Local governments use their own estimated rate of return for their investments to discount their liabilities. By projecting unrealistic high rates of return, they minimize their unfunded liabilities on paper.
Let me quote the controllers message from the FINANCIAL HIGHLIGHTS "County of San Mateo, Fiscal Year Ended June 30, 2010" - "Delaying recognition of these "off book" liabilities can only lead to the same type of financial failures currently experienced globally by the business sector".
Of course David Bailey, Chief Executive Officer of "San Mateo County Employees' Retirement Association" has his take, and writes to the Board of retirement (September 22, 2009) "A retirement Board's duty to its participants and their beneficiaries shall take precedence over any other duty." (I do understand that duty). It continues "As you have seen in the 2009 Valuation report, if we continue with the current rate calculation method, the county employer contribution rate will increase from the current average rate of 24% of payroll to an average rate of 34% of payroll. In dollar terms, the current county contribution of approximately $106 million would increase to an estimated $160 million. This is the estimate for the 2010-2011 fiscal year. Additional increases are projected to occur after that."
That brings us to the mid year update from David M. Boesch the County Manager to the board of supervisors dated 02-04-2010 (FY 2009-10 County Budget Update). Retirement Contribution Rates and Unfunded Pension Liability. "Based on the most recent actuarial valuation as of June 30, 2009, the County’s blended annual retirement contribution rate will increase from 23.6% of payroll to 34% of payroll, resulting in increased retirement costs of $45.3 million for all County funds and $36.5 million for the General Fund. The reason for the increase is due to investment losses incurred by SamCERA since the recession began in the fall of 2008. Prior to the onset of the recession, the plan was funded at 79.1%. As of June 30, 2009, the plan was funded at 63.9%. The actuarial accrued liability (AAL) for benefits was $2,987,712,000, and the actuarial value of assets was $1,909,679,000, resulting in an unfunded actuarial accrued liability (UAAL) of $1,078,033,000. At its November 2009 meeting, the Retirement Board voted to continue the current practice of smoothing gains and losses over a five-year period with a 20% corridor. Gains and losses falling outside of the 20% corridor are fully recognized in the determination of the actuarial asset value. The UAAL is amortized over a fifteen year period. Some jurisdictions have changed the methodology to reduce the contributions in the short-term by expanding the corridor or lengthening the smoothing or amortization periods, or some combination thereof. Changing these assumptions has the effect of increasing costs on the back-end of the amortization period. Further, lowering contributions could result in unrealized investment gains at a time when the market is in recovery. Though it results in increased costs in the short-term, the County Manager’s Office concurs and fully supports the actions of the Retirement Board. Assuming a 7.75% earnings rate over the next four fiscal years, the retirement rates are expected to increase to 41.7% of payroll by FY 2014-15 as additional losses are recognized through the smoothing process. By contributing more now, we improve our chances of mitigating future increases."
Where is the problem?
First in order for the county not to go bankrupt an actuarial smoothing was used to spread the cost of the debt over a 5year period.
Second assuming 7.75% rate of return is not realistic, at this time a 4% rate of return would have been more realistic but would make the unfunded liability even greater.
You get the picture!
According to the SamCERA Comprehensive Annual Financial Report for the year ended June 30, 2010 “Over the immediate future, economic growth is likely to be moderate and inflation is projected to stay low. However, it is widely expected that inflation will accelerate longer term due to the large fiscal deficits. This environment is likely to produce nominal investment returns in the 7% to 8% range over the next five to ten years and real returns in the 5% range.”
To give you an idea, this is from an article in THE WALL STREET JOURNAL. For example, a retiree will collect a $100 pension in 20 years. If a plan assumes it can generate 8% return, it has an obligation of $21.45 today. Lower the discount rate to 4%, and the present liability is $45.64. So the plan with $22 in assets would be fully funded at the higher rate and only 50% funded if it takes the 4% view. Guess who pays the difference!
So what is the county to do? Decrease our services, and raise taxes of course with a new name attached to it "fees". In the budget there is a section called DEVELOPMENT OF FEE POLICY. That is incredible. Is this what are we paying into our county for?
Unfortunately I do not have the Labor version of the story, I would be very much interested to know, because if the County was to go bankrupt the retirement would worth only cents to the dollar. I suggest that they ask their leaders what would happen if this unfortunate event occurs.
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