CalSTRS funding gap grows: new earning forecast

A divided CalSTRS board yesterday voted to lower its long-term forecast of investment earnings by a quarter of one percent, from 8 to 7.75 percent, adding to the cost of closing a major funding gap.

The board rejected a staff recommendation to drop the forecast to 7.5 percent.

Teacher groups said a lower forecast could reduce benefits, apparently referring to annuities, the purchase of service credits to boost pensions and other potential member impacts listed in a staff report.

The lower earning forecast, said to be a trend among public pension funds, reflects the view of many financial experts that investment earnings are likely to be modest in the next decade.

The small forecast change adopted by the California State Teachers Retirement System comes as some economists and other critics argue that unrealistic earning expectations conceal massive public pension debt.

They say public pension funds should use an earnings forecast of about 6 percent, like corporate pension funds, or even a “risk-free” bond rate of around 4 percent because public pensions are risk free, guaranteed by the taxpayer.

Public pension funds such as CalSTRS expect to get two-thirds or more of their funding from investment earnings. But diversified portfolios with most of their money in stocks and other risky but higher-yielding investments can be unpredictable.

“I wish I had a crystal ball,” Chris Ailman, CalSTRS chief investment officer, told the board. “I’d love to say because we have had two bad events in the last 10 years we have smooth sailing ahead. But I really can’t say that.”

The CalSTRS investment fund peaked at $180 billion in in October 2007, dropped after an historic stock market crash to $112 billion in March 2009, and is now up to $141 billion.

Ailman said some experts are predicting a “new normal” of much slower national economic growth than in recent decades. A CalSTRS consultant, the Pension Consulting Alliance, made an unusual forecast revision because of ultra-low bond yields.

The CalSTRS board has been struggling with an earning forecast decision since the staff recommended a drop to 7.5 percent last spring. The board meeting yesterday was the first to be streamed live over the Internet under a new webcast policy.

In an 8-to-3 vote for a 7.75 percent forecast, the “no” votes came from two public representatives appointed by Gov. Arnold Schwarzenegger, Roger Kozberg and Beth Rogers, and the governor’s finance representative, Cynthia Bryant. Kozberg made an unsuccessful motion for a 7.5 percent forecast.

Support for the 7.75 percent forecast came from elected teacher representatives, Dana Dillon, Harry Keiley and Carolyn Widener; appointed school board representative Kathy Brugger; appointed public representative and teacher, Peter Reinke; state Controller John Chiang, and representatives of state treasurer Bill Lockyer and state Superintendent of Public Instruction Jack O’Connell. Chairwoman Jerilyn Harris did not vote.

Widener said she understood the need for a lower forecast, but asked why the staff was recommending 7.5 percent rather than 7.75 percent.

Mark Ollerman of Milliman, the CalSTRS consulting actuary, said 7.5 percent would result in about a 50 percent chance of achieving the earning target, following standard calculations. He had no calculation for a 7.75 percent forecast.

“I share Carolyn’s concerns that we are going probably from one extreme to another,” said Dillon, who made the motion for a 7.75 percent forecast. “The argument is compelling. I guess I’m trying to take a more optimistic viewpoint.”

The chairwoman of the California Teachers Association retirement committee, Maggie Ellis, said that if the forecast has to be lowered it should be 7.75 percent.

“I believe this is a large jump that has a significant impact on our membership and potentially can reduce our already modest benefits,” Ellis said.

Her comments were echoed by Sandy Keaton of United Teachers Los Angeles and Richard Hansen of the Faculty Association of California Community Colleges retirement committee.

In the report given to the board, the impact of lowering the earning forecast is not clear. The estimates are based on the value of the fund in June 2009, before the recent market runup, and there are no dollar amounts.

In the fiscal year ending in June of last year, CalSTRS received $5.3 billion in contributions based on nearly 21 percent of teacher pay — 8 percent of pay from teachers, 8.25 percent of pay from districts and 4.5 percent from the state.

CalSTRS, seriously underfunded, was expected to run out of money in about 35 years under the previous earning forecast. To reach full funding, annual contributions needed to be increased by two-thirds, 13.9 percent of pay.

Now dropping the earning forecast to 7.75 percent increases the need for an additional contribution to 15.1 percent of pay. At the same time, the base or “normal” contribution increases from 17.3 to 17.7 percent of pay.

So, what is the dollar amount of the contribution increase from dropping the earning forecast to 7.75 percent? A rough guess would be around $400 million a year, and nearly three times that amount if the forecast had dropped to 7.5 percent.

When CalSTRS will get a contribution increase is another unknown. Unlike most California public pension funds, CalSTRS cannot set an annual contribution rate that must be paid by employers.

CalSTRS needs legislation to get more money. But most school funding comes from the state general fund, which has a $25 billion funding gap and faces estimates of $20 billion funding gaps for several more years.

And as CalSTRS officials have pointed out, giving public relations firms a $600,000 contract to help make the point, it’s pay now or pay more later. Without additional contributions, the CalSTRS funding gap will continue to grow.

The giant California Public Employees Retirement System, with assets worth $218 billion, is in a year-long process that could lower its 7.75 percent earning forecast, perhaps to 7.5 or 7.25 percent.

The powerful CalPERS board, which can set a contribution rate that must be paid by employers, is scheduled to make a decision about a new asset allocation this month. That may be used to make a decision about an earning forecast in February.

When CalPERS adjusted its earning forecast in 2008, its experts were expecting earnings to average slightly more than 8 percent.

But in keeping with a policy of “conservatism,” the CalPERS board adopted an earning forecast that was a quarter of one percent lower, 7.75 percent.

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 3 Dec 10

One Response to “CalSTRS funding gap grows: new earning forecast”

  1. Rick Roeder Says:

    Hi Ed,

    If you look at the Ramble on our site, you will see our take on the recent reduction of investment assumptions. Do you mind if have your site as a link? Since we are the only entity that does the type of funding ranking surveys that we do, we would be very happy if you also linked to roederfinancial.com.

    Regards, Rick Roeder, FSA

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