Fiduciary Counsel Ashley Dunning Encourages CalPERS to Muscle Actuary to Change His Forecasts of Funding Needs

Yesterday, we reported on how CalPERS’ new fiduciary counsel, Ashley Dunning of Nossaman LLP, endorsed the practice of pension fund staff withholding investment fund documents from board members. She defended her position by false claim that some fund sponsors might insist on that as a condition of investing. New board member Margaret Brown raised the issue because CalPERS staff is apparently not merely denying the board access to fund documents, but even the terms of some funds.

Today, we will discuss another toad that hopped out of Dunning’s mouth in her fiduciary training session for the board. As you will see in the exchange below, Dunning twice endorsed the idea that CalPERS should pressure its actuary to come up with more favorable, as in lower, estimates of what employers needed to pay to fund pensions if his recommendations were higher than what CalPERS was willing to present to employers.

Understand what this means: the position of CalPERS’ chief actuary is considered to be the second most difficult in the United States, with the most demanding actuarial position being that of the chief actuary to the Social Security Administration. CalPERS manages roughly 2200 pension plans. No one has ever suggested that his is not competent to do his work or that it suffers from any analytical flaws.

However, like many public pension funds, CalPERS has been using a discount rate for its future liabilities higher than the one the fiduciary has been using.1 Using a higher rate results in lower payments by plan sponsors like the State of California and the many municipalities and government entities that have CalPERS manage their pension plans.

CalPERS use of a higher discount rate than its actuary recommends results in ongoing pension underfunding. This is a classic “kick the can down the road” approach. CalPERS is essentially betting that the financial markets will somehow bail it out. But with valuations at nosebleed levels, and even normally evenhanded commentators like Mohamed El-Erain giving loud warnings about investment risks, CalPERS is far more likely to suffer from a market swoon that be rescued by more years of robust returns.

Before we turn to the particulars of what Dunning said, it is important for backers of employee pension rights to stop sticking their heads in the sand on the issue of underfunding and the need to provide for adequate payments on a current basis. The right wing so far has been making noise about the problem of public pension underfunding, which is in many jurisdictions a real issue. The silence of unions and the left means they are ceding this issue to public pension fund and government haters. The first deliberate underfunding of a major public pension fund took place in New Jersey in the early 1990s, when Governor Christine Todd Whitman decided to shortchange pension payments to make meeting the rest of the budget easier.

Unlike what pension opponents will try to have you believe, there is no reason these commitments, which were made in lieu of giving employees higher salaries, could not have been funded properly. Pages 95 and 95 of Mayberry v. KKR, embedded in this post, contains a list of well-funded public pension plans.

As for the point of view that pay out the necessary pension reserves will harm the budgets of states and cities, it is remarkable that no one raises similar concerns when the same government entities give massive tax breaks to big box retailers and manufacturers to locate facilities in their jurisdictions. Academic studies have found that the companies have gotten so good at playing localities off against each other that these projects often make zero or even a negative net contribution to tax rolls, even allowing for supposed vaunted job creation. Similarly, too few on the soi-disant left were willing to point out that the Obama Administration policy of intervening on behalf of bank servicers to allow foreclosures to proceed, even though in most cases, mortgage modifications would have been better not just for homeowners but also mortgage investors, also damaged communities though the decline in home values (both directly and by depressing the value of neighboring properties) which hurt tax revenues.

Dunning Encourages CalPERS to Pressure Its Actuary

Board member Dana Hollinger asks about the return assumptions starting at 1:01:55. The most telling part is at 1:04:40. Notice also how carefully Dunning picks her words:

Board Member Dana Hollinger: Going with, regarding the recommendation of the chief actuary, a lot of times we’re also taking into account what our stakeholders can afford, so there may be a disparity between the discount rate the chief actuary recommends and maybe what we think is realistic in terms of affordability for our stakeholders. In that event, do we have to document why we don’t, say, just hypothetically, say something like 6 1/2 percent, say something lower than we’re currently at, we realize when we’re talking to our stakeholders that they couldn’t afford the increased contributions, that there would be financial repercussions to them, does that have to be documented?

Ashley Dunning, Partner, Nossaman LLP: The more documentation you have for that conclusion, the better, because what I am hearing from a fiduciary perspective, you seem to be saying, is that the, um. soundness of the plan, in the sense of “can your employers afford it” [Hollinger cross-talk, “Pay for it”], may be compromised if you increase their costs.

Hollinger: Right.

Dunning: Usually the, often the employers complain of financial woes are not given a whole lot of credence by courts in many circumstances, they are required to pay the benefits that they promised. On the other hand…

Hollinger: But you create systemic risk to the extent that they file bankruptcy, that is systemic risk.

Dunning: Absolutely. That’s the response. The response as a fiduciary is that you are minimizing that systemic risk by moderating how you, the time period over which you collect those contributions. Because ultimately, the contributions have to be paid.

Hollinger: No, I’m not disputing that. I’m disputing…that we get from out consultant,’s a balance.

Dunning: It’s a balance.

The ideal circumstance is for your actuary to incorporate sort of a holistic view of the goal so that collectively you are considering those various factors. Because it is everyone’s goal to make sure, or it should be everyone’s goal to make sure that the system is funded in a manner that will make sure that those promised benefits are paid on time. Now…

Hollinger: I’m just trying to protect us as fiduciaries if the actuary recommends one thing and for these other reasons, we don’t follow it. I just, you know, for the record, and to know that.

Board President Priya Mathur: I think what I am hearing Ms. Hollinger say is that 1) we should encourage our actuary to incorporate those risks into his own analysis, and 2) that we should document and set a record about the rationale behind our decision.

Dunning: That’s right. And it may be that your actuary disagrees with your assessment. He’s not to be a rubber stamp either for certain directives. But the conversation needs to occur with the eye on the ball, which is duty of loyalty to the members and the beneficiaries. You’re not in the business of making sure that the employers are able to pay for other things, but you are in the business of making sure that you’re getting your own required contributions, and that those contributions are going to be able to pay the benefits that they have promised, or the legislature has promised to their employees. That’s why this is a challenge.

This is revealing, and not in a good way.

On the one hand, Dunning does in the end firmly state the only proper conclusion, that CalPERS is tasked to serve its beneficiaries, and that means “getting your own required contributions.”

But on the other hand, Dunning was uncomfortable discussing a practice that takes place not just at CalPERS but at many public pension funds, of setting discounts rates that are high in light of recent and likely future investment returns, as well as in comparison to their own actuaries’ assumptions.

Several elements of Hollinger’s concerns were concern-making. First was that she depicted the reason for not charging the many entities that have CalPERS manage their pensions the full contribution that the actuary deems necessary is that it could create “systemic risk” in the event of bankruptcy. Even worse, Dunning echoes that comment even though she later says that courts haven’t been sympathetic to employers who try to renege on their pension obligations.

Specifically, Dunning and Hollinger should know that CalPERS pension contributions have been backed by courts in the case of municipal bankruptcies. San Bernandino filed for bankruptcy and tried getting its CalPERS obligations reduced. Not only did it fail, but it also owed CalPERS a penalty for not making its full payment on a timely basis, which CalPERS in its infinite munificence decided to reduce…in part. Stockton, which also declared bankruptcy, didn’t even try to have its CalPERS contributions cut. There were more recently three very small entities that did fail where the result instead was that CalPERS cut the payouts to their beneficiaries.

Shorter: there is no such thing as “systemic risk” to CalPERS. CalPERS is a pass through. Its state pensions are backed in the Constitution by the State of California. If a particular employer becomes totally bereft of ability to raise revenues, there is no “systemic” impact. Any consequences will be limited to the beneficiaries of that particular plan.

The second bit that is distressing is to see that Hollinger appeared to be interested primarily in how the board should paper its records so as to avoid liability, as opposed to how to address the underlying issues.

But the most troubling part is that Dunning encourage CalPERS to pressure its actuary to change his recommendations so that CalPERS can dun its various employers for more politically acceptable contributions. Dunning first makes her suggestion in a coded manner, that the actuary should take a more “holistic” view, meaning incorporate the question of the (supposed) ability to pay of various employers. When asked specifically by Mathur, about “incorporating those risks,” Dunning approves, then tries to pretend this isn’t interfering with the work of an independent professional by saying “he’s not a rubber stamp.”

It is particularly surprising to see Dunning endorse the idea of prevailing on the actuary to relent and give more employer-friendly, as in lower, contribution levels. The presumption is that the original estimate by the actuary was his best professional opinion and any reworking will be a fudge and therefore artificially low by design.

The use of inflated return estimates that in turn exacerbated pension underfunding is one of the grounds in Mayberry v. KKR for suing the trustees of Kentucky Retirement Systems and other advisers to the fund. The filing specifically cites the trustees making use of “false actuarial assumptions”. This suit has the potential to be a path-breaking, yet Dunning appears to either be ignorant of it or unwilling to consider that its mere filing of could lead other potential litigants to make similar arguments.

But this proposed fix, to try to influence the grader because he is producing scores that CalPERS finds to be politically inconvenient, is even worse than it appears on the surface.

One of the core practices of fiduciaries is to rely on experts. It goes so far as to turn many duties of a trustee as passively accepting the advice of hired guns, when real investment mavens, like Forbes 400 members and the private equity fund managers, will obtain the opinions of informed parties, but also make a point of discounting them for their biases and commercial agendas. Yet despite fund trustees being held to a “prudent person” standard, applying common sense and a certain amount of skepticism has been absent from the fiduciary trainings at CalPERS in recent years. See the embedded article below for a more nuanced view.

CalPERS’s actuary has no expertise whatsoever on the financial condition of CalPERS’ plan sponsor. Not only is not in the business of making that sort of judgment, it would be a mammoth task to even attempt it. Even bond rating agencies would be loath to deem their ratings as being applicable for the decades-long time frames of public pension funds. The overwhelming majority of the 2009 plus plans in the CalPERS system either have no ratings or have bought municipal bond insurance in lieu of getting a stand-alone rating.

That means that what Dunning is proposing that the actuary do is not “incorporate those risks into his own analysis.” That assessment is completely outside his skill set. Dunning instead is authorizing CalPERS staff and board muscling the actuary to provide results that would be more convenient for them.

And CalPERS wonders why it has a credibility problem.


1 More specifically, the CalPERS investment office has provided the discount rate for the next ten years, and then used the actuary’s discount rate for years 11 onward. As anyone who had done financial modeling will attest, even with low discount rate assumptions, the results will be dominated by results for the early years.

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    1. Lambert Strether

      I’m not sure why workers expecting their employers to adhere to a contract they signed is “cronyism.”

      That said, unions pay a big role in the California political universe, and at CalPERS in particular. So the curious issue is why CalPERS is so heavily invested (emotionally and financially) in private equity when private equity works militantly against the interests of union membership in its business dealings. So, as far as union leadership and private equity, I won’t say “cronyism,” or “capture,” but feel free to think it…

      1. EoH

        I heard once that sanctity of contract was so fundamental, the Constitution insists on it. (Strategic bankruptcies aside.)

        As this site has recounted, private equity’s returns, in light of its exorbitant costs, do not currently seem to be worth the candle for a public pension fund. For a state like California, it appears to make no sense to outsource skills to private fund managers that could readily be hired, trained and supported in-house at a fraction of the cost. The reason not to do so – apart from maintaining a lack of transparency and accountability – would seem to be adherence to the neoliberal position that government should never do anything the private sector is willing to do, regardless of cost.

        1. Michael Froomkin

          Actually, that claim about the Constitution is more than half true: Art. I, Sec. 10 of the US Constitution prevents states from making any “Law impairing the Obligation of Contracts”. Notably no such limit applies to the US Congress itself other than whatever may come from the Takings Clause of the 5th Amendment.

    2. Yves Smith Post author

      Dolan’s article, despite having the veneer of rigor due to its use of data, is flat out false in terms of the claims it makes regarding the early 2000s pension changes. They were designed to apply to “badges” meaning law enforcement officials. And the impact on the overall pension costs was modest, on the order of increasing them by 2-3%. Dolan is a hard core pension hater and this sort of hit piece is a staple for him. I was too busy at the time to debunk it. The second link has the same misinformation on this point; Dolan’s article may have relied on it.

      Regarding the criticism that CalPERS made a big mistake in taking a holiday from pension contributions in the late 1990s, it is more than a bit ironic that the same right wingers who are raking CalPERS over the coals now were the loudest then in demanding that CalPERS cut its contributions when the pension fund looked to be overfunded thanks to the dot-com bubble.

    3. laura

      FYI, it wasn’t the Unions that made changes to pension benefits, it was public agency administrations. Here’s a post SB 400 example from Sonoma County -an Act 37 County. The SCERS fund was superfunded. The then County Administrator, along with department heads worked the board of sups to increase the pension benefit AND applied it retroactively. Then, the county administrators negotiated the increase with the unions. Some leapt at the opportunity and others, seeing the ticking time bomb, resisted and we’re eventually brought on board when the enhanced pension benefit was tied to a wage increase.
      As soon as the enhanced, retroactive pension formula was increased, there was a flood of retirements starting with the very same county administrator and department heads. They literally took the money and ran.
      But you just go on hating on public sector unions and their members because all the cool kids are doing it.

    4. tegnost

      apparently you missed this line in the post Jasbo
      “Unlike what pension opponents will try to have you believe, there is no reason these commitments, which were made in lieu of giving employees higher salaries, could not have been funded properly. “

  1. Tom Stone

    I’m sure Attorney General Becerra will be all over this once he’s done dealing with more important matters.

  2. Jim Haygood

    Pages 95 and 96 of Mayberry v. KKR, embedded in this post, contains a list of well-funded public pension plans.

    Though the source of this list of 90 to 100% funded pensions is unclear, I would bet that all of them are using typical 7.5% assumed returns rather than a state muni bond yield of around 2.5%, which can easily cut funding ratios in half. This is flat-out fraudulent. But it’s “all legal” under the easy-peasy special accounting rules that GASB has carved out for our pampered gov sector.

    As detailed in a report titled Unaccountable and Unaffordable 2017 (page 5):

    “If the Pension Protection Act were applied to the public sector, every single state would be considered at risk of defaulting on their pension obligations assuming a risk-free rate of return.”

    Ashley Dunning’s delicate, euphemistic “balance” (meaning the calculated suppression of employer contributions for political benefit) cannot hold. CalPERS is the Flying Wallendas on a high wire without a net, waiting for the next bear market gust to topple the whole troupe.

    Pension Envy 2020 — it’s only a script for now. But we should have the trailer ready by next year. ;-)

    1. Yves Smith Post author

      New York’s pensions have been using lower return assumptions. So has Wisconsin. All the Canadian pension funds do and they are in better shape than US funds. I don’t know about the rest.

      A risk-free rate of return assumptions is not reasonable. That implies the obligation is as solid as Treasuries, which they aren’t. You as a finance person know better than that, that this line of argument is dishonest.

  3. Etherpuppet

    But… but… but… I thought certain parts of the electorate wanted government to be run like a business!

    In my experience, morphing the underlying, theoretically-independent assumptions to match a predetermined outcome is not uncommon in big business. Doesn’t happen everywhere or on every project, but it’s more common than you would expect.

    Never once has reality matched prediction, of course, but by that time it’s too late, and everyone who needed to benefit had already done so.

    1. flora

      I think it’s a ‘thing’ now. Take, for instance, these 2 sentences from the WaPo story about the opioid epidemic and its, uh, facilitators. I’ve edited the nouns, verbs, and objects so you can provide your own. Works with just about any story I’ve ready regarding banks (Wells, for instance), PE, Pharma, Wall St or other big players fiddling the rules. This seems to be the template of most of the stories I’ve read about fraud and abuse for the past 10 years.

      “[xxx] investigators, agents and supervisors who worked on the [yyy] case said the company paid little or no attention to the unusually large and frequent [zzz], some of them knowingly [qqq].

      “Instead, the [xxx]officials said, the company raised its own self-imposed limits, known as thresholds, on [zzz] and continued to [qqq] in the face of numerous red flags. ”

      As for why the govt doesn’t put a stop to it, that’s covered in the story, too.

      “[He] said [xxx] lawyers would repeatedly ask: “Why would you go after a Fortune 50 company that’s going to cause all these problems with Ivy League attorneys, when we can go after other [weak players] that are much lower, that are going to put up no fight?”

      These sentences encapsulate the protection of corporate/finacncial bad actors to the expense of everyone else, imo. The CalPERS story fits comfortably into this template, imo.

  4. EoH

    I’ve always thought that one price private businesses pay for making money off the public dime is that their arrangements are subject to public disclosure. A naive position, I suppose, given the fraud in government contracting since at least the Civil War – which, in part and at the federal level, led to that small bedtime book, the federal acquisition regulations. When a business sells gauze as a blanket or cardboard-soled boots that melt in the rain, it pays to specify material, warp, weft, thickness and stitching. As each reg is run around, new ones try to compensate, ad nauseum. That such things are routine risks in public contracting is obvious.

    If any state has the power and juice to demand that most contracts for goods and services with the state be public documents, it is California. Its contracts are potentially so large and lucrative, it would be unusual for suppliers to boycott it just to keep its deals secret.

    Transparency is not achieved by publishing names of the parties, the term or the notional price tag. It requires the full contract terms. It would seem that if CalPERS has agreed to terms that bind it to confidentiality, then it wants to be bound. The lack of transparency is fertile ground for overcharging, fraud and avoidance of accountability. In an era where state budgets have never been stretched so thin, no state can afford that way of doing business.

  5. EoH

    To repeat what should be obvious, pensions are deferred compensation. They are earned on the equivalent of a pay-as-you-go basis. An employee takes less today in exchange for more tomorrow, when other sources of income are not as plentiful.

    CEO’s, for example, take advantage of a similar arrangement when agreeing their own deferred comp plans, though these are ordinarily used to minimize taxes rather than manage income. That there are legal restrictions on when pensions are deemed to be earned or when they become payable is a convenience to the employer provided by business-friendly legislators.

    Not many CEOs, for example, are forced to take less income because the board changed its mind and dropped a payment or a benefit for them. The difference is that the CEO has elaborate contracts in place, which she demands be fulfilled, a circumstance intentionally not made available to the average employee. Their typical enforcement mechanism is management’s good faith.

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