Sunday, December 20, 2009

Addendum:
Apparently one or more of the source documents that I referenced in the following article has been removed from the Internet. Fortunately I anticipated such an action and I downloaded and saved all of them so that the evidence is not lost. Rest assured that my quotations and references to material in those documents are accurate. One may disagree with my interpretations and conclusions, but the facts are indisputable.
Regarding my conclusions, however, please consider that when there were market downturns in the past, PERA always published assurances that our retirement was secure because PERA dealt with long time frames and could weather the storms. Then in 2009 PERA did an about-face and claimed drastic changes had to be made immediately. What happened in early 2009? That was when the law was passed requiring the merger with DPSRS, which carried with it the huge DPS offset to employer contributions. Everything PERA has done since then is consistent with the motivating force of trying to equalize the funded status of the School and DPS Divisions as quickly as possible in order to end the DPS offset.
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Problems with Colorado PERA’s 2010 Legislative Proposal
by Jim Prentice, a PERA retiree

Colorado PERA has proposed legislation that will significantly reduce the benefits that a large percentage of its members and retirees expect to receive in the future. My analysis raises serious doubt about the validity of PERA’s assertions that drastic changes are needed in the state-wide retirement program, and it brings to light what I believe is the real agenda behind PERA’s proposal -- something that results from the required merger with the Denver Public Schools Retirement System (DPSRS) on January 1, 2010. Justification does not exist for PERA to breach its contracts with tens or hundreds of thousands of members and retirees regarding fully vested, guaranteed benefits and the benefits promised for both earned and purchased service credit.

After attending the PERA informational meeting in Colorado Springs on November 4, 2009, at which the Executive Director and the Chief Operating Officer of PERA presented their legislative proposal, I began a search to fill in some holes in their data. Information did not come in a neat package but was scattered throughout various documents. What I found has led me to the conclusion that the facts do not justify this legislative proposal that would allow PERA to reduce fully vested and supposedly guaranteed benefits to its retirees while hiding, or at least not highlighting, the real problem facing PERA.

Nearly all of the facts that I unearthed came from the web sites of PERA, Denver Public Schools, and the Denver Public Schools Retirement System. I have included the information necessary to locate these documents on the Internet so that everyone can verify the facts for themselves. I have also downloaded, saved, and printed the DPSRS documents in case PERA takes down the DPSRS web site after the merger. My opinions and conclusions are simply the logical result of piecing this puzzle together.

This article is long and very detailed, but it needs to be because of the complexity of the subject matter. Readers owe it to themselves to go the distance because PERA’s proposed changes may have a significant negative effect on the income of the more than 440,000 PERA members including more than 80,000 retirees, plus the new folks coming in with the merger.

I began my trail of discovery when I noticed that the information packet provided by PERA at the meeting included actuarial projection graphs for the State, Local Government, and School Divisions but not for the Judicial Division. I located that graph along with the other three on PERA’s web site at http://www.copera.org/pdf/Misc/LACGraphs2008.pdf.

I expected the results to be worse than the other divisions because the benefit provisions for the Judicial Division, especially calculation of the Highest Average Salary, absence of a prohibition against salary spiking, and working after retirement, are significantly more generous than for the other divisions. To my surprise, the projections for the Judicial Division are the best of them all. Compare the retirement provisions in PERA’s booklets, available at https://www.copera.org/forms/MemberOrder.html. Especially see the Judicial Division booklet at https://www.copera.org/PDF/5/5-26.pdf.

The better actuarial projection for the Judicial Division did not make sense to me, so I dug further and found a fact sheet at http://www.copera.org/pdf/5/5-123.pdf which shows that the employer contributions are roughly one-third higher in the Judicial Division than in the other divisions. That leads to the obvious conclusion that if the employer contribution rates in the other divisions were the same as the rate for the Judicial Division, then PERA’s funded status could be increased with only minor tweaking rather than a major overhaul.

Next I accessed PERA’s Comprehensive Annual Financial Report For the Fiscal Year Ended December 31, 2008 (CAFR). This is a 143-page document available at http://www.copera.org/pdf/5/5-20-08.pdf.

A table at the bottom of page 28 in the CAFR lists the amount of time until full funding of each division is achieved under the provisions of existing law. It shows that the time for each division is: School, 75 years; Local Government, 19 years; Judicial, 48 years; and an infinite time period for the State Division. (The Health Care Division is not applicable because its funding is different from the others.) But the following statement is made at the top of page 29. “The amortization periods with AED and SAED do not include the full effect of the 2006 legislation. The legislation includes plan changes that will lower the normal cost for future new hires and will allow more of the employer’s contribution to be used to amortize past service costs earned.” In other words, the table would show even better results than it does if all currently existing legal provisions were taken into account!

The table was created by Cavanaugh Macdonald Consulting, LLC, which is the Pension and Health Care Program Actuary for PERA. Although full funding of all divisions is not achieved within 30 years as PERA would like, the table directly contradicts the information package presented by PERA in support of its proposed legislation. It is also important to recognize that an amortization period longer than 30 years does not constitute insolvency! This establishes that actuarial necessity does not exist, so therefore PERA has no justification to reduce fully vested, guaranteed benefits in my opinion.

The discrepancy between PERA’s information package and the table prepared by PERA’s own actuary must be reconciled. We need to know what assumptions were used for PERA’s graphs. Did PERA prepare its graphs when the market was at its lowest in March of 2009? The tables and graphs must be updated using the latest information available since markets have recovered significantly in 2009. PERA should be willing to allow independent verification of the data or at least have it prepared by the actuary firm rather than in-house, and all effects from existing law should be built into the calculations to get an accurate picture. Does the projection program take into account the fact that the group of employees and retirees with the 3.5% annual increase is a closed group with membership declining as deaths occur? Transparency and verification are needed since the proposed major changes are based on PERA’s claims, and data taken from PERA’s own financial report appear to contradict those claims.

Apparently PERA is allowing some access to a coalition of organizations in which the Colorado Education Association is taking a lead role. But to what degree is the coalition challenging PERA’s assertions? After CEA representatives left the PERA Board meeting on December 18, 2009, a Board member asked if updated charts were available from Cavanaugh Macdonald. The Chief Operating Officer replied that new ones are available and would be distributed to the Board members during Closed Executive Session. Closed sessions are used to discuss pending litigation, among other things. Does this mean the new charts do not support the claim of actuarial necessity? I would have expected PERA to present the charts publicly if they were supportive of the claim.

The average PERA member does not have the resources to create the complex financial projections that are required. Therefore we must rely on the coalition and on the members of the General Assembly to demand access and openness. All claims made by PERA must be challenged. Updated and accurate projections must be prepared. Then the results need to be presented to the public, perhaps by making them available through the web sites of both PERA and the coalition members.

My initial conclusion based on what I discovered about the employer contribution rate for the Judicial Division, that a major overhaul is not necessary, is supported by that table and statement on pages 28 and 29 in PERA’s CAFR for 2008. But that being the case, I wondered what was driving PERA’s decision to make big changes.

Digging further into the CAFR, I came across Note 12 to the Financial Statements on pages 61-62. This Note discusses the takeover on January 1, 2010, of Denver Public Schools Retirement System by PERA, as required by a law (SB09-282) enacted in May, 2009.

The following statement is at the top of page 62 of the CAFR. “Allows the DPS [Denver Public Schools] to subtract the amount of principal and interest payments in any year on its Pension Certificates of Participation notes from the employer contributions owed in any year except to the extent necessary to pay the contributions to the Health Care Trust Fund and the Annual Reserve Fund until the DPS Division’s ratio of unfunded actuarial liabilities to payroll equals the School Division’s.”

Following this trail I discovered a PERA publication at http://www.copera.org/pdf/Legislation/2009/LegUp6-09.pdf that mentioned that DPS had ongoing payment obligations for Pension Certificates of Participation (PCOPS) issued in 1997 and 2008. PCOPS are a form of debt like bonds.

An Internet search located a letter written November 9, 2007, by Michael Bennet, then Superintendent of DPS, and Tom Boasberg, then Chief Operating Officer of DPS. DPS borrowed $377 million in 1997 with PCOPS that expire in 2019. (Did they mean 2017?) That money was put into DPSRS. The letter may be viewed at http://blogs.rockymountainnews.com/material_disclosures/archives/2007/11/a_pitch_to_save.html.

Then I located the 2008 Comprehensive Annual Financial Report for DPSRS at http://www.dpsrs.org/docs/FinancialAndPlanning/CAFR2008.pdf. On page 6 it states that DPSRS received $397.8 million in April, 2008, from the issuance of more PCOPS by DPS. The Bennet and Boasberg letter referenced earlier indicated that this second round of PCOPS will be for 30 years.

So between 1997 and 2008, DPS took on nearly $775 million of debt to fund its retirement system, and DPS can offset certain payments to PERA since PERA will be receiving the assets of DPSRS but DPS remains liable for the PCOPS.

The Bennett and Boasberg letter refers to debt service of $40 million per year for the 1997 PCOPS. The DPSRS CAFR for 2008 refers on page 30 to an interest rate of 8.5% for the 2008 PCOPS. Applying a simple interest calculation without factoring in repayment of principal results in debt service of roughly $34 million for the second group, bringing the total debt service into the neighborhood of $74 million per year, plus principal repayment on the 2008 group.

The merger legislation enacted in 2009 sets the employer contribution rate that DPS must pay to PERA at 13.75% from January 1, 2010, through 2012 and 14.15% thereafter. This information is also on page 30 of the DPSRS CAFR for 2008. Subtracting the 1.02% contribution to the Health Care Trust Fund, the rates become 12.73% and 13.13% respectively. But because of the offset provision in the merger legislation, most, if not all, of the employer contribution from DPS will not have to be paid to PERA for many years to come. This information also comes from page 30 which concludes with the following statement. “As stated in the Board of Trustees motion in support of the merger legislation, the Board and the management of the system believe this schedule of employer contributions will lead to a substantial decline in the funded status and soundness of the DPS Division.”

PERA is taking over DPSRS on January 1, 2010, and will be responsible for the payment of retiree benefits, but PERA will receive very little from DPS employer contributions for years to come. Extrapolating from the data on page 63 of the DPSRS CAFR, the employer contribution for 2010, excluding the Health Care and Annual Reserve Funds, would be in the neighborhood of $50 million, but DPS will not have to give that money to PERA because it will be more than offset by the debt service on the PCOPS. This is a cash flow problem for PERA.

On top of that, DPS seems to have pulled a fast one on DPSRS and PERA. DPS paid employer contributions to DPSRS at the rate of 10.21% for 2008 according to the table on page 63 of the DPSRS CAFR. But DPS will put almost no money into DPSRS for the second half of 2009, as described on page 30 of the DPSRS CAFR. “On June 18, 2009, the Board of Education passed Resolution 3164 and established the employer contribution rate at 15.53% for the period beginning July 1, 2009, through December 31, 2009. This employer rate is offset by the District’s payments on the outstanding PCOPs, at an assumed interest rate of 8.5%. The resulting net contribution to the plan is 0.49%, using data provided by the staff of DPS. ... The Board of Trustees and the management of the System strongly disagree with the assertion that the net contribution rate of 0.49% is actuarially sound.” The merger was already decreed by law, so DPS took advantage of the opportunity to essentially stop funding the retirement system for the last six months before the merger even though benefits still had to be paid monthly. No safeguard had been written into the merger law to prevent this.

Interestingly, the DPS money grab for the second half of 2009 will be helpful to PERA because it has the effect of lowering the funded status of DPSRS. That in turn will hasten the day when the funded status of the new DPS Division and the School Division become equal, at which time DPS will lose its right to subtract debt service from its employer contributions to PERA.

The assets of DPSRS will be reduced by the DPS action affecting the last six months of 2009, and beginning January 1, 2010, PERA will have cash outlays for benefits but little inflow from employer contributions by DPS for several years, if not decades, because of the offset for debt service. The amount that PERA does not receive under the offset provision could possibly be more than one billion (with a “b”) dollars, depending upon how long it takes to achieve equalization! One could say that DPS prepaid its contributions by funding the retirement program with debt, but regardless of how it is viewed the fact remains that a high price tag is attached to the assets PERA is receiving from DPSRS.

This, however, still does not completely explain why PERA wants to reduce fully vested benefits to its retirees by negatively changing the annual increase that is currently established by statute.

The provision allowing DPS to offset employer contributions to the extent of debt service continues “until the DPS Division’s ratio of unfunded actuarial accrued liabilities to payroll equals the School Division’s” as stated at the top of page 62 of the PERA CAFR for 2008. The funded status of the new DPS Division will undoubtedly drop as assets are liquidated to pay benefits, but PERA cannot take steps to inappropriately lower the funded status of the DPS Division because that would violate its fiduciary responsibility. Therefore it is in PERA’s interest to raise the funded status of the School Division as quickly as possible to meet the naturally declining funded status of the DPS Division, thereby ending the DPS offset to the employer contributions. The longer it takes to equalize the divisions, the more cash PERA loses to the DPS offset.

One of the quickest ways to raise the funded status is to eliminate or greatly reduce the 3.5% annual increase of the PERA retirees. Using rough numbers extrapolated from the benefit payments information on page 27 of PERA’s CAFR, eliminating the annual increase for 2010, which can happen since the Consumer Price Index is expected to be zero, will save the payment of $50-$60 million or thereabouts from the School Division and around $100 million overall for PERA. Saving the payment of tens of millions of dollars per year by reducing the annual adjustments will raise the funded status and hasten the day when the DPS offset must end. This is a major factor behind the PERA legislative proposal in my opinion because it connects all of the dots!

PERA has apparently seized upon the opportunity presented by the economic downturn to use that as a plausible excuse to make big changes, despite Executive Director Meredith Williams’ statement in the Retiree Report of November, 2008, “...we don’t want to overreact to short-term economic turmoil. Our goal is to keep a steady hand in rough waters so that we can protect our promise to you.” See http://www.copera.org/pdf/Newsletters/RetireeReport/RR11-08.pdf. That statement was made, however, before the law was passed requiring PERA to acquire DPSRS.

It is true that the markets declined badly in 2008. But the markets have also recovered substantially in 2009. Jennifer Paquette, PERA’s Chief Investment Officer, reported at the Board of Trustees meeting on November 20, 2009, that PERA’s investments were up about 20% for the year and investments in emerging markets were up a whopping 75% for the year. Couple this information with the table mentioned earlier showing that PERA’s funded status is manageable or nearly so based on provisions currently provided in the law and one can only conclude that a crisis situation does not exist.

During the PERA Board meeting on December 18, 2009, a representative of ColoradoWINS suggested making lesser changes at this time and then seeing what else might be needed later. PERA Board member Marcus Pennell replied, “I’d like to address the discussion you had about stabilizing the patient. One of the problems with that approach is simply that we can’t make changes of this nature to the pension plan without actuarial necessity. If you make some percentage of changes that need to be made and it gets you out of actuarial necessity but not healed, you don’t have the opportunity to treat the patient any more and they live with the injury as it is.” Mr. Pennell was advocating for the need to approve the proposal as a complete package because doing something less may take away the actuarial necessity argument and thereby prevent PERA from getting all of the changes it seeks. Isn’t that an admission that all of the proposed changes really are not needed but PERA is trying to make unjustified changes by bundling the package and claiming that it is an inseparable whole?

It is my conclusion that published material from PERA’s own actuarial consulting firm shows that actuarial necessity for PERA’s legislative proposal does not exist. PERA seems to be inheriting a significant cash flow problem regarding the acquisition of DPSRS, but that problem should not be solved by reducing the fully vested, guaranteed benefits of retirees and future retirees. Updated, verified information is an absolute necessity before proposed legislation goes forward. PERA’s funded status should be improved, but changes that result in breach of contract or violation of the Colorado Constitution are not justified.