MOORLACH UPDATE — Pension Debt — September 12, 2013

Traditionally, it has been the prerogative of the Board Chair to recommend appointments to the Orange County Employees Retirement System (OCERS). Once the Board approves the appointment, the appointee usually serves for a very long period of time. Consequently, Wayne Lindholm’s reappointment should not be a surprise, at least from an historical practice perspective. During his term of office on the OCERS Board, he has held progressive leadership positions on the Board of the Lincoln Club of Orange County, and serves as the President now. Both are volunteer positions. His bio on the OCERS website provides his business background as an Executive Vice President of Irvine-based Hensel Phelps Construction Co., a reputable firm in the construction industry. His flaw? He understands pension math and is passionate about addressing this critical liability that is making an ever larger dent in the budgets of municipalities here in Orange County. His bias? Don’t postpone your debt payments, thus imposing a larger burden on future generations. Nothing irrational here.

Reed Royalty has served with distinction on the OCERS Board since September of 1998, but recently announced his retirement from this obligation. Allow me to share my gratitude for Reed’s service to the residents of Orange County over these many years. Board Chair Shawn Nelson proposed David Ball as his appointment to fill the vacancy. Mr. Ball has a very strong investment background and would be an asset to the OCERS Board. He fits the criteria that I’m looking for, someone knowledgeable and experienced in portfolio management who has been successful in his own right. Having a city represented, just for the sake of having a city represented, is not my idea of a good appointment. The commitment to serve as an OCERS trustee is very time consuming and should be occupied by someone with the proper skill sets. City councilmembers are more than busy enough with their numerous elected obligations. Therefore, I saw no need to delay the Chair’s recommendation of Mr. Ball. The Voice of OC provides its unique perspective to the interaction during this week’s Board of Supervisors meeting regarding the recommended OCERS appointments in the article below.

Supervisors Appoint Conservative to Pension Board but Delay on Another

By NORBERTO SANTANA JR.

The Orange County Board of Supervisors Tuesday unanimously approved the reappointment of Lincoln Club President Wayne Lindholm to represent them on the Orange County Employees Retirement System despite protests from public sector labor leaders.

Supervisors, however, delayed the appointment of Costa Mesa resident David Ball, former chief financial officer for Republican mogul George Argyros, after members of several local city councils argued that the public seat on the retirement board or OCERS should include a representative from cities.

Supervisor John Moorlach voted against the delay, saying Ball should be seated immediately despite the protests.

Labor leaders, meanwhile, told supervisors that Lindholm is too political, given his post on the Lincoln Club and his outspoken activism on behalf of lowering investment assumptions for the local pension system as well as tightening amortization periods for obligations.

Lindholm, for example, was the leader of a recent effort to pressure Orange County Treasurer-Tax Collector Shari Freidenrich to change her vote on amortizations. Based on the pressure, Freidenrich manufactured a public excuse to reagendize a June vote. She has resisted public comment on the matter, now scheduled for a vote in November.

Labor leaders has asserted that appointments like Lindholm’s are politicizing OCERS and creating a government crisis, because following those kinds of policies could bankrupt cities and severely cut public services.

Republican Supervisor Todd Spitzer Tuesday chastised labor leaders in public, saying the fact that Lindholm is outspoken, even political, is a plus.

“You see that as a criticism. I see that as a positive,” Spitzer said.

He also echoed the sentiments of supervisors Chairman Shawn Nelson, who publicly argued that political appointments are part of the process and the reason elections matter.

“That’s the system we operate in,” Spitzer said.

Lindholm echoes many Republicans who fear that the pension system has fallen too far behind in securing the cash to maintain current retirement benefits, with the result that obligations are being kicked to the next generation.

Indeed, in recent years the county’s unfunded pension liability, now hovering near $5.7 billion, has become a national campaign issue for Republican candidates and party leaders, who argue that the obligations are a signal that organized labor has secured overly rich retirement benefits from timid local elected officials.

The unfunded liability is the gap between the county’s estimated long-term obligations to retirees and the cash on hand to fund them. At this point, Orange County’s retirement system is about 63 percent funded due mainly to pension benefit increases in 2000 for public safety and 2004 for general employees along with investment losses and actuarial changes over the last decade.

On Tuesday, Nelson fired back at labor leaders, saying that financial experts like Warren Buffet have consistently argued that investment return estimates for public pension systems are too generous and suggested that 6 percent is more appropriate. OCERS estimates a 7.25 percent return, and CalPERS, the state system, assumes 7.5 percent.

“It’s not an aggressive, crazy assumption,” Nelson said. “No one would call Warren Buffet extreme,” he said.

Yet an examination of investment returns for both OCERS and CalPERS shows that both have been in double digits in recent years, except for the period around 2008.

While acknowledging the gap is a concern, Orange County labor leaders fume over the Republican focus on retirement benefits while ignoring numerous other cost drivers in local government, such as lucrative corporate contracts connected to campaign cash, a constant wave of expensive and uncontested change orders and executive benefit packages deemed excessive.

They also argue that appointing conservative activists like Lindholm goes against the principle of shared management of a pension system, because instead of acting as a fiduciary and balancing fiscal responsibility with affordability, activists are aiming to create a financial crisis.

The worry for many city leaders such as Stanton Mayor David Shawver, a Republican, and Westminster City Councilwoman Diana Carey is that efforts to drastically reduce the pension system’s unfunded liability measured over 30 years will create enormous strain on city budgets and have the effect of cutting public services.

Shawver and Carey told supervisors that OCERS appointees have no idea that the rates they adopt each year have massive consequences on cities that contract with the county for law enforcement and fire services, because those workers’ pensions are managed by OCERS.

Both city council members said they were stunned at how little understanding OCERS board members had over the impacts to local governments.

“They didn’t even know that local government is impacted by those decisions,” Shawver said. He warned supervisors that “each decision that is made by that board without input from local government can become a catastrophe.”

Tom Dominguez, president of the Association of Orange County Deputy Sheriffs, was also publicly critical of the fact that supervisors are failing to balance affordability with fiscal responsibility in their appointments. Dominguez also urged “an open and transparent process for open seats on the OCERS board.”

Chris Prevatt, an OCERS appointee representing employees, told supervisors on Tuesday that Lindolm’s efforts to tighten amortization schedules added significant yearly costs to the county and cities. He urged that supervisors keep that in mind.

The concerns by both Shawver and Carey did strike a chord with Spitzer and Supervisor Pat Bates, whose district includes many cities that contract with the county for public safety services.

Bates noted that hearing from city leaders that OCERS board members appointed by supervisors don’t know the impacts on cities was “not good news.”

Bates urged and received a delay until next week on the pension debate, summing up by noting that the pension debate features both political and policy aspects and warning that elected leaders need to consider both.

Supervisor Janet Nguyen supported a delay but said it would not likely change her vote to support Ball.

Please contact Norberto Santana Jr. directly at nsantana and follow him on Twitter: twitter.com/norbertosanana.

FIVE-YEAR LOOK BACKS

September 12

2003

Stuart Pfeiffer of the LA Times provided a Pension Obligation Bond (POB) tutorial in “Bond Plan Called Risky – O.C. finance experts say borrowing to buy stocks may cut pension costs. To some officials, it smacks of the strategy that led to bankruptcy.” Issuing POBs is a method of funding a pension plan, but it does not reduce the employer’s overall debt (it’s actually trading debt from the pension system to bondholders). Had the County issued POBs in 2003, it would have paid 5.85% to bondholders. The sales pitch from the investment bankers is that the investment return rate of the pension system then was around 7.75%, providing a 1.9% delta. During the last nine years, the average actuarial value investment return was 6.28% (less than the assumed rate). Consequently, the overall theoretical savings would have been only 43 basis points for this time period, or a push. But, the County would have to hope that investment returns exceeded 5.85%, on average, for the remaining future years left on the outstanding bonds. POBs can work if you utilize them at the appropriate time (right before a major bull market). Regretfully, studies have found that the vast majority of POBs were issued at the wrong time and the pension system yields were lower than the POB interest rates – oops. Therefore, POBs should be considered with extreme caution, as was exercised ten years ago. With interest rates at all-time lows, and the Dow Jones Industrials at all-time highs (hint: potential of facing a flat or bear market), issuing POBs today would be inadvisable.

Nine years after its borrow-and-invest strategy helped plunge Orange County into bankruptcy, some county finance officials want to borrow more than $300 million and invest it — an idea that has met strong resistance from county leaders.

The plan calls for Orange County to borrow the money at 5.85% interest and add it to the county’s undernourished retirement fund, which over the past 10 years has returned 8.83% on investments primarily in stocks, bonds and real estate.

The idea would create two potential benefits: helping the county pay off its debt to the pension system at a lower annual payment and generating a profit, said Thomas Beckett, the county’s public finance manager.

But some county officials said investing borrowed money in the stock market is too great a risk for a public agency. The county retirement system investments posted a gain of about 9% the first six months of this year but lost 5.5% in 2002 and 3.2% in 2001.

"It’s just not prudent to go out and risk taxpayer money based on the possibility of a short-term gain," said Orange County Auditor-Controller David Sundstrom. "If this was a really good strategy, then what I should do is mortgage my house up to 90% loan-to-value and take all that money and invest it in the stock market."

Orange County declared bankruptcy in 1994 after a series of investments by then-Treasurer Robert L. Citron collapsed, leaving the county more than $1 billion in debt. Citron had borrowed money to make the investments, exposing the county to even greater liability. The latest investment strategy has met resistance in a county that still feels the pain of the bankruptcy: Its $873-million bankruptcy debt requires a $91-million annual payment and is not scheduled to be paid off until 2026.

Beckett said the plan for the so-called pension obligation bonds is not comparable to Citron’s investments. "He bet on a derivative product that was highly speculative," Beckett said. The retirement system runs "a balanced fund, spread between equities, fixed income, real estate ….We’ve already got $4 billion in there. All we’re doing is adding to what’s already in there."

Keith Bozarth, chief executive officer of the retirement system, said it’s inaccurate to compare his investments to those made by Citron. "Our investment strategy is designed to produce reasonable returns and avoid significant risks," he said. "It is very unlike the strategies that the former treasurer used."

The county’s retirement system is underfunded by about $1 billion, in part because of the losses in 2001 and 2002 and an increase in retirement benefits paid to county sheriff’s and fire employees, Bozarth said. The county will have to pay an estimated $58 million per year to help repay its debt to the pension system, Bozarth said.

About 22,000 government employees are part of the pension system, and 9,000 retired workers are receiving benefits.

Beckett asked the county Public Financing Advisory Committee to approve the bond issuance last week. He said the retirement system’s investment pool is conservative but one of the best performing of its kind in the state.

By borrowing money and investing it in the pension portfolio, the county would reduce its payments to the fund by about $5 million a year, he noted in a report to the committee.

Orange County Treasurer John M.W. Moorlach, a nonvoting member of the finance committee, said he has concerns about the plan.

"This is something Citron did. Before you enter into it, you better be darn sure you know that [losing money] is something that could happen," said Moorlach, who campaigned against Citron in 1994 and argued that his investment scheme was too risky for a county government.

Still, Moorlach said he’s not ready to rule out the latest investment idea.

"You can’t just have a knee-jerk reaction and say, ‘Oh, I did that before and I have bad feelings,’ " he said. "My big concern is I’d like to spend more time analyzing whether this is a good time to put money in [the stock market]…. If you’re looking for a good time to borrow, this is the time."

The idea met with some resistance at the finance committee and was not forwarded to the Orange County Board of Supervisors. If the committee eventually agrees that borrowing money by selling bonds is a good idea, the matter would go to the board.

Two board members said they are concerned about the idea. "To go out and borrow money to invest, to me, is very scary, and it will take a lot to convince me that would be the prudent thing to do," Supervisor Jim Silva said.

Supervisor Chris Norby said, "Borrowing to invest: bad idea. Those words have special meaning in the Orange County context."

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