Another Open Letter To Tina McKinnor, Tim Grayson, et al.

Dear Assembly Member McKinnor, Senator Grayson and other sponsors of Assembly Bill 1383, which proposes to enhance pension benefits for certain public employees:

One of the beneficiaries of AB 1383 has written you in opposition to my proposal to hold taxpayers harmless from unfunded liabilities arising from the pension enhancements provided by your bill. However, his letter makes a factual error and omits a material fact.

1. The letter states: “[The bill] requires payment of the normal cost, ensuring that retirement security is funded.” [Itals added.] That statement is not correct. Retirement security is only ensured by normal cost if pension plans earn the rate on which normal cost was based. When pension plans earn less than the rate on which normal cost was based, taxpayers — and only taxpayers — must make up the difference.
2. The letter fails to disclose that CalPERS’s determination of its discount rate for setting normal cost is made pursuant to Proposition 162 (1992), which requires public pension fund boards to prioritize employees, not taxpayers. That means that CalPERS has an incentive to select higher rates that minimize normal cost, which is the only cost incurred by employees. The higher the rate, the lower the normal cost, but the higher the rate, the greater the risk that unfunded liabilities will be created that taxpayers must cover in addition to sharing in normal cost.

The consequences from those two facts are enormous. 20 years ago, CalPERS chose an elevated 7.75% rate for setting normal cost at the same time that Warren Buffett was using a 6.9% rate for defined benefit plans at his company, Berkshire Hathaway. Since then, CalPERS has earned a 6.8% compound annual growth rate. That’s a wonderful return, but because it fell short of the 7.75% rate CalPERS used to set normal cost in 2006, taxpayers — and only taxpayers — have had to cover a huge unfunded liability.

This is why, in CalPERS’s most recent fiscal year, taxpayers had to contribute $23.4 billion as opposed to only $6.8 billion contributed by employees. A system in which taxpayers and employees were meant to share costs equally has been transformed into one in which taxpayers are being forced to put up more than $3 for every $1 contributed by employees. That’s because normal cost is regularly set too low by CalPERS and other California public pension funds. Currently CalPERS is using a 6.8% rate when Buffett is using 6.3%.

So long as the interests of taxpayers are disregarded whenever CalPERS and other California public pension funds set normal costs, taxpayers will get hit with unfunded liabilities. Absent repeal and reform of Proposition 162, there are two ways to protect taxpayers from unfunded liabilities. Either set normal cost with reference to risk-free rates like US Treasuries or explicitly hold taxpayers harmless from unfunded liabilities. If those proposals are not acceptable to you, then at a minimum employees should share 50% of any unfunded liabilities just as they share 50% of normal cost. After all, employees get 100% of the upside from the benefit enhancements. Taxpayers should not be burdened with 100% of the downside.