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Mendocino County's Debt Section
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Pension Debt

Retiree Healthcare Debt

"Excess Earnings"

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Budget Crisis Next 2 Years

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What Went Wrong

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Pension Debt

Last update - 2/21/11

Benefits and Organization

A number of factors determine what a County retiree’s pension will be, including a) category of employment, b) age of retirement, c) years of service, d) average of final 3 years salary, and e) if the employee is disabled.

Most counties in California participate in the State-wide California Public Employees Retirement System (CalPERS). Twenty one counties have their own independent retirement systems. The Mendocino County Employees Retirement Association (MCERA) is the smallest of these 21. MCERA has an independent Board of Directors - some chosen by the County, some by employees.

The County and its employees pay annual contributions to MCERA's Pension Fund. MCERA has total control over the County's retirement fund investments. Eventually MCERA pays the actual pensions.

What Actuaries Do, and How They Can be Wrong

Each year an Actuary makes two estimates:

  1. This Year: How much money needs to be contributed this year so there will be enough money to pay the future pensions employees are earning this year? This estimate is reported as a part of the County's employee compensation expense each year
  2. Previous Years: Is there enough money in the Pension Fund to pay all future pensions that employees have already earned in previous years?

Keep in mind these two aspects of what the Actuary does:

First - Past Expenses: For the most part Actuaries are not concerned with pensions that will be earned in the future beyond the current year. They are mostly concerned about pensions that have already been earned and that will be earned in the current year.

Second - Estimates: Actuaries make estimates about how much needs to be contributed each year. That amount is reported as that year's pension expense. Estimates can be wrong - very wrong.

Unfunded Pension Obligations

When Actuaries make the second estimate about previous years they may determine there is an "Unfunded Pension Obligation". This means there is not enough money in the Pension Fund to make future pension payments that have already been earned by employees in the past.

Both the County and its employees make annual contributions to the Pension Fund. Those contributions are calculated only to provide for the pensions those employees are earning that year.

However, if a significant Unfunded Pension Obligation develops only the County is obligated to pay extra to eliminate it. This is the part of Mendocino County's yearly payments that is rapidly growing.

Unfunded Pension Obligations have to do with what employees have already earned - they relate to expenses in the past. Most simply put - if there is an Unfunded Pension Obligation and the County contributed what it was told to in the past, it means the real pension expense was more than originally estimated and reported. There are many things that can make this happen (see below).

Pension Debt
Growth of Mendocino County Pension Debt.
The Growth of Mendocino County's Pension Debt

The County’s Pension Liabilities exist in two forms:

  • Unfunded Pension Obligations
  • Pension Obligation Bonds (POB)

This shows the growth of Unfunded Pension Liabilities including Pension Obligation Bonds. The value of 2011 is estimated - those earlier are actual values - based on the market value of Pension Fund investments.

The County has twice sold POBs:

  1. 1996 - $31 Million
  2. 2002 - Net of $76 Million in 2002.

The 2002 POBs actually totalled $92 million, but some was used to pay off part of the previous bonds - so the net was $76 million.

Pension Obligation Bonds simply transform Unfunded Obligations into Bond Debt. In fact the total debt winds up being larger because the cost of issuing the POBs is rolled into the value of the bonds. POBs are Unfunded Pensions in a different form; the cause of the debt is the same.

Unreported Pension Expense

To paraphrase the fundamental "GASB" principle about guaranteed retirement benefits, the payment of pensions is not an expense - it's the payment of a debt. Pensions are earned by employees whle they are working - not when they are retired. The expense - or cost happens while they are employeed.

Based on the real market value of the Pension Fund's investments as of June 30, 2010 and the remaining balance of Pension Bonds, the County's total Pension Debt caused by Unfunded Pensions was about $25 million. The County paid almost as much to the Pension Fund as the Actuary told it to in past years. Economically that means the Actuary's estimates of what the real pension expense was in those earlier years was wrong. The County has incurred about $225 million of real pension expenses that it has not reported to the people!

What Caused the County's Unfunded Pension Debt?

There are two major causes:

  1. Inadequate Pension Fund Investment Earnings: MCERA's target yearly return on investment has been 8% for decades. The Pension Fund's own Actuary reported actual returns from 1997 through 2010 were 5.2% - a third less than target. This is, by far, the source of the largest amount of Unfunded Pension Obligations.
  2. Diversion of Pension Funds: For years County and MCERA officials said that MCERA paid the County's retiree healthcare benefits out of "Pension Fund Excess Earnings. This was an utterly absurd claim. This is described on the next page under the heading "What Excess Earnings?".
Other Sources of Mendocino County's Pension Debt

Although they weren't as costly, there are a number of other factors that increased Mendocino County's Unfunded Pensions:

  • Increase in payroll in some years was greater than it told its actuary
  • Retroactive pension increases to 50 employees without contributing extra funding
  • Didn't pay into the Pension Fund what it was supposed to a couple of years
  • Much higher than average rate of disability retirements
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