The Legislative Analyst's Office has taken a look a pension bill that was key to last year's budget deal and concluded that it was well-intentioned but flawed.
Senate Bill 867, authored by Republican Dennis Hollingsworth and backed by Gov. Arnold Schwarzenegger, established several new public reporting requirements and, most significantly, told CalPERS to make estimates of its unfunded liabilities based on the so-called "zero-risk rate."
The LAO concluded that the bill has "serious drafting problems" that make it needlessly alarmist or unworkable:
As part of its efforts to encourage scrutiny of CalPERS' investment return assumptions, SB 867 requires CalPERS to calculate pension liabilities in its reports to the Legislature and others using "a discount rate equal to the rate of the 10-year United States Treasury (UST) Note as of 30 days before the date of the report." This means that instead of calculating liabilities using CalPERS' annual assumed investment return (currently 7.75 percent), this report would require liability reporting assuming a much lower discount rate. As of January 21, 2010, the 10-year UST yield is 3.4 percent. Using such a lower discount rate would result in CalPERS calculating a much higher amount of liabilities and, therefore, future state and local costs, compared to standard public pension reporting methods.
Currently, there is significant debate in the pension policy, accounting, and actuarial arenas concerning the appropriate method of discounting of pension system liabilities. ... Currently, CalPERS estimates that this long-term yield is about 7.75 percent, on average, per year. By contrast, some ... believe that guaranteed public sector pension liabilities should be discounted at a "riskless rate" of investment return, such as the 10-year UST Note rate cited in SB 867. The riskless rate, some say, is more appropriate since current law provides almost no way--outside of a local entity's filing for bankruptcy--that public entities can avoid paying the full employer share of their accrued defined benefit pension liabilities.
Rather than gin up a "riskless rate number" that may be "more alarmist than useful," the LAO suggests this:
An alternative, for example, would be to require this reporting based on an assumed future investment return that averages about 70 percent of the rate actually assumed by the system. Accordingly, if CalPERS continues to assume a 7.75 percent annual investment return rate, this alternate reporting would assume an approximately 5.0 percent to 5.5 percent rate of average annual investment return over the long term. This would provide more of a "worst-case" scenario for lawmakers to consider, in our view.
Among the LAO's other tweaks:
-Change the reporting requirements of the bill to focus more tightly on state government pensions than on local plans administered by CalPERS.
-Keep the reports annual, but make the hearings on them biannual.
-Require those biannual hearings at the committee level instead of the Hollingsworth requirement of a yearly hearing of the entire Legislature.
Click here for the LAO's recommendations.