CalPERS financial sleight of hand is reminiscent of Bernie Madoff’s lying to his investors through phony statements designed to mask losses and outright fraud.
Much has been written about The California Public Employees’ Retirement System (CalPERS) being underfunded by $500 billion due to massive investment losses over the last decade, but now we have video of a CalPERS Senior Pension Actuary, Kung-pei Hwang, describing how they intend to change basic assumptions in their financial model to (please allow me to mix my metaphors) Hide The Decline in their assets held for municipal, county, and state employee’s retirement.
Through this statistical gimmickry, CalPERS can push the loss into later years and appear solvent today. Of course, at some point in the future it will need to raise funds from state and local governments to compensate for these losses. But for now, they seem content to hide the disastrous condition of their fund.
As you can hear Mr. Hwang say in his presentation to the Huntington Park City Council last week, “that means we will defer most of the loss to future years.” “This means the city will realize another increase in future years. I hate to bring bad news, but those are the facts.” Well, the fact is this bad news will hit budgets for all cities, counties and the state of California and not just Huntington Park. By playing with its financial model in this way, CalPERS is treating all California taxpayers like Madoff investors by cooking its actuarial books to Hide The Decline in its assets.
It gets worse, much worse as noted below after the video………..
In addition, the actuary reports at the beginning of the video that the key “rate of return” assumption is likely to change to a lower level that will then require cities, counties, and the state (read that as “taxpayers”) to significantly increase payments to CalPERS in 2012 and thereafter.
The current rate of return assumption CalPERS is using is 7.75% compounded annually. However, CalPERS board is working on a new asset allocation policy based on a meeting two weeks ago with investment professionals. The new “rate of return” assumption will be lower and announced in February 2011. For every point CalPERS lowers its investment return assumption, each city and county, or the states cost will go up 2 % in one of two categories of contributions it must pay into CalPERS and 4% in the other.
In other words, the burden on local governments and the state is about to balloon. If CalPERS were to lower the rate of return assumption to Bill Gross’ widely discussed “new normal” rate of return of 4%, that would mean a city or county would have to pay over 20-30% MORE in contributions; a sum sure to sink many cities and maybe a few counties. If the return assumption gets lowered a tiny amount and the actual returns over time are close to the “new normal” then CalPERS will just dig an even larger hole that will need to be filled down the road by taxpayers.
The video begins 3 minutes into the presentation. Not much happens up to this point other than a discussion on the history of CalPERS and the demographics of its members. The actuary points out that with CalPERS the employee contribution amount is fixed but the employer amount varies so the risk to the plan is borne by the employer (city, county, state).
The Senior Pension Actuary then explains that because of losses in 2008-2009 CalPERS assets are 50% below what the actuarial model expected. Next is the discussion about the rate of return assumption and its implications and resulting higher costs to governments. It is pointed out that compounding the problem is the fact that in 2005 after CalPERS lost 1/3 of its assets in the dotcom bubble it created a “new rate stabilization policy,” another Madoff worthy statistical trick.
The new policy changed the model’s Actuarial Value of Assets (AVA), a method of smoothing the asset valuation, from an average of 3 years to an average of 15, thus inflating the average assets held due to previously strong years. By doing this they masked the downturn in the assets thinking the following years would allow them to catch up and smooth out the massive dotcom loss. Trouble is, 2008-2009 came along which shot holes in this assumption and now they are in even worse shape.
Another Madoff-worthy trick then compounded the problem more. After the 2008-2009 losses CalPERS changed their assumptions AGAIN to “smooth” the losses. They then changed the AVA to MVA (market value of assets) ratio to 60% to 140% from 70% to 120%. As you can hear the actuarial state on the video and it is worth repeating in this story, “that means we will defer most of the loss to future years.” “This means the city will realize another increase in future years. I hate to bring bad news but those are the facts.”
The bottom line is CalPERS pension model is not to be trusted. Rather than building a realistic financial model and then inserting the actual assets to obtain an understanding of its solvency, they have changed and tweaked and twisted their model and its assumptions to obtain the results desired.
California bond holders beware.
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