R9F-Discuss Actuarial Valuation Reports For The City's Pension Plans -Weithorn-OFFICE OF THE MAYOR AND COMMISSION
TO:
FROM:
DATE:
SUBJECT:
Mr. Jimmy Morales, City Manager
Mr. Rafael Granado, City Clerk
Commissioner Deede Weithorn
April 9, 2013
Discussion Item: Actuarial Valuation Reports
MEMORANDUM
As per my email of Friday, March 22, 2013 to then Interim City Manager Kathie Brooks, please include on
the agenda for the City Commission meeting of April 17, 2013 a public discussion of the Actuarial
Valuation Reports for the City's two pension plans, the Miami Beach Employees Plan, and the City
Pension Fund for Firefighters and Police Officers. I would also like to suggest that the Commission
continue this discussion during Executive Session to establish direction on the issue.
Please do not hesitate to contact my office at extension 7105 with any questions and/or concerns.
Thank you,,
Deede Welthorn, Commissioner
City of Miami Beach
Wo oro comrni/tod lo providing excel/en/ P('b/ic ssNico and sofely io u/1 who live, wo1k, and ploy in our vib1
620
Agenda Item ·~q F __
Date S-~-:-13 _
Andy Kessler: The Pension Rate-of-Return Fantasy-WSJ.com Page 1 of3
Is Another Bear Market Around the Corner?
If you have a $500,000 portfolio, you should download the latest report by Forbes columnist
Ken Fisher's flrm, It tells you where we think the stock market is headed and Why, This
must-read report Includes our latest stock marl<et forecast, plus research and analysis you can
use in your portfolio right now I~>, Click Here to Download
'1 o or•Jer pre:r.cntatlo·'l·ro.:,dy CCJpies fer dlstnbutiun to your (X!Heague5. tliunts or e~.r&!omers
wv."·.ane•o11n'" ~;otrl
See a sample reprint in PDF format Order a repnnt of thls article
THE WALL STREET JOURNAL.
WSJ,C<lm
OPINION Updated April 9, 2013, 7 21 p.m. ET
Andy Kessler: The Pension Rate-of-Return Fantasy
Counting on 7..5% when Treasury bonds are paying 1.74%? That's going to cost ta:tpayers billions.
By ANDY KESSLER
It has been said that an actuary is someone who really wanted to be an accountant but didn't have
the personality for it. See who's laughing now. Things are starting to get very interesting, actuarially
~speaking.
Federal bankruptcy judge Christopher Klein ruled on April1 that Stockton, Calif., can file for
bankruptcy via Chapter 9 (Chapter u's ugly cousin). The ruling may start the actuarial dominoes
falling across the country, because Stockton's predicament stems from financial assumptions that
are hardly restricted to one improvident California municipality.
Stockton may expose the little-known but biggest lie in global finance: pension funds' expected rate
of return. It turns out that the California Public Employees' Retirement System, or Calpers, is
Stockton's largest creditor and is owed some $900 million. But in the likelihood that U.S.
bankruptcy law trumps California pension law, Calpers might not ever be fully repaid.
Getty Images
So what? Calpers has $255 billion in assets to cover
present and future pension obligations for its 1.6 million
members. Yes, but ... in March, Calpers Chief Actuary
Alan Milligan published a report suggesting that various
state employee and school pension funds are only 62%-
68% funded 10 years out and only 79%-86% funded 30
years out. Mr. Milligan then proposed-and Calpers
approved-raising state employer contributions to the
pension fund by so% over the next six years to return to
full funding. That is money these towns and school
systems don't really have. Even with the fee raise, the
goal of being fully funded is wishful thinking.
Pension math is more art than science. Actuaries guess, er, compute how much money is needed
today based on life expectancies of retirees as well as the expected investment return on the pension
portfolio. Shortfalls, or "underfunded pension liabilities," need to be made up by employers or, in
the case of California, taxpayers.
http:/ /online.wsj .com/article/SB 1000142412788762110904578403213 83 5796062.html 04/10/2013
Andy Kessler: The Pension Rate-of-Return Fantasy-WSJ.com Page 2 of3
In June of 2012, Calpers lowered the expected rate of return on its portfolio to 7.5% from 7· 75%.
Mr. Milligan suggested 7.25%. Calpers had last dropped the rate in 2004, from 8.25%. But even the
7.5% return is fiction. Wall Street would laugh if the matter weren't so serious.
And the trouble is not just in California. Public-pension funds in Illinois use an average of 8.18%
expected returns. According to the actuarial firm Millman, the 100 top U.S. public companies with
defined benefit pension assets of $1.3 trillion have an average expected rate of return of7.5%. Three
of them are over 9%. (Since 2000, these assets have returned 5.6%.)
Who wouldn't want 7.5%-8% returns these days? Ten-year U.S. Treasury bonds are paying 1.74%.
There is almost zero probability that Calpers vvill earn 7.5% on its $255 billion anytime soon.
The right number is probably 3%. Fixed income has negative real rates right now and will be a drag
on returns. The math is not this easy, but in general, the expected return for equities is the inflation
rate plus productivity improvements plus the expansion of the price/earnings multiple. For the past
30 years, an 8.5% expected return was reasonable, given +3%-4% inflation, +2% productivity, and
+3% multiple expansion as interest rates plummeted. But in our new environment, inflation is +2%,
productivity is +2% and given that interest rates are zero, multiple expansion should be, and I'm
being generous, -1%.
So what to do? I recall a conversation from 20 years ago. I was hoping to get into the money-
management business at Morgan Stanley . I wanted to ramp up its venture-capital investing in
Silicon Valley, but I was waved away. It was explained to me that investors wanted instead to put
billions into private equity.
One ofthe firm's big clients, General Motors, had a huge problem. Its pension shortfall rose from
$14 billion in 1992 to $22-4 billion in 1993. The company had to put up assets. Instead, Morgan
Stanley suggested that it only had an actuarial problem. Pension money invested for an 8% return,
the going expected rate at the time, would grow 10 times over the next 30 years. But money
invested in "alternative assets" like private equity (and venture capital) would see expected returns
of 14%-16%. At 16%, capital would grow 85 times over 30 years. Woo-hoo: problem solved. With the
stroke of a pen and no new money from corporate, the GM pension could be fully funded-
actuarially anyway.
Things didn't go as planned. The fund put up $170 million in equity and borrowed another $505
million and invested in-I'm not kidding-a northern Missouri farm raising genetically engineered
pigs. Meatier pork chops for all! Everything went wrong. In May 1996, the pigs defaulted on $412
million in junk debt. In a perhaps related event, General Motors entered 2012 with its global
pension plans underfunded by $25-4 billion.
In other words, you can't wish this stuff away. Over time, returns are going to be subpar and the
contributions demanded from cities across California and companies across America are going to
go up and more dominoes are going to falL San Bernardino and seven other California cities may
also be headed to Chapter 9· The more Chapter 9 filings, the less money Calpers receives, and the
more strain on the fictional expected rate of return until the boiler bursts.
In the long run, defined-contribution plans that most corporations have embraced will also be
adopted by local and state governments. Meanwhile, though, all the knobs and levers that can be
pulled to delay Armageddon have already been used. California, through Prop 30, has tapped the
top 1% of taxpayers. State employers are facing so% contribution increases. Private equity has
shuffled all the mattress and rental-car companies it can. Buying out Dell is the most exciting thing
http://online.wsj .com/article/SB 100014241278876221090457840321383 5796062.html 04/10/2013
Andy Kessler: The Pension Rate-of-Return Fantasy-WSJ.com Page 3 of3
they can come up with. Expected rates of return on pension portfolios are going down, not up. Even
Facebook millionaires won't make up the shortfall.
Sadly, the only thing left is to cut retiree payouts, something Judge Klein has left open. There are
12,338 retired California government workers receiving $100,000 or more in pension payments
from Calpers. Michael D. Johnson, a retiree from the County of Solano, pulls in $30,920.24 per
month. As more municipalities file Chapter 9, the more these kinds of retirement deals will be
broken. When Wisconsin public employees protested the state government's move to rein in
pensions in 2011, the demonstrations got ugly-but that was just a hint of the torches and pitchforks
likely to come.
Meanwhile, it's business as usual. California Gov. Jerry Brown released a state budget suggesting a
$29 million surplus for the fiscal year ending June 2013 and $1 billion in the next fiscal year.
Actuarially anyway.
Or as Utah Rep. Jason Chaffetz told Vermont Gov. Peter Shumlin, upon learning at a 2011 House
hearing about that state's unrealistic pension assumptions: "If someone told me they expected to
get an 8% to 8.5% return, I'd say they were probably smoking those maple leaves."
Mr. Kessler, aformer hedge-fund manager, is the author most recently of "Eat People" (Portfolio,
2011).
A version ~~{this article appeared April w, 20i,}, on pa[Je A13 in the U.S. edition c1fThe Wall Street
Journal, with the headline: Tlw Pension Rate oF Return Fantasy.
Copyright 2012 Dow Jones & Company, Inc. All Rights Reserved
This copy is for your personal, non-commercial use only. Distribution and use of this material are governed by our Subscriber Agreement and by
oopyright law. For non-personal use or to order multiple oopies, please contact Dow Jones Reprints at 1·800-843-0008 or visit
www.djreprints.com
http://online.wsj.com/article/SB 1000 1424127887:62J 1 0904578403213835796062.html 04/10/2013