by Tom Dillon
American Reporter Correspondent
August 5, 2005
HOW CalPERS, NATION'S LARGEST PENSION FUND, MISSED KEY OPPORTUNITY
SACRAMENTO, Calif. -- I have been in the financial services industry for over 20 years. I've worked for Merrill Lynch, Bank of America, Dean Witter, Morgan Stanley and, finally, for myself. But I've never seen a financial trasnaction like one I'm going to describe at the nation's largest retirement pension fund, the California Public Employment Retirement System, known by the acronym CalPERS.
At the end of the first quarter of 2005, CalPERS had $182,234,000,000 invested for its 1.4 million public employees and 2,500 member firms, and enjoyed an $-0.02 percent on its investment for the quarter. And on behalf of those retirees, it ultimately turned down an offer by the worldwide insurance firm ING to guarantee it a four to seven percent annula return on investments, and to allow retirees to gain up to $100,000 for their estates at the time of their death.
In brief, CalPERS hired consultants to do a job; the consultants' ensuing report was factually inaccurate; the consultants were given the correct information and asked to do the job over; the consultants said no; the consultants kept the money and that is the end of the story.
The money the consultant was paid was taxpayer money, representing contributions from the State of California to CalPERS so that state retirees will have a safe, happy retirement.
Only in a government-run bureaucracy can someone get paid to do a job, not do the job, refuse to do it correctly, and keep all the money. Oh - the consultants are still among the preferred vendors for CalPERS. No one there even thinks this is wrong.
Let me back up and provide some details. In 2000 President Bush changed some tax laws that made some guaranteed insurance investments subject to two separate taxes. The insurance industry makes a lot of money on these products and didn't want to lose that income, so they made some changes in their products.
Specifically, they started to offer a rider called an "Enhanced Earnings Benefit" (EEB). With this rider attached to your account, when you die any earnings in your account will be added to by up to 55% capping out at 150% of your deposit.
For example: You deposit $100,000. The account grows to $200,000 and you die; your account has grown by $100,000. Multiply 55 percent times $100,000, giving your estate $55,000 (the enhanced earnings benefit tops out at $150,000, however). Your beneficiaries will receive $255,000. The insurer, ING, charges 0.30% of the balance for this rider.
Why can't pensions plans use this? Structuring the accounts is a bit complicated but achievable. Insurance companies also offer riders that guarantee minimum returns of four to seven percent even if the markets go down and never come back.
There is only one catch. In order to actually use these ridersm someone has to die - not a good exchange for most individuals but for pensions? Absolutely! As the saying goes, no one can avoid death and taxes.
It was the Holy Grail of pension investments! We had found a way to guarantee pension assets, and increase any growth (up to $100,000) by 55 percent, while guaranteeing a minimum return of four to seven percent on pension monies.
We would make pensions safer, increase the returns and save taxpayers money. Now all we had to do was tell the right people about it.
Enter CalPERS. Rob Feckner, the president of CalPERS, saw our presentation and loved it. He had some questions he needed answered, like how can insurance companies make money offering all this? (The answer is "lapse rates" - most people surrender their accounts before they die and never receive the promised benefits.) And how much money could we invest? Other than that it looked like the perfect arrangement.
Enter the Consultant. CalPERS, like most Defined Benefit/Pension plans do, has outside consultants they hire to review and offer their opinion on different investment strategies. RV Kuhns & Associates, a respected investment consulting firm from Portland, Ore., was hired for this assignment.
RV Kuhn's review of this strategy was primitive and rudimentary at best:
They did offer this opinion:
"As this is a potential arbitrage strategy exploiting the pricing habits of [mostly publicly traded] insurance companies, it is unlikely that either the capital markets or internal controls will allow such any potential mispricing to continue for very long. This is even if potentially attractive, accordingly, a very fragile opportunity with a higher return on investment hurdle."
They didn't base this opinion on any facts, nor did they appear to want any facts. They suffered from "confirmation bias:" they had made up their minds, and didn't want to confuse them with the facts!
One month later, after barraging Rob Feckner with the reality of the review, we finally had a face to face meeting with RV Kuhns, at our expense and in Portland; our offices are in Sacramento.)
When presented with the facts, which they found interesting, we asked if they would re-evaluate and re-issue their report.
They declined, saying they had no client at present requesting such a task, and adding that since this request was from a hypothetical client they couldn't assure us they would take the assignment if offered.
No wonder Governor Arnold Schwarzenegger wants California to stop paying pensions and change the retirement plan to the 401k. No sane person would do this to themselves.
Tom Dillon writes a monthly article on labor pensions for the California Democratic Dialogue, is a member of the Office and Professional Employees (OPEIU) Local 29 and a registered representative and investment advisor for Cambridge Registered Insurance Advisors, Inc., based in Sacramento. Visit him at www.dillonblonskij.com.