CalPERS debt is a drain on future
It’s a debt that could have been avoided if CalPERS had used realistic investment forecasts and collected sufficient funds up front.
When the nation’s largest pension system Monday announced its annual earnings, news coverage focused on the dismal 0.61 percent return for the last fiscal year. That missed the bigger picture: The paltry investment yield leaves the California Public Employees’ Retirement System with a record $139 billion shortfall. That’s $46 billion more than just two years ago.
Consequently, CalPERS has just 68 percent of the assets it should, the system’s lowest ratio at any time except the two years coming out of the Great Recession.
This isn’t a problem for workers and retirees. It’s a problem for you, the taxpayers. The shortfall is a debt that must be paid off by state and local governments. That means
higher taxes or fewer public services, or both.
In essence, CalPERS continues to underprice its pensions and then put the shortfall on your credit card.
The Great Recession battered CalPERS’ portfolio and forced it to require greater contributions from state and local governments. But if it doesn’t further bolster its accounts, the damage from the next recession could be even worse.
The only thing that saved CalPERS last time was that it was fully funded when it entered the Great Recession. Within two years its funded ratio plummeted to 61 percent.
If it had entered that downturn in the position it’s in today, the results would have been catastrophic, requiring a massive infusion from state and local governments — that is, taxpayers.
Make no mistake: Another recession is coming. We don’t know when, but we know we’re due. The current recovery, entering its eighth year, is already two years longer than the postwar historical average.
Unfortunately, at CalPERS, which administers pensions for 1.8 million current and former government workers and dependents, it’s business as usual.
Like most government pension systems, CalPERS requires contributions from employers and workers. But the biggest portion of the retirement payouts comes from investment earnings on those contributions.
For far too long, the retirement system has kept contribution rates too low, instead banking on overly optimistic investment return forecasts that failed to materialize.
CalPERS’ average earnings haven’t met the current 7.5 percent average annual return target over the last three, five, 10, 15 or 20 years. And going forward, a CalPERS consultant warns, the system is likely to earn an average of just 6.4 percent annually over the next decade. That would mean about $50 billion less in earnings.
But CalPERS has no plans to adjust its projection and increase the required state and local government contributions until at least 2018. Delaying a correction will exacerbate the long-term problem, creating a larger taxpayer debt.
The shortfall is not some hypothetical future problem. It’s today’s problem. It’s the amount the pension system should have now so that, after investment returns, it can pay for retirement benefits workers have already earned.
That’s an important point. We’re not talking about paying for benefits a current worker will earn with future labor. We’re talking about sufficiently funding what he or she is entitled to for past labor.
It’s for that obligation that CalPERS is $139 billion short. CalPERS amortizes that debt, requiring extra payments from state and local governments for up to 30 years.
Currently, most government workers covered by CalPERS contribute between 7 and 9 percent of their salaries toward their pensions, although the amount varies depending on the particular labor agreement.
But for their state and local government employers, the share is much higher. For example, to fund the pensions of their police and firefighters, employers often pay CalPERS 30 to 40 cents, or more, for every dollar of payroll. Of that, roughly a third pays down the debt due to past underfunding. That will increase as the debt rises, taking more money away from other government programs.
It’s a debt that could have been avoided if CalPERS had used realistic investment forecasts and collected sufficient funds up front.
But the CalPERS board is dominated by worker representatives and elected officials beholden to organized labor for campaign support. They know that higher investment return forecasts mean lower contributions to CalPERS and more immediate money for worker salaries.
Consequently, the board has consistently overridden the judgment of its professional staff. In 2011, the board kept the assumed return rate at 7.75 percent, ignoring its actuary’s recommendation to lower it. In 2012, facing a recommendation of 7.25 percent, the board lowered the rate to only 7.5 percent.
Overly optimistic investment forecasts are one of the key reasons the pension system is, at best, only 68 percent funded. The biggest fear is that the system could slip below 50 percent, which CalPERS Chief Investment Officer Ted Eliopoulos calls a “crisis” point, “a very difficult place to climb out of if we get there.”
Yet, CalPERS projected last year that there’s a 23 to 35 percent chance of falling below that level at some time in the next 30 years. The longer the board ignores the problem, the more likely the problem will become critical.
But it shouldn’t take the threat of a doomsday scenario to prompt CalPERS action. Pension plans should be properly funded up front. They shouldn’t turn into nightmare credit card accounts for you with never-ending debt payments.