UC Berkeley News


Many eyes on the pension prize
There's no shortage of opposition to the pending restart of contributions to UC's pension fund. Critics worry about fund's management-and the bigger benefits picture

| 26 October 2006

Last week the Berkeleyan published the first part of a two-part report on the UC Regents' plan to restart contributions to the UC Retirement Plan (UCRP) in July 2007, following a 16-year "holiday" during which UC and its employees did not pay into the pension fund. We covered the regents' analysis of UCRP's future funding needs, the systemwide Academic Council's formal position on the proposal, and the plight of pension plans nationally as reported in the media. This week we wrap up our coverage with critiques of the proposal and of the recent performance of UCRP's management.

Back off our benefits
Representatives from two UC unions are shown here at the Mission Bay site of the regents' meeting in San Francisco on July 19, when the board approved as policy the proposal to restart employee contributions to the University of California Retirement Plan. UC and the unions are meeting this week to begin negotiations on retirement benefits for the 65,000 union members systemwide. (Eric Gillet photo)
For more information...
A binder as big as all outdoors - stuffed with three-hole-punched memos, reports, newspaper clips, UC Regents' meeting minutes, and much more - was Associate Editor Cathy Cockrell's constant companion during the weeks she researched and wrote this two-part report on UCRP. For links to selected resources used in the preparation of this series, visit "Resources on the UC Retirement Plan."
Early this year, in an Associated Press report on looming retirement-benefits issues nationwide, a prominent equity-market analyst predicted that coming discussions around both pensions and retiree healthcare coverage will be "lively, political, and complex." This week the University of California and its employees join that consequential exchange, as UC and three of its largest unions begin their first formal negotiations on a watershed change to the system's retirement-benefits equation.

The subject of their conversation is UC's plan to restart contributions to the University of California Retirement Plan - the $42 billion defined-benefit pension fund for the UC system's current and future retirees - for the first time since 1990. Based on their analysis, the regents and UC administrators insist that contributions from both employees and the university - together equaling 16 percent of covered earnings by 2014 - are necessary, beginning in July 2007. The change is required, they say, to prevent further erosion of UCRP's funded ratio (fund assets divided by present and future obligations) so that it can keep its promises to current and future retirees.

To make its proposal fly, UC will need money from the state (and perhaps other sources) to cover its yet-to-be-determined portion of the contribution, to be sure. But it also must negotiate with UC unions, which together represent 65,000 employees, to secure their agreement on whether, when, and how much their members will contribute to the plan. (For non-represented employees, numbering about 105,000, the university sets the terms of the contribution.)

Getting labor's buy-in won't be an easy sell.

Critics of the plan raise a number of questions and concerns about the proposed employee contribution: How wisely has the retirement fund been managed in recent years, and why the trou-bling erosion of its once-impressive surplus? Is there sufficient sunshine and public input on critical decisions affecting UCRP? Are contributions in fact necessary as soon as next year to keep UCRP solvent? If they are necessary, what's the appropriate split between UC and employees? Why not return to the formula in effect before the contribution "holiday," between 1976 and 1990 (when employees contributed, in any given year, 1.7 to 3 percent of covered pay, and UC added 4 to 16 percent)? What further benefits cuts may be on the horizon? If employees start paying into the pension fund, what guarantee is there of pay raises adequate to cover the additional costs?

'Let's look at this ourselves'

'Employees need to know and understand their total compensation. A good pension plan is a hell of a lot more important financially to employees than arguing about small, or even annual, salary increases from time to time.'
-Patricia Small Kellett, former UC Treasurer
Though the unions are taking a lead role in articulating such questions, their concerns are shared by many unrepresented employees and faculty, for whom there are no easy answers and many fractious ramifications. Professional actuaries, as in the national debate on the future of Social Security, disagree on the retirement fund's long-term prognosis. UC's most vocal critics accuse the regents of mismanaging UCRP. Faculty and staff versed in the politics of benefits funding see even bigger struggles on the horizon. And trust between unions and management - not a hallmark of labor negotiations in the best of times - is in uniquely bad repair at the moment, if the chorus of union voices on this point is any indication.

Berkeley staff member Jim Stockinger does double duty as a childcare worker (making him a member of CUE, the Coalition of University Employees) and a sociology lecturer (thus his membership in the American Federation of Teachers' branch for UC lecturers and librarians). He says the past year's executive-compensation controversy has "seriously undermined" UC management's credibility.

"The question of accountability has been festering for years," insists Kevin Roddy, a UC Davis lecturer and an AFT officer. But the "recent scandals," he says, have made that issue "more pernicious" than ever.

Faith Raider, a researcher for the American Federation of State, County and Municipal Employees (AFSCME), echoes the theme: "Workers' trust level in UC management is at an all-time low. So when workers learned that UC was saying the plan needs to be funded [by employee contributions], their reaction was, 'Let's look at this ourselves; we don't trust what they say to us anymore.'"

One Berkeley employee who has steeped himself in these issues is Paul Brooks, a spectroscopist at the College of Natural Resources and a bargainer for the University Professional and Technical Employees (UPTE). A 27-year UC employee, Brooks first began tracking UCRP's fortunes in the early '90s, he says, and has stepped up his background reading and number-crunching since first getting wind of the contribution plan.

"This issue has really got me going," he says. "Everyone wants to make sure that the pension fund stays solvent. But we need to get better oversight and management and determine whether the contribution is necessary or not."

UCRP's performance: against its benchmarks and its comparator funds

Performance of all external investment managers – latest 1-year period

Recent comparisons of 1-year total returns on investments for California's three largest retirement plans

Longer-time comparison (UCRP vs. CalPERS) of 1-year total returns on investments
Brooks points to three key areas on which critics of UCRP's management have focused: the fund's overall financial performance, especially over the past few years; the reasons behind its shrinking surplus; and the regents' decision to restart contributions to meet their "100 percent funded" target. He's troubled by policy decisions he believes have weakened UCRP. On the liabilities side of the ledger, he points to the wave of early-retirement incentive programs, known as VERIPs, in the early '90s, which increased the number of retirees drawing from the pension fund and, for most who signed on, the number of years they would enjoy those benefits.

How UCRP's assets are being managed is another area of concern for Brooks. In the past, the lion's share of those assets was managed internally, and the costs of doing so were "minuscule," says former UC Treasurer Patricia Small (Kellett), now a private investment manager in Marin County. Today, private firms are paid to do much of that work. "If the fund has $40 billion and there's a 0.5 percent commission," Brooks calculates, "that's $200 million a year; if the commission is 1 percent, it's $400 million." The unions recently forwarded to UC a number of requests for information on the pension fund; one question Brooks would like answered is how much its external managers are being paid.

Following threads of UCRP history back in time, he's even more deeply disturbed by decisions in 2000 to change the financial management of the fund, "which was one of the most successful in the U.S. up to that time. Why on earth was that done?" he demands.

A sea change

It wasn't, in fact, only the management of the fund that saw a change in 2000: It was the overall investment philosophy adopted by the regents and executed by the Treasurer's Office. For many years, UC's investments had been managed by an in-house staff, focusing on a group of carefully screened, mostly large-cap U.S. stocks. Under the direction of three successive treasurers, the last of whom was Small (1995-2000), returns were robust enough to keep UCRP fully funded and then some, in marked contrast to most other public-pension funds. ("The returns over that time period were above average versus the toughest and highest-quality benchmarks in existence and versus our peers," she says.)

A tale of two actuaries
Each side in the pension dispute — UC and the unions — sought actuarial support for their position.
Then, in 1999, the regents called for a review of the Treasurer's Office. Selecting Wilshire Associates as their consultant, they charged the firm with "[making] recommendations about the Treasurer's overall investment approach," says Small. Wilshire recommended that UC diversify its investment portfolio (primarily by reducing its exposure to blue-chip U.S. stocks), increase its exposure in private-equity arrangements, and add non-U.S. equities to the mix - and that it accomplish this by shifting billions of dollars to index funds managed by outside firms.

The shift to index funds has attracted much criticism, particularly as overall investment returns have returned to single-digit levels since the end of market boom of the late '90s. Index funds are "passively managed," in that they attempt to mimic the makeup of entire indices such as the S&P 500 or the Russell 3000; their selling point is that they essentially guarantee investors that they'll do no worse than the overall market. Critics point out the converse: index investors also do no better than the market.

Treasurer Small, at the January 2000 meeting of the investment committee, said (as the minutes report) that "studies show that diversification for its own sake serves to dilute returns over the long term." If, between 1989 and 1999, she calculated, UCRP's assets had been passively invested in this manner, "the fund's return would have been lower by 127 basis points per year," translating to a $5.2 billion loss over that time period.

Despite these arguments, the regents adopted Wilshire's recommendations, contained in a 30-page "Investment Strategy Study" dated March 16, 2000. These included changing the Treasurer's reporting arrangement, from the regents directly to UC's Office of the President; revising the successful asset-allocation model that Small and her staff had followed (in part, it was later explained by Regent Judith Hopkinson in a meeting with a group of UC employees, "to decrease risk and volatility while enhancing returns"); and moving $8 billion in equity investments into index funds managed by commercial investment-management groups.

Wilshire's role expanded by the next regents meeting, in May 2000, when it was hired for a three-year run as a "general consultant" to the Investment Advisory Committee, to provide ongoing financial advice and to "assist in implementing" its own asset-allocation recommendations to the regents. Treasurer Small retired soon thereafter. (It is frequently asserted that she was "forced out," though she declines to discuss those circumstances publicly.) In 2002 the Treasurer's Office equity-investment staff was laid off, and management of the $15 billion it had overseen was outsourced to several dozen private-sector investment managers. Left in-house, for the time being, was the fixed-income portion of the UCRP portfolio, although in November 2005 some $8 billion of those assets were also transferred to external managers.

Watchdogging the regents

'The usual argument in favor of 'privatization' in any sphere of governmental activity is the claim that the private sector is more efficient. The new data presented here allows us to start making a judgment of how well that has worked out for UCRP. It doesn't look good.'
-Professor Emeritus Charles Schwartz, "Performance Reports for UC's External Investment Managers," Aug. 23, 2006

The outsourcing of investment management has been labeled (and decried as) "privatization" by some, including Charles Schwartz, an emeritus professor of physics at Berkeley and self-described "whistleblower." A longtime observer and critic of the regents, Schwartz believes that "the overall path down which the regents have been taking the UC pension fund in recent years is unmistakably the path toward privatization of the investment-management activity."

According to his analysis of financial reports, more than half the 40 external fund managers responsible for UC's investments "failed to perform at the level of their assigned benchmarks" between June 2005 and June 2006. In the absence of other historical and financial data (a great deal of which, Schwartz says, he's requested over the years to no avail), he concludes that subpar performance by UC's external investment managers is at least partially to blame for UCRP's declining surplus.

In the wake of the dramatic events of early 2000, Schwartz penned the first in a series of more than 20 "little papers," published online under the running title "What's Happening With the Pension Fund?" In these writings he challenges the decision-making of the regents, the Investment Advisory Committee, and their consultants in great detail and increasingly heated rhetoric as he unearths and reports on what he says are misleading statements or mystifying omissions by Wilshire (such as its failure to report investment returns on a risk-adjusted basis) and what he sees as a gross failure of fiduciary oversight by the regents. (The latter, he has said at various times, could be explained by a "bias" of several regents toward professional outside management of investments, or even by their desire to "put this big pot of money where [their] friends are in the business world."

How do the regents and UCRP's fiduciary stewards account for the shrinking funded ratio? In part because of the secrecy in which minutes of closed meetings and other key documents are held, the Berkeleyan has been unable to determine, from the University's perspective, why the diminished performance of the past several years has negatively affected the regents' stated goal at the beginning of that decline: the preservation of "the Plan's envious level of assets in relation to liabilities." The more modest goals enunciated in UCRP's current Investment Policy Statement (dated May 2, 2006) are "to maximize return within reasonable and prudent levels of risk" and "to preserve the real (i.e., inflation-adjusted) purchasing power of assets," among others; no mention is made of the funded ratio whose erosion has prompted the call to restart contributions.

'Eerily quiet' in Sacramento

The pension and related issues have inspired other watchdogs, among them Roddy, at UC Davis, who as AFT vice president for legislation has been keeping close tabs on recent proposals (both legislative and ballot measures) to overhaul California's public-pension systems. These include Gov. Schwarzenegger's plan, first announced in his January 2005 State of the State address, to get the state out of the business of offering defined-benefit pensions. (The governor eventually retreated from this plan after intense pressure from public-employee unions.)

'Risk shift': the future of defined benefits plans

Roddy attended a "dramatic" Sacramento legislative hearing on March 2, 2005, at which Haas School of Business Dean Tom Campbell, at that time serving as Schwarzenegger's finance director, made a case for doing away with defined-benefit pensions for new state employees, starting in July 2007. One of the voices raised in opposition was that of UC Board of Regents Chair Gerald Parsky, who asserted that forcing new employees to move to a 401(k)-style defined-contribution model would harm UC's competitive edge in attracting top talent.

At present, Roddy says, it's "eerily quiet" in Sacramento on the pension-reform front. "People are waiting for the upcoming election, to see where it falls. If Schwarzenegger wins reelection," the notion will be revived, he believes. "I really think that there are dangers that the defined-benefit [pension] will disappear," he adds.

Tanya Smith, a Berkeley staffer for nearly 20 years and now president of the UPTE local for Berkeley and UC Office of the President employees, likewise takes an intense interest in the fortunes of the UC retirement fund. It's Smith's suspicion that UC decision-makers "are hoping people will just glaze over and say, 'You guys take care of it. It's your job; you're the professionals.'" If, on the other hand, "we pay attention, we'll find out more about why the fund isn't doing as well as it might be doing." The proposed pension contribution, she says, "has everybody's ears up."

Brooks, who is planning a presentation on UCRP for interested faculty, has also encountered great interest in the subject. "A large number of people I have met, including faculty - people who were never interested in union affairs before - get very interested when you describe potential changes to the pension plan." UC's defined-benefit pension, he says, "is one of the huge benefits of working here."

Berkeleyan Editor Jonathan King collaborated on the research for this story.

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