California Agency Calls State's Pensions 'Dangerously Underfunded,' Suggests DB-DC Hybrid Solution

California’s Little Hoover Commission, an independent state agency created to develop recommendations to control state and local government pension costs, found that the 10 largest pension funds faced a combined unfunded liability of $240 billion in 2010.

(February 28, 2011) — A new report issued by California’s Little Hoover Commission has recommended that California’s public pension plans should switch to a hybrid model with elements of a defined benefit plan and a defined contribution plan.

Hoover’s report explained that California’s pension plans are “dangerously underfunded.” The causes, they outline, are overly generous benefit promises, wishful thinking and an unwillingness to plan prudently. “Unless aggressive reforms are implemented now, the problem will get far worse, forcing counties and cities to severely reduce services and layoff employees to meet pension obligations,” the commission stated.

In the commission’s study of public pensions, the finding showed that the state’s 10 largest pension funds – encompassing 90% of all public employees – are overextended in their promises to current workers and retirees. To combat growing liabilities, the commission recommended that a hybrid model, which combines a lower defined-benefit pension with an employer-matched defined-contribution plan, is a model that must be made available to public agencies. According to the report, California must collapse unsustainable pension formulas and create a lower defined-benefit formula to facilitate this approach. Furthermore, the report suggested that a cap should be put in place on the maximum salary that can be used to determine pension payments, or on the maximum pension that an employee can earn, protecting pensions for lower-wage earners.

“California’s pension system – a conglomeration of 85 defined-benefit pension plans – demands more uniformity and oversight,” according to the report.

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In response to the report, the $226.5 billion California Public Employees’ Retirement System (CalPERS) issued a statement saying: “Pensions play an important role in the overall compensation of public employees today and have for nearly 80 years, and any change must honor the promises made to all public servants…CalPERS has earned a 7.9% return over the last 20 years above our assumed rate of return and we have gained more than $70 billion back since the financial crisis. We look forward to engaging with the decision-makers who must rely on all the facts when confronting these important issues and recommendations.”

To contact the <em>aiCIO</em> editor of this story: Paula Vasan at <a href='mailto:pvasan@assetinternational.com'>pvasan@assetinternational.com</a>; 646-308-2742

US District Judge Mariana Pfaelzer in Los Angeles has required Countrywide and its parent company, Bank of America Corp., to provide $600 million for former Countrywide shareholders, yet many investors aren't satisfied by the settlement.

(February 28, 2011) — A federal judge in Los Angeles has approved a deal for Bank of America to pay hundreds of millions of dollars to 33 investors, including pension funds, that filed a class action lawsuit against it for misleading investors about Countrywide’s deteriorating financial condition during the height of the financial crisis.

Bank of America, the biggest US bank by assets, will pay $600 million to the New York State Common Retirement Fund and New York City pension funds that sued Countrywide. Despite the settlement, some institutional investors involved in the suit have rejected the court settlement and are trying to settle with Bank of America on their own terms, The Los Angeles Times reported. Those that pulled out of the agreement include BlackRock, the California Public Employees Retirement System, T. Rowe Price Group, Nuveen Investments, and the Maryland State Retirement and Pension System.

Bank of America took control of Countrywide during the financial crisis. While Countrywide denied the charges, the firm settled the case as opposed to spending time and resources to defend it. “We are pleased that the judge approved the settlement as fair and reasonable,” Bank of America said in a statement.

The settlement deal comes from a class-action lawsuit that accused Countrywide of failing to fully disclose to pension funds details about the riskiness of its mortgage-backed bonds. Countrywide’s shares fell precipitously in 2007.

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As a result, the financial firm had been the target of lawsuits by pensions who owned shares of Countrywide. In January, the State of Michigan sued Bank of America Corp.’s Countrywide Financial unit in a bid to recover $65 million for its public pension funds.

“Protecting the hard-earned dollars of Michigan taxpayers from fraud is one of my top priorities,” said Attorney General Bill Schuette in a statement. In the complaint, the Attorney General’s office claims that Countrywide had effectively become a subprime lender while telling investors that it continued to maintain stringent mortgage loan underwriting standards that differentiated it from its competitors and subprime lenders. While Countrywide assured the market that it should not be impacted by a downturn in the housing market, Countrywide’s stock price dropped about 90%, from over $35 per share to about $5 per share between March 12, 2004 and March 7, 2008.

As one of the largest pension systems in the nation, the State of Michigan Retirement Systems (SMRS) holds combined assets of approximately $47.5 billion. The complaint, filed in federal court in Los Angeles, is State Treasurer of the State of Michigan v. Countrywide Financial Corp.

The suit by Michigan follows a string of lawsuits involving state pensions suing financial firms for investment losses while the US housing market faltered. In November, Oregon sued former financial giant Bear Stearns & Co. to recover about $17 million in losses to the Oregon Public Employees Retirement Fund. Oregon Attorney General John Kroger was joined by Oregon Treasurer Ted Wheeler in bringing the suit.

The Oregon Attorney General alleged that the losses at Bear Stearns — accused of exaggerating the value and quality of the securities they sold — are directly attributable to misleading filings in connection with mortgage-backed securities. “We believe that these junk investments were intentionally mislabeled, and all Oregonians are still reeling from the economic fallout,” Oregon Treasurer Ted Wheeler said in a statement obtained by the Journal. “If you hurt Oregonians financially, we are coming after you.”

To contact the <em>aiCIO</em> editor of this story: Paula Vasan at <a href='mailto:pvasan@assetinternational.com'>pvasan@assetinternational.com</a>; 646-308-2742