Monday, June 8, 2015

Pension Initiative Could Create a Run on the Bank

An interesting item in deals with how CalPERS currently handles terminated local pension funds. CalPERS takes care of the pensions of many local governments. Calpensions describes the procedure for termination but doesn't point to the initiative's potential to create a run on the system.*

If one of those governments closes a plan, i.e., stops admitting new hires to eligibility and pulls out of the system, CalPERS charges that entity a "termination fee" which is supposed to deal with the obligation to pay pensions for those remaining in the plan. Note that under the pension initiative, all public pensions in California would be closed in 2019. Some plans might choose to terminate entirely by paying off CalPERS to cover the cost of paying the closed pensions.

The termination fee currently charged by CalPERS is based on the unfunded liability of the plan, but calculated at a much lower interest rate (discount rate) than the 7.5% long-term annual rate of earnings currently assumed by CalPERS (and, by the way, also assumed by UC). Using a lower interest rate substantially raises the calculated unfunded liability. CalPERS justifies this procedure by maintaining a pool of safe (and therefore low yield) assets to back such terminated plans. The lower interest rate reflects earnings on that pool. Because the termination fee is therefore large, local governments are discouraged from terminating their pension plans with CalPERS.

The new pension initiative has the following language:

Retirement boards shall not impose termination fees, accelerate payments on existing debt, or impose other financial conditions against a government employer that proposes to close a defined benefit pension plan to new members, unless voters of that jurisdiction or the sponsoring government employer approve the fees, accelerated payment, or financial conditions.

With no termination fees, what exactly would happen if CalPERS over the long run doesn't have enough assets to pay all the pensions promised in the plans to pre-2019 employees and retirees? All of its plans would be closed by the initiative and none would pay termination fees if they pulled out. Would CalPERS cut pensions to match assets? Would it try and somehow get contributions from the remaining jurisdictions with terminated plans to cover the liability? Would remaining local jurisdictions try to leave CalPERS in that event, even though they had pre-2019 employees and retirees covered? Would individuals covered by CalPERS rush to cash out their pensions, given the uncertainty? Essentially, this is a problem for all orphan pension plans (plans in which no new folks are paying in because the plan is closed) and where there is no backup assured financing of whatever unfunded liability there may be. But under the pension initiative, ALL plans become orphans in 2019.

As the calpensions article notes, back when Gov. Brown's (eventually enacted) pension legislation was being debated and CalPERS alluded to the issue of termination, Brown said it showed the system was a Ponzi scheme. Such language could add to the panic atmosphere.

In principle, these issues do not directly affect UC since it is not part of CalPERS. But panicked reactions at CalPERS would surely have an impact on UC. UC retirees might view lump-sum cashing out as their best option, for example. UC's pension system in absolute terms is quite large with over $50 billion in assets. But it is dwarfed in California by CalPERS and tends to be swept into the issues of the much larger system.

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