Mendo’s Mythical ‘Excess Earnings’

by Ted Stephens, March 24, 2010

I attended the recent Mendocino County Employ­ees Retirement Association (MCERA) board meeting. Even though we do not elect these folks (i.e., they are not responsible to us), I did it as Supervisor Smith told me to at the March 2 Board of Supervisors meeting in response to my comments about the very large deficits from this program and my frustration with what I see as misleading reporting. Supervisor Smith does sit on the MCERA board as one of the four appointees of the BOS. There are also four elected from the county employee pool and the Treasurer-Tax Collector also sits on the board. As an important note, I believe most of the board members are set-up to participate in the pre 1998 health care benefit deal, thus having a vested interested in the “Excess Earnings” policy.

I became involved in this looking at these numbers for MCFB and also being on John Dickerson's Your Public Money.Com (YPM.com) peer review group.

I asked John Dickerson to join me at this meeting as I know he has been looking at this process for quite a long time. The YPM.com video on this subject is an excellent place to get additional information. The MCERA meetings are recorded and viewable on the MCERA website. I was the only MCFB member I know of at the meeting. Besides John there were about five other people. Four were retired County employees and one was a retired citizen.

Background

All County employees are covered under the Defined Benefit Retirement Program. The employees make contributions, but the majority of the funding, and the covering for any shortages, are paid by the county. To fix prior underfunded problems the county floated Pension Obligation Bonds (POBs) in 1996 and 2002. These bonds currently have a balance of about $92 million dollars and take about $10 to$11 million in debt service each year per the counties audited finan­cial statements and the sheets John McCowan gave us last summer. The POBs were done to bring the fund­ing from an underfunded situation to a fully funded condition. This action was taken via the BOS and not a vote of the people. As of the last actuarial study dated 6/30/2009 we are underfunded on an actuarial basis at about the $66 million range and underfunded on a market value basis in the $130 million range. Actuarial basis is a system to smooth out the invest­ment years and also spread the underfunded amount over a 30 year period; changes last year lowered the amount the county currently has to put into the pro­gram. Most of the counties debt comes from this Pen­sion Plan and also the unfunded retiree health care benefits in the range of $130 million. Certificates of Participation (COPs) of $26 million and Teeter of $11 million are the only other real debt we have. The Pen­sion is a responsibility of the county. In 1998 the county decided to stop funding future retiree health care benefits. Some pre 1998 employees say they were promised health care benefits for life; the county says it was a goal, but is not a liability of the county. With approval of the BOS, the MCERA has been using the “Excess Earnings” from the pension plan to fund the pre 1998 retiree health care benefits. Excess earnings are defined as anything over the 8% Target rate of return and a 1% reserve in a single year. This appears to be justified by a 1937 State Act allowing the proc­ess. In any good year the earnings have been stripped out of the plan and put into the retiree health bene­fits. Since good years have been stripped out, there has not been a cushion, beyond the 1% reserve, for the bad years. Because there are not any current “Excess Earnings,” the retiree health care plan is set to run out early next year if additional money is not contributed by the county.

Total Debt Recap

• POBs of $92 million + current Unfunded Pension Liability averaged at $100 million

• COPs at $26 million + Teeter at $11 million = $227 million If you add the $130 million unfunded retiree health care liability this would be $357 million.

The Issue

Even though we were fully funded with the POB flotations in 2002, we are now greatly underfunded again. Part of this is from the practice of taking any good year earnings, after a 1% reserve over the target goal of 8%, and striping them as “Excess Earnings” to put in the retire health care fund. One problem with this is the dollars are coming from the earnings on all people in the pension plan and going to a special class of beneficiaries to pay for those pre 1998 employees with health care. It is my understanding that about 70% of the employees are not covered under the pre 1998 deal and 30% are covered. Thus, the “Excess Earnings” comes from all the people covered by the pension program and is given to the 30% who are pre 1998 health care retirees. This practice has helped create the $158 million to $222 million in current pen­sion total debt the county is responsible for. There is also a problem in that our the target rate of return is 8%, but the rate of return for the last 13 years is 4.4% BEFORE the “Excess Earnings” were stripped. This process of how much excess earnings have been stripped and what the return was after the earnings and MCERA expenses were taken out has not been reported. Today, for the first time John Dickerson and I saw a report showing that about $30 million has been taken out of the pension over the last 11 or so years. If this money had stayed invested it would go a long way towards solving our underfunded condition.

Another problem with the current setup is the non-elected, vested interest MCERA is making policy decisions that the taxpayers are responsible for. They have no funding risk by robbing Peter to pay Paul. The county, as long as it is solvent, must pickup the unfunded obligation created by stripping the earnings from the pension plan that had been funded. In short, this is a recipe for disaster and one that I have become very frustrated with as people in power seem to avoid addressing the situation The BOS likes to say that they don't have any say in the “Excess Earnings” deal. The reality is this policy has created a huge drain on our county budget. It is a classic example of poli­tics, rather than sound fiscal policy, allocating resources. The BOS could certainly replace the four MCERA board members and could also threaten to minimum fund the Pension to force this practice to stop. The BOS bully pulpit could also work. I imagine the 70% with their pensions at risk would speak up on this practice only benefiting the 30% if it was being discussed openly.

The pension contribution rate by the county for the next fiscal year has to increase in the range of an 30% additional contribution per payroll dollar to amortize this current unfunded situation over the next 30 years. This will cost the county about an addi­tional $2.5 million dollars this next fiscal year. Add this to the $10 million to $11 million going to the payment of POBs and we have about $13 million going out for this practice when we currently have a budget deficit for the rest of this year and all of next year in the $7.6 million range.

What I said about “Excess Earnings” today at the MCERA Meeting (3 Minuite puplic expression period at the beginning of the meeting only; I was asked to sit down)

From Yorkville, my educational background, profes­sional background, had looked at County finance for MCFB, was on peer review for YPM.com

While it may be legal, this is a practice that would make Charles Ponzi proud as it gives returns from all investors to a special class of investors, overstates the returns and the system is destined to collapse from this practice.

That while funding retiree health care is a noble and honorable task, hiding it through an accounting gimmick at the expense of other retirees, citizens of our county and the taxpayers is a despicable act.

That from a normal financial perspective, there have never been any “Excess Earnings” and I would like the word stricken from their vocabulary until we are over funded, on a market value basis, at the 150% level.

That I believe this is a breach of fiduciary responsi­bility taking from one class of beneficiaries and giving to another class of beneficiaries.

That this practice has created our single largest source of county debt.

That this program makes Teeter look like a Piker.

That the reporting from Buck and Callan does not show the true numbers and would not be allowed for use with the investing public (this is because they report numbers BEFORE “excess earnings” are stripped).

What Happened?

Jim Andersen, MCERA Administrator brought agenda items forward for consideration. The main ones were:

“Using excess earnings to build pension benefits compared to funding OPEB programs, i.e., retiree health care.”

It was decided that the excess earnings policy should be kept available, but not used until the actu­arial funding is in the 95% to 100% range. They are going to discuss this further in the next meeting.

“Reducing or eliminating the Accuarial Value of Unrecorded Earnings (Account 1300)” It was decided to repay this $9.5 million liability from “Excess Earn­ings” as soon as possible. John Dickerson and I were not really sure what this is, or how it relates to our current underfunding. We were not allowed to ask questions and they did not make the numbers they were looking at available to us until I had asked for them several times so we had a hard time following. It also appeared that others on the MCERA board really did not understand how this works. I raised my hand to try to clarify until it was very clear they were not going to call on me. John Dickerson thought this was a liability from the county advancing funds to the pension so they could give them to the health care plan in bad years and that they would be repaid by the pension to the County in later years when they could take “Excess Earnings.” The $9.5 million came from fiscal years 2003/2004, 2004/2005, 2005/2006.

Although Supervisor Smith had suggested it, this was somewhat frustrating going to a board where you can not really speak or ask questions; the board is not accountable to the taxpayers or voters. This board was not pleased with the little I did say.

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