CalPERS piling more pension debt on California taxpayers

Despite nearly a decade of economic growth since the end of the Great Recession, the nation’s largest public pension system remains badly underfunded with only about two-thirds of the assets it should now have.

It’s time for the California Public Employees’ Retirement System to address one of the causes of the shortfall: It should stop relying on unrealistically optimistic investment-return forecasts to help bankroll the retirement of 1.9 million state and local government workers and family members.

CalPERS is currently in the middle of a three-year lowering of its assumed investment-earnings rate, from 7.5 percent annually to 7 percent. But that’s still not low enough.

The pension system’s staff and board members should know that. Their outside consultant warned them in 2016 that the best average annual return they could expect over the next 10 years was 6.2 percent.

For the sake of taxpayers and government workers, it’s time to further reduce the critical investment-earnings assumption.

To understand the significance of the assumed rate of return, keep in mind that public pensions are funded from three sources: Contributions from government employers (taxpayers), contributions from public employees and investment returns on those contributions.

The greater the assumed rate of return on those investments, the less money employers and employees must kick in up front. So, to leave more immediate money in government coffers for salaries and public projects, politically influential labor unions and many lawmakers push for optimistic assumptions about investment returns.

But reality catches up when those investment-return projections fail to pan out. The resulting shortfall is a debt that must be paid off to ensure workers’ pensions are safe.

CalPERS’ debt now stands at an all-time high $146 billion, an average of more than $11,000 per California household. Payments on the shortfall are helping drive today’s rapidly rising pension costs that siphon off a growing portion of government revenues.

It’s time to break the cycle, to use realistic investment assumptions to properly fund the system upfront, rather than financing it through costly debt payments.

Using overly aggressive forecasting is unfair and financially unwise for many reasons:

Unfair to taxpayers: It transfers pension costs from government employees to taxpayers. Upfront pension costs are shared by workers and employers. But when investment earnings fall short, government employers (taxpayers), make up the difference. Unfair to future generations: Pensions should be properly funded upfront, when government workers perform labor and earn benefits. When investment earnings fall short, the debt is amortized over 20 to 30 years, forcing our children and grandchildren to pay costs for labor that benefits the current generation. That means future generations will have to pay more taxes or absorb more service cuts. Hides full cost of pensions:

Overdependence on investment earnings hides part of the cost of pensions, making them look cheaper than they are. The result: Current politicians agree to benefits their agencies can’t afford but leave future leaders to find a way to help pay for it. Increases long-term cost: It takes money to make money. Underfunding the system upfront reduces the potential for future investment returns and increases the total cost to taxpayers. Leaves CalPERS more vulnerable: Underfunding a pension system leaves it more vulnerable to economic downturn, and puts workers’ pensions at greater risk. The only thing that saved CalPERS during the Great Recession was that it was fully funded, with 101 percent of the assets it should have had, as the downturn began. Two years later that funded ratio had dropped precipitously to 61 percent.

CalPERS has struggled to recover ever since. On June 30, 2018, CalPERS had just 71 percent of the assets it should have had on hand. By Dec. 31, that funded ratio had dropped to about 66 percent, although it has recovered some since. CalPERS would slip into insolvency if it had to absorb another 40-point decline.

To be sure, overly optimistic investment forecasting is not the only cause of the system’s severe shortfall. It’s actuarial assumptions about life expectancy were off and had been leading to undercollection of contributions; that’s been fixed. And it had been slow to cover past shortfalls; that’s been only partially fixed.

As for the 7 percent investment assumption, many like to cherry-pick the pension system’s past years of strong performance returns to justify the forecast.

But, Yu Ben Meng, CalPERS’ newly appointed chief investment officer, told his board last month that over the past 10 years and past 20 years, the system had fallen short of the 7 percent mark. Moreover, he said, market conditions make hitting that target in the future even more challenging.

Reaching that target requires making riskier investments, with greater upside potential and, of course, greater downside peril. It’s risk that an already underfunded pension system cannot afford to take.

For the sake of taxpayers and government workers, CalPERS should not be relying so heavily on overly optimistic investment forecasts. They should stop digging the hole deeper.