Archive for March, 2012

Century-old CalSTRS faces lengthy funding gap

March 29, 2012

After a decade of similar below-target investment earnings, punctuated by huge losses during the stock market crash in 2008, the nation’s two largest public pension funds are looking at different futures.

The California Public Employees Retirement System, putting a new focus on risk, worries about another recession dropping pension funding levels to 40 percent or below, a warning track zone that could make it difficult to get back to full funding in the future.

The California State Teachers Retirement System, no longer aiming for full funding, has developed several limited funding scenarios for legislative consideration that would keep the system from running out of money three decades from now.

The views emerged as CalPERS and CalSTRS lowered their earnings forecasts from 7.75 to 7.5 percent. The small drop raises employer pension costs to offset lower investment earnings, which are expected to provide two-thirds of future pension revenue.

The reason the two retirement systems are looking at different funding scenarios is that the CalPERS board, like most public pension boards in California, has the power to set annual contribution rates that must be paid by government employers.

But CalSTRS, the nation’s second largest public pension system, also is one of the oldest, formed in 1913. As if trapped by time, CalSTRS is an outlier unable to raise employer contribution rates, needing legislation instead.

For more than five years, CalSTRS has been trying to get the Legislature to raise contribution rates. It has explored getting the power to raise contribution rates, pursued more aggressive lobbying and even issued a $600,000 public relations contract.

Teacher unions, one of the most powerful groups at the Capitol, are consumed by historic cuts in school funding and teacher layoffs. School districts are said to have had more than $20 billion in reductions in the last four years.

Now the annual increase in contributions needed to get CalSTRS to full funding in 30 years, more than $4 billion, is approaching the total amount of contributions CalSTRS received from all sources last fiscal year, $5.3 billion.

A breakdown of the contributions, little changed from the previous year: teachers $2.4 billion, employers $2.3 billion and state $600 million. The state contributes another $600 million to a separate inflation-adjustment fund.

Meanwhile, pension payments going out to CalSTRS retirees last year increased to $10.1 billion, up 7.8 percent. Spending nearly twice as much on pensions as received in contributions eats up an investment fund valued at $150 billion earlier this year.

Even if investment earnings hit the target, 7.5 percent (which critics say is overly optimistic), the CalSTRS investment fund is expected to run out of money in about 30 years.

In an era of deep cuts in funding for current school operations, future teacher retirement costs have not been a priority. Gov. Brown’s 12-point pension reform plan does not specifically address the CalSTRS funding gap.

Part of the governor’s plan would put new state and local government hires in a “hybrid” plan combining a lower pension with a 401(k)-style individual investment plan. Phasing in a hybrid, opposed by unions, could take decades to yield significant savings.

“It would have some impact — nothing nearly enough to address the problem,” Ed Derman, CalSTRS deputy chief executive, told the board last month, referring to an analysis of the governor’s concepts done before bill language was introduced.

A two-house legislative committee is working on pension reform. Unions support curbs on excessive pensions and other abuses, but are skeptical or opposed to cost-cutting structural changes such as a hybrid, delayed retirement and higher worker contributions.

At the request of legislators, CalSTRS gave the committee a half dozen easily altered funding scenarios to consider. Only one, which boosts new member contributions by the Social Security rate, is projected to get CalSTRS to full funding.

But under that scenario CalSTRS would not be 100 percent funded until 2085, with a 47 percent chance of running out of money at some point before then.

Under the other five scenarios, CalSTRS is projected after 75 years to have funding levels ranging from 14 to 32 percent. The chance of running out of money before then is calculated to be 54 to 56 percent.

“If we are not going to be fully funded, quite honestly I think the next best solution is to know we can pay benefits forever, that we never run out of money,” Derman told the board.

The CalSTRS scenarios seem to put pension debt in a new light. Some point to the “unfunded liability,” when projected assets fall short of covering future pension obligations, as if it is a mortgage that has to be paid off in a given time period.

A well-publicized Stanford graduate student report two years ago showed how the reported $55 billion unfunded liability of the three state pension funds (CalPERS, CalSTRS and UC) ballooned to $500 billion if a lower risk-free earnings forecast is used.

The unfunded liability is based on the shortfall of projected assets needed to reach full funding in 30 years, the amortization period recommended but not required by the Governmental Accounting Standards Board.

What the CalSTRS scenarios show is that the pension funds, when under duress, have the unhappy option of not trying to reach full funding in 30 years. Future generations would be forced to pay for services received by current generations.

But that would not be a first. For example, the “intergenerational transfer” of debt already is the apparent policy for the rapidly growing cost of state worker retiree health care, expected to be $1.7 billion next fiscal year.

Legislation two decades ago by former Assemblyman Dave Elder, D-Long Beach, created a fund to begin investing money to help pay for future retiree health care. But lawmakers chose not to put money in the fund.

Now state Controller John Chiang estimates that the state owes $62 billion for retiree health care promised current state workers and retirees over the next 30 years. His actuaries say it would cost $1.6 billion a year to “prefund” the retiree health care.

“Even slight amounts set aside will help lessen the impact on future generations, and ensure that we fulfill our responsibilities to the state workforce and our taxpayers,” Chiang said in a news release last month.

The same notion, pay what you can even if it’s far from the full amount owed, delays the phasing in of increased contributions under the CalSTRS scenarios until 2016, when the state may be surfacing from more than a decade spent deep in red ink.

The CalSTRS “unfunded liability” as of June 30, 2010, was $56 billion and the funding level 71 percent. A new annual actuarial valuation due next month may report a larger unfunded liability and a lower funding level.

But as the CalSTRS scenarios show, the unfunded liability is a conventional measure of the shortfall in assets needed to reach full funding in 30 years, not a debt that must be paid off in three decades.

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 29 Mar 12


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