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by Carol Goodhue Shull and Bob Shull | inewsource

When members of a government board take a vote that brings them personal financial gain, that’s generally called unethical, or even illegal.

But on California’s public-employee pension board, it’s standard procedure, practically guaranteed by the makeup of the board — and required by the state Constitution.

Gov. Jerry Brown, who came into office this year with pension reform as his top priority, announced a plan Oct. 27 that might be a game-changer. Although State Senate Republican leader Bob Huff introduced legislation Feb. 22 encompassing Brown’s plan, the bill faces daunting legal and political obstacles, however – the fiercest posed by public employees themselves.

Understanding how the California Public Employees’ Retirement System, (CalPERS), operates can go a long way toward devising solutions not only at home in the nation’s largest pension system, but across the country.

inewsource, a journalism nonprofit based at San Diego State University, delved into the legal and practical intricacies of the pension system and found that while some reforms have been implemented over the years, built-in conflicts of interest can only mean bigger bills for the taxpayers now and in the future.

“What the boards have been doing is sugar-coating the risk and the cost of benefits in order to encourage the highest benefits possible to members, and then when things go awry, they do a tap dance,” said Marcia Fritz, a C.P.A. and president of the pension reform group California Foundation for Fiscal Responsibility.

Most people didn’t pay a lot of attention to public pensions when the funds were flush. But since the bottom fell out of the economy starting in the fall of 2007, it’s tough to find anyone in California who doesn’t know the taxpayers are in a deep hole. The unfunded liabilities for pensioners are an estimated $181 billion.

A lot of people are piping mad about the debt, scandals and sky-high pensions some individuals are collecting.

The state’s political watchdog fined 16 CalPERS officials on Sept. 22 for failing to report gifts. That paled compared with the state Attorney General’s $95 million lawsuit against former CalPERS board member Alfred J.R. Villalobos. It accused him of securities fraud for hiring former chief executive Federico Buenrostro, Jr., to pressure the board to invest in companies Villalobos represented, collecting more than $70 million in fees as a placement agent. A report for CalPERS in March said the two were still under investigation on possible criminal charges.

Finally, stoking the taxpayers’ ire is the list of people collecting pensions of $100,000 or more. The top figures are so dazzling that it’s difficult to see that the average retired state worker lives on a pension of about $26,400 a year.

Only 2 percent of public employee retirees get more than $100,000. However, that 2 percent collect 7 to 9 percent of the benefits.

Colossal gains

Even after taking a haircut in 2007 and 2008, CalPERS remains the 500-pound gorilla of pension funds, able to move markets with more than $236.5 billion in assets serving 1.6 million members, including many local as well as state government workers, as of Feb. 28. Next in line: California State Teachers Retirement System, (CalSTRS), which reported a $148.9 billion fund and more than 852,000 members on Jan. 31.

But both state pension funds face gaps in funding for pension payouts now and for years to come. How this happened can be explained only in part by the bursting of the real estate bubble and the stock market crash.

It can be traced back to 1984, when voters passed Proposition 21.That removed restrictions that said the pension funds had to maintain 75 percent of their investments in bonds. Suddenly, all bets were on, and the funds rode the stock market with impressive results.

The surplus at CalPERS caught the attention of politicians coping with a state budget deficit. “They’ve got green eyes,” longtime board member Robert Carlson told Pensions & Investments in 2007. He was there in 1991, when then-Gov. Pete Wilson tried to raid the pension funds. Labor unions reacted by successfully backing Proposition 162, which in 1992 made beneficiaries the pension board’s priority.

“Prior to that there had been a balance, where they were supposed to protect taxpayers and also supposed to protect the members,” said Ed Mendel, who developed expertise in the state’s pension funds through covering California government for nearly three decades and now reports on them in the Calpensions blog. “What Proposition 162 said was, from now on, first and foremost you protect the members.”

That legal change protected pensions from a governor’s hungry eyes and would maximize pensioners’ benefits, but it meant that nobody on the board had the taxpayers’ backs. Six of the 13 board members are current or former public employees elected by their peers, and they’re present or future beneficiaries of the system. The rest are appointees, or they serve because of their job or elected office.

Joe Nation, a professor in Stanford University’s Public Policy Program and a former state Assembly member, is among those questioning the makeup of the board. He said he’s heard about the conflicts of interest first-hand.

“I will tell you what staff members have whispered to me on a couple of occasions: ‘Look, we’re trying to do the right thing here, but we have a board that doesn’t always let us …’ ”

For example, Nation said staff members told him that the board in March 2011 projected a higher rate of return on investments than the staff believed was realistic.

“And part of the reason they did it, I believe,” Nation said, “is the board has a large number of public employee representatives, and they are directly impacted by what the predicted rate of return is through the contributions they have to make.” In other words, the bigger the yearly estimate of how much investments will grow over time, the smaller the amount workers and their employers (the state or other government entities) have to contribute to the pension fund each month.

But if reality falls short of the predictions, the taxpayers have to fill the gap. That void is estimated at $4 billion this fiscal year.

Fritz believes that if more board members were independent, they would see their obligation as ensuring the long-term health of the funds, “not ensuring the highest possible benefit is awarded to every member.”

Benefit boosts and scandals

In 1999, the legislature passed a bill that increased pension payments. California Highway Patrol officers got a 50 percent boost, and other changes enabled some workers to retire at age 50 with pensions amounting to as much as 90 percent of their last salaries.

The bill, which initially provided for a modest increase in benefits to widows and orphans of state workers, slipped under the radar, passing easily, with assurances from CalPERS.

“They said it was going to cost nothing — zero dollars,” recalled Dede Alpert, who represented the San Diego region in the state Legislature from 1991 to 2004. “I’m not an expert, but I’ve seen the economy go up and down … To think it would always be rosy — we must have been crazy.”

At least lawmakers weren’t voting in their own interest, she noted. Those elected from 1990 on lost their generous pension and health benefits when term limits were established.

Scandals in the pension system prompted reforms, such as legislation requiring placement agents like Villalobos to register as lobbyists. That legislation, Assembly Bill 1743, took effect Jan. 1, 2011.

On Oct. 7, Gov. Brown signed legislation that extended a cooling-off period from one year to 10 years for former pension board members and executives who might get paid as placement agents for CalPERS or CalSTRS.

One avenue for potential influence that hasn’t been closed is campaign contributions. In particular, unions have donated to campaigns of board member candidates elected from the ranks of workers and retirees as well as the two elected state officials serving on the board: State Controller John Chiang, who got relatively low amounts of campaign money from unions, and State Treasurer Bill Lockyer, whose contributions from unions were substantial.

Mendel, the Calpensions blogger, said CalPERS deserves some credit for toughening certain restrictions and for releasing – without a fight — information about its top pension recipients.

Risky bets

In addition to problems of its own making, there have been others beyond the pension system’s control. One is higher salaries. Another is state workers retiring younger and living longer. That not only extends the period when they collect pensions; it increases health insurance costs substantially until they qualify for Medicare. CalPERS provides generous health plans that might cost $24,000 a year for a worker and a spouse in their late 50s or early 60s.

These rising costs in a difficult investment market have led CalPERS to make higher-risk investments in search of greater growth in the funds. In the past year, the fund’s chief investment officer, Joseph A. Dear, has spoken openly about the pressure to deliver profits that far exceed recent market returns.

As part of its new strategy, CalPERS is not only turning to riskier private equity and hedge funds but also investing farther from home. Not surprisingly, international investments make sense to Laurence Fink, who heads a global investment management firm that manages $1 billion in assets for CalPERS.

However, that means the biggest investment fund in the country will be putting its money to work creating companies and jobs overseas when nearly one out of 10 Americans can’t find work, he told Moneynews in September. “Is that good for the U.S.?”

Many questions about pensions for state workers are up for debate now that Brown has revealed his plans for narrowing the pension funding gap, and Fritz said taxpayers are eager to weigh in.

“I have been told by pollsters … that they have never seen an issue where people will answer every question, where they will keep the pollster on the phone to talk about it more,” she said. “There’s something going on; the people are very engaged in this.”

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