CalPERS and the Fair-Value Method of Measuring Under-Funding

[johnkarls]

.
Yesterday (Saturday 4/27/2013), Pat posted a set of comments on this bulletin board focusing on how CalPERS suddenly began providing more financial disclosure on its website after our quite-critical Q&A’s were posted last Tuesday evening (4/23/2013).

The reader can judge for her/him-self whether this was mere coincidence.

When our Q&A’s were posted last Tuesday evening (4/23/2013), CalPERS’ website offered only 10 years’ worth of INVESTMENT reports and the most recent one was 22 months out of date. Here is the most recent one that had been posted --

RL-z420-Calpers-AnnualInvestmentReport-6-30-2011.pdf

(817.04 KiB) Downloaded 138 times

As noted in Pat’s posting, before the week was out, the INVESTMENT reports (including the one immediately above) suddenly disappeared from the CalPERS website and were replaced by 10 years’ worth of “COMPREHENSIVE ANNUAL” reports, the most recent of which was for the fiscal year ended only 10 months ago (vs. 22 months ago). Here is the most recent one of those --

RL-z427-Calpers-ComprehensiveAnnualReport-6-30-2012.pdf

(3.31 MiB) Downloaded 208 times

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COMPLIMENTS FOR CALPERS

Whether or not Pat is correct that the timing of the disclosure changes is too coincidental not to have been caused by the criticisms in our Q&A’s, let’s be gracious and applaud CalPERS’ change of heart.

In addition, CalPERS should also be complimented that unlike the INVESTMENT reports, the “COMPREHENSIVE ANNUAL” reports --

(1) are audited,
(2) include income statements, not merely balance-sheet (“photo date”) tables of the various types of investments and their respective amounts, and
(3) disclose the assumed rate-of-return that is used to calculate the percentage by which CalPERS is underfunded.


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THE FAILURE OF THE “COMPREHENSIVE ANNUAL” REPORTS TO USE THE “FAIR VALUE” METHOD FOR COMPUTING UNDERFUNDING REQUIRED BY THE U.S. SECURITIES AND EXCHANGE COMMISSION

The Transmittal Letter of the CalPERS C.E.O. (pp. 2-5 of the 6/30/2012 Comprehensive Annual Report) states in its penultimate paragraph that the CalPERS assets are expected to be 74% of CalPERS liabilities as of 6/30/2012 -- which would be comparable to the weighted-average 74.8% that we had calculated in Q&A-17 for 6/30/2011, the most recent date for which such information had been available as of our Tuesday-evening (4/23/2013) Q&A posting.

However, the C.E.O.’s comment is extremely odd because the date of her Transmittal Letter is 12/31/2012 -- SIX MONTHS AFTER THE CLOSE OF THE 6/30/2012 FISCAL YEAR AND SIX MONTHS AFTER THE 6/30/2012 DATE FOR WHICH SHE WAS SPECULATING THAT CALPERS WILL ONLY BE 74% FUNDED!!!

[Six months should have been more than enough time to have made the actual calculation!!!]

Q&A-22 had noted that CalPERS’ total rate of return (which would include both income and appreciation) for the 5-year period ended 1/31/2013 (the most recent date for which such information had been available) was only 2.2% -- or 0.4%/year.

The Transmittal Letter of the CalPERS C.E.O. (second paragraph) admits that for the fiscal year ended 6/30/2012, this was only 0.1%.

Despite the dismal earnings record of CalPERS in recent years, the Transmittal Letter of the CalPERS C.E.O. (fourth paragraph) admits that CalPERS is assuming that it will earn 7.5%/year in calculating that it is only 74% funded!!!

Our Q&A’s noted that this is “GETTING AWAY WITH MURDER” compared to the “Fair Value” Method for computing underfunding which --

(1) is required by the U.S. Securities and Exchange Commission for Annual Reports of corporations; and

(2) can, according to the non-partisan U.S. Congressional Budget Office (please see Q&A-19), “be thought of as what a private insurance company operating in a competitive market would charge to assume responsibility for those [pension] obligations.”

What is truly laughable about this “GETTING AWAY WITH MURDER” is that the CalPERS “Comprehensive Annual” Report claims (its last unnumbered page before its 236 numbered pages) that The Government Finance Officers’ Association of the United States and Canada awarded the CalPERS Annual Report for 6/30/2011 a “Certificate for Excellence in Financial Reporting” and that the prior 15 annual reports had also received such certificates.

Let’s put aside petty speculation about how many such certificates are issued every year and whether virtually all reports by governmental units in both countries received such certificates.

The fact remains that CalPERS does NOT use the Fair-Value Method for calculating under-funding because the so-called Government Accounting Standards Board permits them to assume any rate of return they please (the “GETTING AWAY WITH MURDER” RULE).

And of course CalPERS, as the largest pension fund in America (corporate or government) and probably the world, has a great deal of influence over the Government Accounting Standards Board in perpetuating this “GETTING AWAY WITH MURDER” rule of assuming whatever rate of return CalPERS pleases!!!

So is it any wonder that although the Independent Auditors’ Report (pp. 14-15 of the CalPERS Annual Report) appears to disclose in pains-taking detail exactly what CalPERS is doing, and to disclose the limits on the scope of its audit and the limits on the scope of its opinion, the opinion concludes that the financial statements are “in conformity with accounting principles generally accepted in the United States of America -- WITHOUT EVER BOTHERING TO MENTION THE VAST GULF IN BOTH PHILOSOPHY AND NUMERICAL RESULTS BETWEEN THE “GETTING AWAY WITH MURDER” RULE THAT CALPERS AND ITS FELLOW GOVERNMENT PENSION FUNDS AUTHORIZE THEMSELVES TO USE VIA THEIR SO-CALLED “GOVERNMENTAL ACCOUNTING STANDARDS BOARD” AND THE FAIR-VALUE METHOD REQUIRED BY THE U.S. SECURITIES AND EXCHANGE COMMISSION FOR CORPORATIONS???!!!

Before CalPERS leads itself and other state-and-local pension plans into bankruptcy for which U.S. taxpayers will be asked to provide a bailout, Congress should pass a law requiring state-and-local pension plans to publish annual reports that use the “Fair Value” Method of computing under-funding.

And even if Congress fails to act, for the sake of decency CalPERS should disclose to its constituents (both governmental units and the employees/pensioners) the extent to which CalPERS is under-funded using the “Fair Value” Method required of corporations by the S.E.C., as well as the extent of under-funding using the “GETTING AWAY WITH MURDER” rule.

Respectfully submitted,

John S. Karls, Esq.
JD, Harvard Law School, 1967
Retired Senior International Tax Partner (Technical) – Ernst & Young International
Elijah Watt Sells Silver Medal (for ranking 2d nationally among 28,788 candidates on the Fall 1971 Uniform CPA Examination)
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