Poor Financial Estimates Plague Orange County, CA Retirement System

Here’s a piece of good news for Orange County taxpayers: Over the past decade, the county has acted fiscally responsible by paying 100 percent of the amount financial risk specialists suggested should be saved to pay for pension benefits that have been promised to employees.

But here’s the bad news: The financial experts haven’t been making good estimates, and the Orange County Employees Retirement System has $5.4 billion in debt.

In 2000, OCERS had more assets on hand than it had promised to pay in retirement benefits. But today, the system has just 65 percent of the money needed to pay for pension promises made to employees.

So what happened?

Pension systems are “prefunded,” so, each year, taxpayers are supposed to pay a certain dollar amount into the county’s defined-benefit retirement system. This money gets invested and grows so that when today’s employees retire there is money available to pay the pension benefits they’ve earned. But defined-benefit pension systems can only work when the financial risk specialists – called actuaries – get their estimates about the future right. And they’ve screwed up big time.

First, consider that 10 years ago OCERS officially assumed that it would earn a 7.75 percent investment return on its assets over the following decade. Instead, the county earned 6.56 percent. While that is a good return, it created a canyon between money saved and pension benefits promised.

Getting the investment return assumption right is a critical part of the actuary’s job because it greatly influences how much the county should save for retirement benefits annually. If the county had used a more conservative estimate for its investment returns, it would have had to save more money each year, yes, but pension debt would have never grown so high.

Second, actuaries didn’t make very good assumptions about the life expectancy of retirees. When you’re promising a guaranteed lifetime pension, it is important to have good estimates of how long people will live.

Unfortunately, the life expectancy projections the county was using 10 years ago were nearly 50 percent too low for most age groups.

While it’s great we are living longer – and the county’s projections have since been updated to reflect that – the inaccurate mortality rate assumptions mean Orange County hasn’t been saving enough to cover all the pension benefits that are being claimed and now needs to catch up.

We can see the effects of these poor actuarial assumptions reflected in the most recent valuation of OCERS, released in June. Pension liabilities have more than doubled over the last decade from $7.4 billion to $15.8 billion.

Yet pension assets haven’t grown fast enough to keep up, and are only at $10.4 billion today. That’s why there is $5.4 billion in pension debt – and the promise of more debt to come.

Every year that the county hires new workers and puts them into this retirement system, there is a growth in liabilities without enough money being saved to pay those benefits.

The first step the county should take is to put future employees in a more fiscally sustainable retirement system, like the 401(k)-style retirement plans nearly all private sector companies offer.

The county should also start saving more to pay for future retirement benefits. Last year, the county added about $1 million in additional contributions to reduce pension debt, but it’s not nearly enough.

Similarly, the OCERS board has lowered the assumed rate of return on investments to 7.25 percent, but even that is unrealistic and needs to be lowered further. In the years since the 2008 financial crisis, the stock market has made big gains, but the county’s investment returns have averaged just 4.9 percent on an actuarial valuation basis. Today, the most that private sector defined-benefit retirement systems would assume for their investment returns is around 5 percent.

County employees should join the calls for reform because, if the fiscal trends in OCERS continue, Orange County could end up bankrupt like Stockton – where a federal judge recently ruled that employees’ pension benefits could be cut in bankruptcy. And taxpayers should be clamoring for the county to reform its pension system so they don’t saddle today’s young people and future generations with such large public employee pension debt in the years to come.

Anthony Randazzo is director of economic policy at the Reason Foundation. This article originally appeared in the Orange County Register.