The big question is exactly how much money Sierra Madre actually is in the hole to CalPERS. The two numbers being tossed around are either $10 million dollars or $40 million dollars. Quite a discrepancy no matter how you happen to round them off. Apparently there are two distinctly different ways of calculating Sierra Madre's quite troubling pension debt. And even then there is a very good possibility that neither of them is going to be all that accurate. Just to make this real easy for you.
What follows just below are the figures supplied to us by the Stanford Institute for Economic Policy Research, which supplies us with both the "Actuarial Liability" and "Market Pension Debt" calculation varieties. This is how they display Sierra Madre's pension woes (link):
There you go. You have your "Actuarial Pension Debt," which is $10,678,446. And you also have your "Market Pension Debt" at $40,428,900." So how much does Sierra Madre really owe CalPERS? $10 million big ones? $40 million long? Somewhere in between? Your guess is as good as mine. I don't know. And neither, apparently, does anybody else.
When I discover that I don't know something, I go ask people questions. Over the years I have managed to find a few people who really do know a lot about things such as this, and on the CalPERS pension debt tip some do have this down cold. First I went to the knowledgeable Gabe Engeland, Sierra Madre's new City Manager.
As a disclosure, I have never gotten along very well with City Managers in the past, but Gabe so far has come off as being a fairly reasonable guy. That said, in his July report on Sierra Madre's CalPERS exposure Gabe did cite the far lower "Actuarial Pension Debt" number, which I thought might have been a little too convenient.
Here is how our e-mail exchange went:
Gabe: This from today's Tattler post:
"While the "Actuarial Liability" numbers being supplied by both City Hall and this Stanford based outfit are the same at $10,678,00, there is another number. The Stanford Institute for Economic Policy Research also talks about something called "Market Pension Debt." At right around $40 million, that figure is approximately four times Sierra Madre's reported actuarial pension debt, or right around $8,500 per unhappy household.
Sierra Madre's report does not discuss "Market Pension Debt."
What is the difference between "actuarial pension debt" and "market pension debt?"
Here is Gabe's reply:
I love the Market Liability vs. Actuarial Liability debate! In its simplest terms here is the difference:
The Market Liability is what assets and liabilities are actually worth today, according to the market. To determine market liability you would take actual pension fund assets and subtract from them from actual obligations and you are left with your “unfunded” pension obligation.
The Actuarial Liability is the expected value of assets and liabilities over a given period of time. To calculate actuarial liability you have to make assumptions about your liabilities (total value of payouts, length of time it is to be paid, etc.) as well as your assets (rate of return).
The actuarial liability can get you in trouble if your assumptions are wrong (Hello, CalPERS!).
The market liability has shortcomings as well, but mostly it ignores long-term market or economic trends and can greatly overstate or greatly understate the total liability, especially for pensions, where liabilities are difficult to calculate.
I think both numbers are helpful when looking at your total obligation picture.
I replied: Such a wide discrepancy between the two! Is it possible to say we really don't know for certain where this will all go? The two approaches being just bookends with everything in-between a possibility?
Gabe answered: Yes, it will end up somewhere in-between. The better the assumptions made, the closer it will be to actuarial, the worse the assumptions made, the closer it will be to market. CalPERS has a long time to provide more realistic scenarios, the key is they need to do it.
Next I turned to my panel of pension experts. Robert Fellner, of Transparent California acclaim, praised Engeland's open approach and assured me that he was not cherry picking his numbers as I so coldly suggested, but just going with the information CalPERS had supplied. Which is proper for what he does and the best that can be expected under the circumstances.
No, he’s definitely not cherry picking. Honestly, pretty cool to see him addressing this at all, normally they just hide it.
The difference between market and actuarial reflects pension accounting practices used by all U.S. public pension plans, and the rest of the world.
U.S. public pension plans discount their debt by assumed investment returns = actuarial debt.
The rest of the world (including private US pension plans and even the US federal govt plan) understand that a guaranteed promise can not be discounted by an assumed investment return (which isn’t guaranteed) and instead can only be discounted by something with the same degree of certainty as the guaranteed promised benefits. That number is typically U.S. government bonds, which are also guaranteed.
The market value is the correct measure of the true cost of pension debt. I'm not defending the use of the inflated actuarial numbers used by CalPERS by pretending an assumed investment return is guaranteed, but I don’t think you can expect the Sierra Madre city manager to reject the numbers provided to him by CalPERS.
So while the actuarial numbers are bogus, Gabe is not the culprit. If anything he should be commended for being transparent and addressing this issue head on. The actuarial versus market discussion is much bigger than him and outside of his authority to change. CalPERS dictates these decisions, and he can only go on the numbers they provide him.
Sincerely, Robert Fellner
Research Director, Transparent California
Fair enough, and very good to know. My next e-mail went off to Jack Dean, gatekeeper of the excellent Pension Tsunami website (link). An incredible news resource that I read most every day. He offered me the following insights.
On this data page, if you place your pointer over the little blue dot with an "i" in it, you'll see a pop-up with a definition for each term.
He's using the number that government officials use -- the actuarial liability: "Present Value of future benefits for current members, using discount rates reported by most systems, typically 7.5%." Using this number, Sierra Madre's funded ratio is 74.2%.
The larger number is provided on Pension Tracker to show the more realistic market valuation. This is the definition: "Present Value of future benefits for current members, discounted at a market rate of return, ranging from 2.82% to 4.82% between 2011 and 2013." Using this number, Sierra Madre's funded ratio is 41.3%.
It's the same debt but calculated differently (more conservatively) -- using a lower, more realistic discount rate. - Jack
Here are the definitions Jack Dean is referring to:
Jack Dean suggested I drop a line to Joe Nation, the noted Stanford University economics professor who runs the rather remarkable Stanford Institute for Economic Policy Research website. Which is where this conversation all began. Joe got back to me in about 15 minutes.
John - I would just use the verbiage on Pension Tracker to highlight the actuarial and market value differences. Actuarial values, while used by CalPERS and most municipal finance managers, are not what is generally accepted by financial economists. The biggest difference is that actuarial values assume CalPERS (and others) will earn their discount rate forever, even as CalPERS acknowledges this remains too high. The market value uses a 20-year Treasury yield instead, providing a better assessment of the financial status for any municipal government plan and for CalPERS overall. From the site: "The use of this discount rate is intended, as most financial economists agree, to more closely represent market realities and system liabilities.” - Joe
So that is where we are at. I hope this clears things up at least a little bit. It did for me.
However, I will leave you with this rather melancholy thought. Sierra Madre's CalPERS debt exposure is hard to accurately calculate. It could be $10 million if you believe the overly optimistic CalPERS' numbers, or it could be as high as $40 million if you use the kinds of accounting standards privately run concerns do when calculating their pensions costs.
But apparently nobody can really say for certain what the final numbers are going to be in the next few years. Only time will tell. Back in the day City Hall placed Sierra Madre's financial fate into the hands of a failed pension bureaucracy called CalPERS. In the end everything, including the fate of this town, depends on them.
Which is probably the scariest prospect of them all.