Public Pension Ponzi

George Rebane

[This is the full length piece the first part of which was published today in the 15jul09 Union under the less dramatic title ‘Public Pensions – a breakdown’, although the latter part could be taken as a double entendre.  (updated 16aug09) The full length version appears in the newspaper’s online edition.  gjr]

Sophistry - a deliberately invalid argument displaying ingenuity in reasoning in the hope of deceiving someone.

The public pension ponzi is rapidly coming unglued as already pointed out in this newspaper and many others across the land.  Only the most glaciated or glazed minds still believe the public sector has not been overpaid and over pensioned.    The damage radius of the pension ponzi is much greater and more immediate than Madoff’s, and you are in it whether or not you pay taxes, and especially if you are a government employee.

In this short piece we’ll take a look at a typical pension formula and see how it is ‘used’.  Without this basic knowledge, all you can do is react emotionally to the crisis.  With it, hopefully, you will be able to direct your efforts productively.  California and its pension fund manager Calpers will again be our poster child.

The basic Calpers formula that calculates a government employee’s annual pension is very simple –

Annual Pension = (# of Years Worked) x (Highest Annual Salary) x (Multiplier)

The multiplier is somewhere in the two to three percent range, and is usually set by the jurisdiction (city, county) or agency (CARB, NID).  Grass Valley recently raised its multiplier from 2 to 2.5%.  The multiplier will also vary for categories of work and retirement age – police and fire usually have higher multipliers.

Important to note right away – any percent change in any of the three factors in the formula becomes the percent change in the annual pension.

To nail it down, let’s use some numbers.  Say Sam worked 30 years for Agency37 and maxed his annual salary at $90,000 somewhere along the way (the highest salary doesn’t have to be the one you have at termination or retirement).  The current multiplier for Agency37 is 2.5% for retiring at 55.  Sam’s annual pension from Agency37 then calculates to

30 x $90,000 x 0.025 = $67,500.

If Sam is expected to live until, say, 83, then Calpers has to have more than $1,062,000 in Sam’s name earning interest at 4.5% per year to throw off 28 yearly pension payments of $67.5K until Sam is expected to die.  Calpers will invest this amount in a portfolio with thousands of other retirement accounts, and at retirement, handles Sam’s account as an annuity.  An annuity is a fixed amount invested at a given interest rate that starts being drawn down by regular payments made to its owner.  At the end of a stipulated number of payments the annuity amount is drained to zero.  When Sam retires, this $1,062,000 needs to be in place at Calpers.  (And yes, Sam is now a millionaire.)

This ‘given interest rate’ is another big bugaboo and source of a lot of mischief.  The higher you assume it is, the less you have to have at the start of Sam’s retirement, and the less Agency37 thinks it must cough up when Sam does retire.  For example Agency37’s books cook much better by simply assuming that Calpers investments will appreciate at 7.5% annually instead of the more realistic 4.5% used above.  Why?  Because with 7.5% Agency37 needs to provide only $781,200 for Sam’s retirement.

But we all understand that this is a game.  Agency37 must pay Sam $67,500 a year for life, regardless of what numbers are used to cook the books.

And if somewhere along the way Agency37 decides to ‘upgrade’ its retirement program by increasing the multiplier from, say, 2 to 2.5%, as Grass Valley recently did, then this automatically incurs a huge and instant unfunded liability for the city.  The jurisdiction will be underfunded by 20% for increasing the multiplier by ‘only a measly 0.5%’.  The uninformed voters, ignorant of the basic formula, will focus on this seemingly insignificant fraction, and go back to their knitting without a clue that their liability just increased 25%.  And this has happened thousands of times across California in recent years.  

So far this has been pretty simple stuff, but absolutely required if you want to understand and discuss the major cost of government.  But this is just the start of where the fun begins on public pensions.  We will now see how the future cost of the pension system becomes an unknown to all concerned, how government employees game the system, and how the accountable jurisdictions make it into a ponzi scheme as they hope that the music never stops.

First, what happens when Agency37 (or Grass Valley) kicks its multiplier up from 2 to 2.5%?  It immediately has to increase its retroactive pension funding by 25% for its employees.  And if it doesn’t have that cash on hand, then it has to take out a loan for the amount, send it to Calpers, and start paying loan service costs on its generosity.  This loan obligation becomes known as a “side fund” and may be hard to spot in the financial reports from most agencies.  But exposed or hidden, it’s there as another unfunded liability waiting in the wings.

Meanwhile, as Sam keeps working, he and Agency37 must keep making payments to Calpers – Sam will pay about 8% of his salary and his employer will pay about 11%.  These monies are added to Sam’s account which is invested in a ‘pool’ that is a collection of other similar retirement accounts.  At this point no one knows exactly how many more years Sam will work, and what his highest salary will be, and when he’ll actually die.  It’s all guesswork and all figured from something called aggregate statistics that Calpers calculates for the management fees it charges the jurisdictions and agencies.  You can now see why Calpers uses such risk dispersing pools of accounts, because that lets them even things out as all these random variables for the workers become real numbers over time.

Unfortunately, these Calpers pools are also used as a ‘common’, and we know, sooner than later all commons get run down and depleted  (Recall that a common is a resource that hides and delays its true cost of consumption to its users. Cf. Garrett Hardin.)  As long as monies keep arriving in a pool faster than it has to pay out pensions, everything seems to be going fine.  This is known by the seemingly frugal and fiscally responsible ‘pay as you go’ label.  It is just another name for a ponzi because Calpers is already underfunded and not all jurisdictions keep their payments current.  Madoff was running a ‘pay as you go’ for years until he ran out of ‘go’.

Today it’s safe to say that all Calpers pools are underfunded and operate like this to various extents.  To preview some actual numbers, a 31jul09 letter from Mac Taylor, an analyst in the California Legislative Analyst’s Office (the state’s version of the Congressional Budget Office), estimated that today the state’s “unfunded retirement-related liabilities” fall somewhere between $100 billion and $130 billion.

The equivalent unfunded liabilities of local jurisdictions are unknown and may total in the same range as the state’s.  A recent look at some unfunded liabilities in Nevada County was done by Mike McDaniel of the Sierra Environmental Studies Foundation (www.sesfoundation.org).

All jurisdictions across the land are strapped for cash and pay as little as possible, as late as possible into their own retirement funds such as Calpers.  In California Calpers supports this policy by publishing its accounting reports two years late to the jurisdictions.  So everything about these accounts is dated and delinquent by some unknown amounts.  Deep and murky waters indeed.

But there’s much more.  First, Sam may not work only for Agency37.  He may quit after 15 years, go to Agency12 and work there 10 years, and then transfer to Agency21 to work for another 5 years before retiring.  According to applicable law, Sam’s pension will still be computed from the basic formula above as if he had worked at only one agency for a total of 30 years, and somewhere along the line (not necessarily during his last working year) had earned his high of $90K a year.  Well, not actually.  Each jurisdiction will have to use its own ‘multiplier percent’ and the ‘years worked’ in the formula in the attempt to calculate its obligated share of Sam’s pension.

How can they do that?  Short answer, they can’t.

In researching all this, I talked to a Calpers pension maven and asked her to calculate the liability each agency would accrue from numbers such as given above.  The response would have spun your head but contained no answer, only a promise to look into it and get back to me.  This is clearly hard stuff, and it’s getting harder.  But before we go on, keep in mind that Sam’s retirement income stream is the same as if he had managed to accumulate a million dollar portfolio in addition to his wages and other benefits such as healthcare (the costs of which we won’t have time to cover here).

Finally, Sam and his fellow government employees are no dummies.  The California State University teaches courses on how to legally game the pension system.  There Sam will learn how to hoard vacation and sick leave pay during his last years and ‘sell’ it back to the jurisdiction to bump up his ‘highest annual salary’ figure.  And if his last year is going to be the highest, then he’ll learn how to change his job and work hours so as to maximize his last year’s earnings with night shifts and overtime and … .  And finally, if he’s got the right connections, Sam will also be able to get a significant pre-retirement raise which spikes up his highest salary, and is therefore called ‘spiking’.  Anything and everything is taught in such courses so that the basic formula computes out to the maximum pension possible.

Of course, the jurisdiction responsible for contributing to such retirement annuities doesn’t have a clue as to what all Sam will be able to accomplish through his final years’ efforts in pumping his pay or adding to his years of service in the formula.  The only thing guaranteed is that the bill will be high and the taxpayers are stuck with it.

So when we ask our local California jurisdiction how much they are on the hook for, they really don’t have a good handle on it, and now you can see why.  And we remember that Calpers contributes to the fog by publishing their reports two years late, so no one is really current.

The local in-and-out-of-office politicians also add to this expensive confusion when they cave to the appeals of staff or their unions to monkey with the numbers and retirement age thresholds in the basic formula – see the Grass Valley example above.

Now you know how most of this ‘pay as you go’ ponzi has been assembled.  In a future edition we’ll look into some actual dollar sums that do so much to attract our youth into government service.  But in the interval, let me invite you to ponder the following - back of envelopes at the ready, please!

Calpers handles retirement accounts for about 1,400,000 people in California. About 400,000 of them are already retired and drawing $10 billion in pensions annually.  During the next four years 40%, or another 400,000 of the one million now working, will retire.  Currently Calpers has about $168 billion invested and under management, and has convinced its clients, the California jurisdictions, that it will be able to achieve a 7.5% annual return over the coming years from which it takes about $1,000,000,000 annually for its services.  Question – when will the music stop?

We conclude by recalling that Calpers is only the fund manager, and not responsible for paying one penny of any planned or unplanned pension shortfalls that will occur in the future.  Those have to be made up by the blissfully unperturbed California taxpayers and/or suffered by the equally blissful government employees.

Oh yes, did I mention that on top of it all, COLAs (cost of living allowances) are regularly added to all the pensions? 

Comments

[Ben Mavy]

Excellent job George,

And you didn't mention the abusive practice of pension funds to overestimate future investment returns to appear less underfunded than they care to admit. Our concerns will all go away if there is any possibility the liberal utopia of everything government is true. We simply need a constant stream of more government employees (no problem there, we have 4,000 more State employees than last year), and higher government salaries to sustain the pension fund. Tell your friends! If you can get just three of your firends to come work for the state and they can get three of their friends and so on, PERS might not go bust!

[DaveC]

I have often felt agencies who put their new employees in the Calpers system should offer new hires a defined contribution retirement. However, if they did the Calpers system would collapse because the new workers would not be able to pay the retired employee's stipend. This, of course, is not part of Ponzi's plan.

[James Lewis]

Excellent article. You did a terrific job of explaining a complicated scheme with concrete examples. As you continue to write similar articles, I'd like you to consider tweaking your message just a bit. Towards the end, you said, "The uninformed voters, ignorant of the basic formula, will focus on this seemingly insignificant faction, and go back to their knitting without a clue that their liability just increased 25 percent."

I think your message would have perhaps been more effective without the tone of condescencion, even though it is apparently justified. Maybe you could have slightly changed it to say, "MOST uninformed voters, ignorant of the basic formula, will focus on this insignificant faction without a clue that their liability just increased 25 percent." The "knitting" part detracts from your article.

I was totally clueless about the specific numbers. However, many of us here in Nevada County are aware of the problem, and aware that an increase by an "insignificant faction" will cause a rapid geometric increase.

Good work. Thanks for the articles. James Lewis

[George Rebane]

Well said James Lewis, and thank you. I often feel that time is short and try to stand concurrently on too many soap boxes. Our public education system has now produced at least two generations of adults that many authors have named 'post-intellectual', with the measure of their literacy quietly taken and buried by the Dept of Education. No one has yet found the magic words to motivate the radical change required in both education policy and curriculum to start turning out enough young people who can competitively sell their labor in the global free markets. The entrenched and strongly liberal education industry is dedicated to an egalitarian lowest common denominator that prepares a compliant workforce suited primarily for sectors funded by charities and government monies. But many of us still try in our clumsy ways to point out the problem whereever we can. You shined a bright light on my inadequate effort. Thank you again.

[Steve Enos]

George, it might be informative for you to run down and do a post about what our local elected representatives at the County Board of Supervisors and City Councils are "provided" in the way of compensation and benefits for holding elected (or some times appointed) office.

Who gets paid what? What benefits do they get, what about Supervisors getting health insurance? Is being a County Supervisor intended to be a full time job? What do they "get" when they leave office? Do any of these elected offices provide for some level of retirement funding or health insurance?

[George Rebane]

Good point Steve. In this series, focusing on the compensation component of the cost of government, my next installment will be on some specific examples of government employee compensation. Including our electeds, as you suggest, would be a proper complement to such a piece. Thank you.

[Steve Enos]

Thanks George. These are issues that few in the public have any knowlwdge of. In most cases the "feather the nest" takes place out of public view.

The last few years of employment service is when some set up for the post retirement double dipping and rack up overtime to pad their retirement earnings basis.

Look forward to another story from you about the compensation and benefits of our local elected officials.

In my case I was paid $200.00 a month for being an elected city council person. No other benefits were provided, no insurance, no retirement. Make sure you get all the info about being a county supervisor as that seems to be a pretty good "gig".

[Steve Enos]

George, today’s (Mondays) front page of the Sacramento Bee covered the governor’s latest effort to address public employee retirement and benefits. It's going to be a hard fight as the state employee unions have a tight grip on the folks in Sacramento.

Closer to home it would be nice to see the info over the last 10 years or so about our Sheriff's Department. Things like wage spiking, overtime pumping, sick leave, holiday and vacation leave payouts in the last couple of years before employee retirements. Also look at things like position transfers, upgrades and promotions in the last year or two before taking retirement, another form of preretirement spiking.

Then we also have a bit of retire and return and "double dipping" that have taken place. The Sheriff's Dept. and election candidate endorsements are a very real part of this situation. This is our local version, just like at the state level with the state employee’s unions and our state elected representatives. Would be very informative to have more light shed on this local issue.

How has this been allowed to happen? What is the voting record of our county supervisors on these issues and the employee contracts that have allowed this to hapen? Wonder if any of our county supervisors are willing to step up and discuss these issues and provide the facts and data about what has taken place as our County Supervisors are the decision makers that have allowed this to happen.

[George Rebane]

Steve, half the people commenting on The Union seem to be (ex)government employees who have difficulty with the language (as predicted by our Dept of Education surveys), and are taking me to task for warning them of the unfunded pension liabilities problem. In any case they are both uninformed and quite sanguine about the pension status of the state's jurisdictions. The situation would be humorous, but these same people also vote. Maybe you can explain the matter to them.

And regarding the homework that you're lining up for me, it feels as if you're sending me into a hornet's nest ;-) As a former council member, have you attempted to get any of this stuff from GV? That should give an indication of how hard it would be to dig it out.

[Steve Enos]

George, I think the Sheriff's Deparment issues I raise are a real good, local example of what you are trying to discuss. This local discussion should take place as we can have an impact on the local situation if the BOS is willing to take action.

This local example needs to be uncovered and the facts need to be made available to our local voters. The County Board of Supervisors has had the authority over these Sheriff Dept. issues. The BOS (past and present) could have addressed these issues and taken action. So where is the information and accountabily for their actions, or lack of it?

Since the majority of our current and past BOS members claim to be conservatives and Republicans it would be enlighting to know what they have done to make all this possible. What have they done to end this or in reality what have they done to facilitate these types of things from happening here at home?

We have some current and former County BOS members making statements about the state of our federal and state goverment, spending, retirement, benefits etc., etc. but what are the facts? What have these folks done and what do they propose to do on a local level on these issues?

Our local County BOS members have had the ability and authority to address this, so what have they really done vs. what some of them are saying?

George, you post that "it feels as if you're sending me into a hornet's nest", my take is that you are already feeling the stings of those that want this issue to be left in the back room, away from public view.

Since County Supervisor John Spencer comments on your site and Russ's too it's simple. Our local elected representative can provide the information about these issues, ask him for the data and his past actions, efforts and BOS votes to address these issues.

Better yet, Supervisor Spencer, will you please provide us all the information about the above issues and our local Sheriff's Department? This way we can hear it directly from our elected representative.

We have the ability to make change at the local level on the issues George has raised here. We vote our County Supervisors into office to represent the interests of the people, not the unions.

Our local elected representatives need to do more than complain about Sacramento and Washington, let's hope Supervisor Spencer provides facts and answers to those he was elected to represent.

[Ben Mavy]

You're ahead of the curve on this one George. This showed up two days after your post: Calpers Takes Another Property Hit

[George Rebane]

Thank you Ben. This morning's Sacramento NPR also had a big piece on people beginning to discover that Calpers is forced by the jurisdictions and unions to run a non-sustainable pension scheme. Meanwhile, it is disturbing to see the sample of the people who don't get any of this, and think that my piece in the Union is a partisan rant. Their level of ignorance is mind-boggling, especially when considered in light of America's competitive position viz globalization. More on that to come.

[George Rebane]

Thank you Ben. This morning's Sacramento NPR also had a big piece on people beginning to discover that Calpers is forced by the jurisdictions and unions to run a non-sustainable pension scheme. Meanwhile, it is disturbing to see the sample of the people who don't get any of this, and think that my piece in the Union is a partisan rant. Their level of ignorance is mind-boggling, especially when considered in light of America's competitive position viz globalization. More on that to come.