LOS ANGELES – Turns out the Los Angeles Fire and Police Pension system return rate was 17.3 percent for 2013-2014, and other public pension funds reported similar double-digit returns and five-year returns exceeding their assumed rates.
– LAPPL Board of Directors on 08/07/2014, in their post “Misuse of statistics behind erroneous LA police officer salary claims.”
The above quote was made in response to our recent article “How Much Do Los Angeles Police Officers Make?” that analyzed total compensation for LAPD officers. The substance of their overall response was to challenge two assumptions made in that editorial, (1) that the annual rate-of-return projection of 7.75% used by the LAFPP (Los Angeles Fire & Police Pensions system) is too optimistic, and (2) that the employer’s “unfunded contribution” – that annual sum paid to LAFPP by the City of Los Angeles towards reducing the plan’s unfunded liability – must be considered part of an officer’s annual total compensation. Only the 2nd of these challenges, by the way, might indicate any downward impact on our average total compensation estimate of $157,151 per year.
This article will examine and defend both of these assumptions, starting with our assertion that a 7.75% rate-of-return projection is too optimistic. How much a pension fund can earn each year, on average, over the long-term, is a topic of intense expert debate. The historical performance of the LAFPP shows that as of 6-30-2013 their one year return was 13.01%, but the five year average return through that date was only 5.05%. If you go back ten years the annual average was 7.66%. But as investment professionals always remind us, past performance is not an indicator of future performance. The global economy is in the terminal phases of a debt binge that began back in the 1980′s; we’re in uncharted territory; nobody knows how investments will perform as this debt unwinds. What we do know is that throughout the industrialized world the population is aging – as a percent of total population, we have twice as many people selling their investments to fund their retirements as a generation ago. These twin phenomena, debt and demographics, suggest investment performances from now on face unprecedented headwinds. To debate this point is not to “misuse statistics.” To ignore this debate is intellectually dishonest. We are at the top of a bull market and LAFPP is only 83% funded. If the long-term average annual earnings projections aren’t overly optimistic, when you’re at the top of a market there should be a surplus in the pension fund.
Ultimately, if the LAPPL Board of Directors are so confident that a 7.75% rate-of-return can be sustained over the next 20-30 years, then they should support building triggers into the benefit formulas, allowing them to be lowered if and when earnings do not meet projections. Here is a summary of proposals to do just that: “The Case for Adjustable Defined Benefits,” CPC, July 2014. The sooner they adopt options like these, the less likely their entire defined benefit system will eventually catastrophically implode.
Which brings us to the unfunded liability, and why employer payments against this unfunded liability belong included in the total compensation of employees.
The LAPPL argument appears partly valid when they state “unfunded liabilities include pension liabilities of already retired and deferred plan members, not just active officers.” That’s true – but the problem with that reasoning is this unfunded liability is not being paid down. This means the payment towards the unfunded liability – to the extent it is not actually reducing the amount owed – is a permanent annual payment required to financially sustain the pension fund. If that is true, then currently active employees will benefit when they retire from the employer’s ongoing unfunded contribution that will, at that point, be allocated to those still active employees. Only if the unfunded liability is being paid down can you begin to make the argument that all of it does not belong included in total compensation for active employees.
Basic accounting concepts support this. If the unfunded liability is not being reduced, then the entire employer’s payment towards the unfunded liability is additional deferred compensation towards their future pension benefits. So how much of an unfunded payment is being made by the City of Los Angeles into the LAFPP? Is it reducing the balance owed?
Reviewing the most recent publicly available statements, the City of Los Angeles, Fire and Police Pension System – Financial Statements, 6-30-2013, on page 19 there is a discussion of the allocation of employer pension contributions. In that fiscal year, the employer made a $246 million “normal contribution” and a $129 million “unfunded contribution.”
The official unfunded liability for LAFPP is $2.97 billion. At a discount rate of 7.75%, just a minimal interest only payment would be $230 million. This means that during FYE 6-30-2013, the LAFPP received an unfunded contribution from the employer that was $101 million less than the amount required just to pay the interest! The fund necessarily incurred negative amortization. In that context, 100% of that unfunded contribution belongs allocated to the active employees as part of their total compensation, because at that rate, a generation from now, these unfunded contributions will continue unabated to shore up the system they will then benefit from as retirees.
For these reasons, our organization stands behind the earlier estimate of total compensation for Los Angeles police officers of $157,151 per year. The debate over whether or not any of the unfunded contribution should not be allocated to individual officers as part of their compensation is moot until the amount of the employer’s unfunded contribution, at the very least, is sufficient to avoid negative amortization.
When discussing what levels of total compensation are affordable and appropriate, especially in the case of police officers who risk their lives every day to protect the public, the best approach is to strive for accuracy and fairness, to always behave with intellectual honesty, and to engage in the debate with mutual respect. Unfortunately, the tone of the LAPPL rebuttal to our editorial deviates from these ideals. But that is their job. As unions, their rhetoric easily gravitates to an “us vs. them” mentality. This can have a corrupting effect on public servants, alienating them from private citizens.
The job of public sector unions, and they do it all too well, is to get as much for their members as they possibly can, utilizing the extraordinary leverage they have over public officials who they help elect, and then negotiate with. This tone, and this leverage, does not belong in government work. Public employee unions should be illegal, and can be replaced by voluntary associations that would still wield considerable influence. And public employees should look to the deeper causes of our shared middle class struggle; high taxes, excessive regulations, failed welfare and immigration policies, and inordinate restrictions on land and energy development.
Authored by Ed Ring, executive director of the California Policy Center.
The quantitative work for this article and the preceding one is summarized on the Excel spreadsheet that can be downloaded by clicking on the link provided below. The CPC welcomes commentary and corrections, if any, and will acknowledge and if necessary retract any statements, calculations or estimates that are demonstrated to be inaccurate: