How did CalPERS dig a $153 billion pension hole?
During the next five weeks, the CalPERS board, custodian of $326 billion in assets needed to fulfill retirement promises for 1.8 million California public employees and beneficiaries, will make decisions affecting government budgets for decades to come.
The problem is, despite their fiduciary duty under the state Constitution to “protect the competency of the assets” under their absolute control, CalPERS is roughly $153 billion short of fully funding the retirement promises earned to date.
How did CalPERS dig this huge hole? During the last decade, it manipulated actuarial assumptions and methods to keep employer and employee contribution rates low in the short term.
Besides overestimating investment returns, CalPERS uses very long amortization schedules to push debts onto future generations, greatly increasing the pension system’s long-term cost. As a result, CalPERS is just 68 percent funded, barely above what would be “critical” status for private-sector pension plans.
Just like a family that assumes it will receive healthy raises every year and only makes minimum payments on its credit card debts, there must be a day of reckoning. Yet it is not clear the CalPERS board recognizes this important moment is now.
This week, CalPERS will discuss its quadrennial Asset Liability Management process, one that assesses its financial position and proposes course corrections. The results are pretty bleak.
All pension plans make many assumptions about the future, but the most important is the assumed rate of return on investments. The money available to pay pension benefits comes from employer and employee contributions and the investment earnings on those assets. The higher the return, the less money government agencies and employees must contribute each year.
CalPERS assumes it will earn 7 percent on its assets for the next decade, an assumption that might look good now, reflecting the historic stock market run-up since the Great Recession, but CalPERS staff knows better.
Their presentations for this week’s meetings include compelling charts showing the S&P 500 price-to-earnings ratio is nearly twice its historic average, meaning the stock market is ripe for a significant correction and the average rate of return might be just 3 percent to 4 percent during the next 10 years.
Indeed, last year independent experts told CalPERS board members to expect a 6.2 percent average 10-year return, advice that they ignored when they opted instead for the 7 percent rate.
The second most important actuarial factor is how fast pension funds pay down their unfunded liabilities. Although federal law requires private-sector pension funds to make up for their investment shortfalls in seven years, CalPERS uses a much easier 30-year amortization schedule that increases total costs.
To their credit, the CalPERS staff is recommending a 20year amortization of new investment losses, a good step toward adopting the best practice. As the staff report notes, the current policy pushes debts to future generations and falls outside of industry guidance.
The biggest question is whether the CalPERS board, dominated by public employee unions, will take its staff’s advice and approve these prudent changes.
Simple math requires government employers and employees to contribute more money to fill the roughly $153 billion gap. Yet government agencies do not want pension costs to crowd out expenditures for other worthy programs. And government employees would rather have pay increases and force taxpayers 30 years later to finish paying today’s pension bill.
The state Constitution is very clear that protecting the assets needed to fulfill pension promises is CalPERS’ first priority. We will see whether the political temptation to take impotent half measures is stronger than CalPERS’ fiduciary duty to maximize fund security. The California taxpayers of 2047 have a huge stake in this decision.
During the last decade, they manipulated actuarial assumptions and methods to keep employer and employee contribution rates low in the short term.