PERSPECTIVE-I was not surprised by Councilmember Paul Krekorian’s reaction to the 20-20 Commission’s recommendation to lower the earnings rate assumption for the city’s employee pension programs.
Lowering the outlook from 7.75% to 4%, a rate in line with what Warren Buffet’s Berkshire Hathaway uses to calculate its pension liability, would disclose a far more realistic estimate of what the citizens of our city are on the hook for in the long run. Simply stated, the lower the rate, the more assets you need to cover the guaranteed retirement benefits of city employees.
He called the recommendation “absurd”, according to the Daily News, stating that the returns over 25 years have been much better than that.
Krekorian is not what one would call financially astute. As the Chair of the Budget and Finance Committee, he has labeled the city’s budget as balanced.
That’s right, folks. The budget is so balanced that the city is contemplating a sales tax increase to cover street and sidewalk deferred maintenance (a.k.a. neglect) to the tune of $4.5 billion. The budget also defers the payment of police overtime to future periods. Hundreds of millions of dollars are taken from our DWP ratepayer money to plug the overall budget gap – funds that should be invested in utility improvements.
When you defer current obligations year after year, you are robbing from the future. That’s not balancing the budget.
But what does Krekorian know….or care? It won’t be his problem down the line when he collects his city and state pensions.
Back to the rate of return.
The holy grail of public employee unions in general – not just the city unions – is that past performance is indicative of future returns. That’s just the opposite of the financial advice offered by investment advisers, whether they are employed by large Wall Street firms or independent professionals working from home.
Krekorian chooses to hide in the past.
Markets have become more volatile and will likely stay that way for a long time to come. Political unrest and growing international competition almost guarantee it. High risk demands conservative long-term earnings estimates.
Selecting a rate assumption involves a high degree of subjectivity. I prefer to focus on the relevant range of time.
If you look too short or too far back you risk putting too much weight on current events, such as a bull or bear market, or long-gone structural elements, such as regulatory controls no longer in effect (i.e, Glass-Steagall).
A rolling period covering the 5 to 15 year average return is probably more indicative of reality as it relates to contemporary times. As an example, for LACERS, that would support something closer to a 6.5% return.
The 4% recommendation is perhaps too conservative, but it would be wise to apply it to the assets needed to fund anticipated benefit payouts for the next 2-3 years. For that matter, the unfunded liabilities should be disclosed for several outcomes. Does Krekorian or any of his colleagues understand the meaning of disclosure?
Whether the assumption is 6.5% or 4%, or anything in between, the unfunded liability of the pension plans will soar. But better to face reality than otherwise. How else can you negotiate employee pension contribution requirements without considering a range of possibilities?
(Paul Hatfield is a CPA and former NC Valley Village board member and treasurer. He blogs at Village to Village and contributes to CityWatch. He can be reached at: [email protected])
–cw
CityWatch
Vol 12 Issue 30
Pub: Apr 11, 2014