The Orange County Employees Retirement System board in session.

Not unlike it’s behemoth statewide counterparts, CalPERS and CalSTRS, the Orange County Public Employee Retirement System (OCERS) is facing an unfunded pension liability that is epic in size (for Orange County it’s approaching $6 billion, for the statewide groups its exponentially larger).

In fact a study out of Stanford University pegs the aggregate unfunded liability statewide at just shy of half a trillion dollars. To illustrate the difficulty of trying to bring down these numbers, you need look no further than the very modest so-called Public Employees Pension Reform Act (PEPRA) which contained limited reforms championed in the 2012 legislative session by Governor Brown and legislative Democrats.

For all of the hoopla and declarations of “meaningful pension reform” that new law addressed significantly less than 10% of the liability — it hardly moved the needle. Yet it was trumpeted as ultimate pain by the unions, and ultimate gain by Brown and legislative leaders (who, by the way, were all elected with massive infusions of campaign cash from the a fore-mentioned unions).

Realistically there are three routes to get rid of these unfunded liabilities — one is politically impossible, one is mathematically improbable, and the other then becomes the most practical. This third option, by the way, is only possible for OCERS. There are no obvious answers for the larger statewide retirement systems, where unlike OCERS, the unions dominate their governing boards.

The first option, which due to the pervasive control of state and local government by the unions, seems to be politically impossible — is for hardline negotiations with all current public employees, making it clear that until the unfunded pension liability is reduced by voluntary reductions in current employee retirement benefits, there are no more raises — and in fact, where possible, there may be reductions in total compensation. Give current workers a choice between compensation in their paychecks today, or in their retirement tomorrow. This would be a “claw back” from years of granting unwise and unsustainable levels of benefits for public workers. Unfortunately this is unlikely to happen. The only place you see this happening in a small way is in local cities where (and this is for real) the Councils actually give employees a raise (sometimes with a “wink wink”) which allows those employees to increase their contributions to their own retirement (while notching up the employee benefits in the process). Of course this is a zero-sum game, shifting money from one pot to another, but not reducing the overall costs.

The second option, which is mathematically improbable, is to count on rosy investment returns to somehow “save the day” with investments constantly making awesome returns. This method has been an abject failure. This is a method hailed by public employee union bosses, who are much more loyal to their current union members than their retirees. After all, the less money that actually has to be paid into the retirement system, the more money that is available to hire new union members and give raises out to current workers. This method also has the benefit of shielding from the pubic the very real, impending danger: that in order to make good to all of the current and pending pensioners, it is going to either mean higher taxes, or state and local governments having to severely cut back on their funds for other services in order to meet their pension obligations.

It’s worth mentioning that these current, massive unfunded liabilities are largely due to two reasons. The first — ongoing “rosy” predictions of investment income that have fallen short. The other — a series of tragic votes at the state and local level by politicians increasing retirement benefits for workers retroactively. So new commitments are made in the latter years of someone’s employment, but are made retroactive to when that employee started. But no “back payment” is made at the time to make these retirement systems “whole” for the new liability — hence a deficit. You can’t make this stuff up.

The most obvious path to really start to address and bring down the unfunded liabilities — and thus protect the taxpayers from potentially being on the hook through new taxes, and protect retirees from the specter of not having funds available upon which to draw in their latter years — is to be more realistic about what it will take to pay down the unfunded liability, and to be on a fairly aggressive pace to get this done. As a practical matter, this conversation centers around the two variables in the control the retirement system board — how long you amortize the liability (how long to do plan to take to pay it off) and how much do you increase the required payments into the system from customers (county, cities, JPA’s) in order to pay down the deficit?

At OCERS, the agency has a ten-member governing board with a fiduciary obligation to address this issue. Four of the board members are there representing the current employees, and are selected internally by public employee unions. Four of the board members are appointed by the Board of Supervisors, to make sure taxpayers are represented on the board. There is a ballot sent to retirees so that they get a representative. And finally the elected County Treasurer rounds out the body. As I said above, the unions have a huge interest in not wanting to divert resources away from the pot of available funds that give them their current raises, and allows for the growth of their membership. Fortunately the balance of the OCERS board is tilted towards fulfilling the responsibility to the retireees and to the taxpayers.

There has been a lot of controversy because of a recent decision by the OCERS board to reduce the assumed rate of return on investments by a half point (and the assumed rate of return is STILL dangerously aggressive). There have also been discussions about reducing the number of years it will take to pay it off (right now the liability is amortized, like a home loan, over such a long period of time that when you actually crunch the numbers the liability still GROWS for many years because of interest liability before eventually a corner is turned and you start to pay down principle).

At a critical time in the midst of all of this, one of the Supervisors’ appointees to the OCERS Board, Reed Royalty, announced his retirement. Yesterday the Board of Supervisors replaced him with David Ball, who comes from the private business sector with considerable investment experience. He also is a fiscal conservative who is likely to vote with the other appointees of the Board. It was a unanimous vote by the way by Supervisors Bates, Moorlach, Nelson, Nguyen, and Spitzer – for which they should be praised.

The appointment did not come without some criticism. Representatives of some of the counties largest public employee unions vocalized their dismay. Which in the context of the situation, as you have read in this column, makes perfect sense. It’s not enough that they have four of their own appointees, who vote in lock-step. There was also some concern from a couple of city council members (one of them, Dave Shawver, a longtime ally of the unions and who received hundreds of thousands of dollars in union support in his unsuccessful bid against John Moorlach for Supervisor many years ago). The stated concern was that if the OCERS board ups the required pay-in levels for local governments that it will negatively impact their ability to provide city services. Think about that. This is analogous to someone on a fixed income maxing out their credit card debt and then complaining that the minimum payments are too high and crowding out the rest of their budget. Oh, this is an imperfect analogy because OCERS is not making a profit like a credit card company, so all of the funds paid are simply going to fund obligations. Shawver and one other Council Member said that there should be a representative of cities on the OCERS board. This is just a political ploy by the unions who (unfortunately) have a lot of sway over many local elected officials. I would say that if the unions want to give up a seat or two to the cities, the they can work that out and bring back a proposal. In the meantime the appointees of the Supervisors are there to represent all residents, including those that live in cities.

These kinds of problems are less pervasive, by way, in private sector retirement funds because the requirements placed on their governing boards in terms of assumptions for rate of return. In other words, the law requires private pension funds to be more aggressively funded, and thus they are, in general, in better shape. These laws do not apply to public pension funding. Seriously.

This saga will continue to play out in Orange County. And while I believe that the over-arching motivation of those on the OCERS board is their obligation to the retirees, I would add that there also needs to be a focus on trying to minimize “generational theft” — where politicians obligate future generations to pay for things that they are utilizing today. It makes sense to finance infrastructure, like a bridge or a building, over decades. The benefit from those things lasts generations. But for something like retirement for an employee, the goal should be to set aside the funds needed for their retirement while they are still working. We are a long way from that, unfortunately.

Finally, if you are interested in getting a more in-depth look at the challenges facing OCERS, I strongly recommend that you click through to this column by Ed Ring, who is the executive director of the California Public Policy Center. His organization got under the hood of OCERS and really crunched and analyzed the numbers.

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