This commentary was contributed by Marty Richman.
As of June 30, 2016, San Benito County could have terminated its contracts and walked away from all its future CalPERS retirement plan obligations for an estimated one-time payment of between $196 million and $257 million. There is no way they could find that amount even if they wanted to and even if they did, the county would still have to start a non-CalPERS retirement system of its own to move forward. Yet the numbers serve a purpose for comparison.
The hypothetical termination lump sum payments would be in addition to the then-existing $145 million market value of the county’s CalPERS accounts, the total county obligation being $341 million or $402 million depending on the interest rate available on a “secure” investment option.
It takes a law firm, CPA, actuary, a deck of tarot cards and a pair of dice to determine a reliable funding status for all CalPERS retirement plans and San Benito County is no different; it’s a moving target. One of the data points – the most expensive because it strips away much value from future investment returns – is termination costs. CalPERS supplies two theoretical termination cost calculations, one for a secure investment returning 1.75 percent annually and another returning 3.00 percent annually; that’s why there are two theoretical termination costs. The 1.25 percent difference in investment returns account for the $61 million spread between the estimates over time.
CalPERS relies on tomorrow’s investment returns to pay for retirement obligations promised yesterday. To get tomorrow’s investment returns the employer has to be a going concern (in the plan). CalPERS invests for high average returns, although the future estimate is on its way down from 7.5 percent to 7.0 percent annually.
This is an important concept. Currently, if CalPERS fails to get its projected long-term return on investments, they just demand more money from the employer in future payments that are adjusted annually and amortized over 20-years. If the employer is out of the plan they cannot do that.
Their theory is that the funds already collected and the investment returns to date ($145 million in market value for San Benito County, but it changes constantly) would have to go into a very-low or no-risk investment on termination to assure that there will be no loss; therefore, the county would have to put in added funds to make up for the future shortage of investment return.
Example, for Fiscal Year 2016-17 CalPERS calculations were based on an average annual rate of return of 7.375 percent. A 3.00 percent secure investment would fall 4.375 percent short for that year. How would they make it up in years to come if we walked away? “Cash in advance (termination charges) – thank you.”
The theoretical termination costs are not the be-all or end-all of understanding CalPERS funding, but they are one important data point among many. They do serve to illustrate how much the system bets on high investment returns which inherently include higher risks.