CalSTRS funding gap may widen

The CalSTRS board may cut its investment earnings forecast, a small move that could add hundreds of millions of dollars to the current $4 billion annual shortfall needed for full funding.

The nation’s second largest public pension fund, with assets valued at $131 billion at the end of January, began to consider the issue last month and may act in September or even sooner.

Amid predictions of slower economic growth, several CalSTRS board members said they would support lowering the annual earnings forecast of 8 percent to 7.75 percent, the first change in 15 years.

The board’s actuary, Milliman, said most of its clients use a forecast of 7.75 percent and, recently, there has been talk of dropping to 7.5 percent.

“I think it’s a good chance I’ll be going to 7.5 percent,” Nick Collier of Milliman told the CalSTRS board last month. “If I was going to make a recommendation to you, I would definitely considering lowering it a quarter to a half percent.”

Like most public pension funds, CalSTRS had major investment losses in the stock market crash, plummeting from a peak of more than $170 billion in 2007.

CalSTRS has been seeking an annual increase in employer-employee contributions of 14 percent of payroll, about $4 billion, nearly doubling the current contribution of more than 18 percent from schools, teachers and the state.

Milliman said a quarter percent reduction in the earnings forecast amounts to 3 percent of payroll, which would boost the increase needed to fully fund CalSTRS obligations over the next 30 years to 17 percent of payroll.

Nearly all public pension funds in California have the power to set their own contribution rates. But CalSTRS is an exception that must get legislation for a rate increase.

CalSTRS was seeking a rate increase before the market crash, when it had 87 percent of the projected assets needed to pay for 30-year obligations. Now it’s funding level is 77 percent, below the 80 percent some regard as the acceptable minimum.

The long-term CalSTRS strategy is to build support for a rate increase, currently expected to be proposed in legislation next year.

But schools have already been hit by budget cuts, including teacher layoffs. And the source of most school funding, the state budget, has an estimated $20 billion deficit over the next 16 months.

As painful as a small forecast reduction may be, long-time critics such as the governor’s pension advisor, David Crane, argue that there should be even bigger cuts in pension fund earnings assumptions.

David Crane

There was some irony as Crane, an investment banker, was mentioned twice during the CalSTRS board discussion last month. He was removed from the CalSTRS board four years ago by the state Senate, reportedly for warning that earnings forecasts were too high.

Board member Roger Kozberg said he had been asked by Crane, who could not attend because he was out of state, to express Crane’s view that the earnings forecast was too high.

He said Crane gave board members a report from Warren Buffet in which the famous investor and his associate, Charlie Munger, were forecasting earnings of 6.8 percent in the years ahead.

“I think, given what’s happened, in my view I would not be opposed to using a lower assumption of our rate of return … probably not more than a quarter percent at this time,” said Kozberg.

Board member Peter Reinke said he could support lowering the forecast to 7.75 percent. He said Crane made a “very compelling” argument in an op-ed article in the San Diego Union-Tribune on Dec. 15.

Crane also was mentioned in a Wall Street Journal story last Monday (March 1) that said the California Public Employees Retirement System, the nation’s largest public pension fund, is being urged to cut its earnings forecast to as low as 6 percent.

“It’s bruising … but it has to be done,” Crane was quoted as saying.

CalPERS assets are currently valued at $203 billion, down from a peak of $260 billion. In 2003 CalPERS dropped its earnings forecast to 7.75 percent, a target said to have been met during the last two decades even with the historic market crash.

Now CalPERS, as it does every three years, is conducting an “asset liability management” review that will include discussions of its earnings forecast, probably beginning in May and continuing through the end of the year.

The CalPERS board president, Rob Feckner, urged the staff to “reach out” to ensure public discussion. Board member Tony Oliveira said qualified persons should be invited to give arguments “counter” to the norms of the past.

“We are going to open that question: Is the 7.75 percent objective reasonable and obtainable and should we consider other possible outcomes,” Joe Dear, the CalPERS chief investment officer told the board. “There will be opportunity for public comment.”

Dear said the discussion also will consider whether returns from private equity investments will be “3 percentage points above what we can expect in public markets.”

If earnings forecasts are above average market returns, some worry that pension funds will put more money into riskier investments such as private equity and real estate in an attempt to hit their earnings targets.

A study of 231 state public pension funds issued by the Pew Center on the States last month said most have an earnings forecast of 8 percent. Over the last two decades, earnings averaged more than 8 percent.

The Pew report, noting that Buffett and others expect lower earnings, said private-sector pensions are required by the Financial Accounting Standards Board to use investment earnings forecasts based on corporate bond rates.

“As of December 2008 the top 100 private pensions had an average assumed return of 6.36 percent,” said the Pew report.

A look at public pensions begun by the Governmental Accounting Standards Board last year created alarm. One of the questions put out for comment: Should public pensions switch to the earnings forecasts used by private pensions?

The response from various groups of state officials was that the switch could increase pension costs, result in big swings in contribution rates, and unfairly spread the burden among generations by overstating current costs.

Others said the corporate “market value” method reduces the temptation to increase benefits based on projections of future earnings, lessens the shift of costs to future generations, and makes investment risk easier for the public to see.

GASB shook up state and local governments six years ago by directing that the debt for retiree health care be calculated and reported. Many governments had not been setting aside money for future health care, ignoring mounting long-term obligations.

Now GASB is expected to issue its “preliminary views” on public pensions in June, seeking a new round of comments and reaction from state and local government groups.

Reporter Ed Mendel covered the Capitol in Sacramento for nearly three decades, most recently for the San Diego Union-Tribune. More stories are at http://calpensions.com/ Posted 5 Mar 10

One Response to “CalSTRS funding gap may widen”

  1. Dave Horne Says:

    David — Great story, are you hearing anything about “busting” the plan? I spoke to a 52 year old fire chief last month who was embarrassed to say that his pension would be $305,000/year ++ if he retires in 2 years. This cannot stand.

    Dave

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