiring in check."

In Riverside County, its pension plan went from a $530 million surplus to a $471 million unfunded liability after the bear market. In March, the county sold $400 million in pension obligation bonds to lower the cost of its CalPERS retirement program.

"Rates had gone up fairly dramatically," said Paul McDonnell, county treasurer-tax collector. In recent years, for example, Riverside's contribution rate for public safety employees swung wildly, going from a normal 14 percent to zero to 24.4 percent this fiscal year.

"If you look at these employer rates over the years, they're going to vary. It's cyclical," said Robert Bendorf, assistant executive officer for Placer County. In the past three years, the county's rate for rank-and-file employees has risen from zero to 3.2 percent in 2003-04 to 11.5 percent this fiscal year.

While the overall payments balance out in the long run, Bendorf and other public officials say the volatility wreaks havoc for budget planners. "We would certainly like to have some level of predictability."

New York pension consultant Ron Ryan and a few others say the move to stock market investments was the mistake.

"They needed to stay with bonds that matched liabilities," said Ryan, who advocates more of a pay-as-you-go system. Now, he said, it's almost impossible to go back.

To bridge the gap, pension officials must generate exceptionally high investment returns, boost contributions or reduce benefits. Experts aren't banking on most pension funds investing out of the financial hole.

"The hope that a market reversal will make the problem go away isn't going to materialize," Kent said. "The prospects of a booming market in the next couple of years isn't encouraging."

Consequently, states such as Florida and Oregon have adopted so-called hybrid pension plans offering a combination of guaranteed benefits and 401(k)-style investment programs.

Schwarzenegger went even further by proposing to replace traditional pension plans with individual accounts. Although he has retreated from the campaign this year, the governor continues to call for easing future pension burdens on taxpayers.

In radio ads last month, he said growing government pension contributions are putting a squeeze on already tight state and local budgets.

Proponents of 401(k)-style plans say these accounts would reduce the financial burden on state and local governments. Future pension benefits would be determined by the employee's investment decisions, and government agencies would no longer be on the hook for a guaranteed benefit when shortfalls occur.

Schwarzenegger's criticism inspired CalPERS trustees in April to enact new accounting methods to stabilize contributions rates for government employers.

The plan includes spreading the investment gains and losses over a 30-year period, calculating the value of local retirement plans over 15 years instead of three and requiring a minimum contribution even when there is a surplus. This is what allowed pension officials to lower the state's contribution this year.

Ryan, the pension fund consultant, doesn't expect this to work as a permanent solution: "They are buying time. It's just an actuarial game to reduce contributions. But it doesn't tell me the economic truth."

About the writer:

• The Bee's Gilbert Chan can be reached at (916) 321-1045 or gchan@sacbee.com.