Archive for March, 2011

CalSTRS funding up a bit, rate hike still needed

March 31, 2011

The most publicly troubled of the three state pension funds, CalSTRS, is reporting a small increase in its market value funding level, but still expects to need a rate increase when the deficit-ridden state budget improves.

The slight increase in the funding level, from 58 to 61 percent in an annual report, is significant because CalSTRS and CalPERS officials say a key indicator is not the 70 or 80 percent some say is adequate, but whether the funding level is moving up or down.

CalSTRS has been aided by strong investment earnings, 12.2 percent last year, the end of a decade-long diversion of a quarter of the teacher contribution into a 401(k)-style plan with guaranteed earning, and an automatic increase under an old law.

But the amount of additional funding that would be needed to produce an estimate that the California State Teachers Retirement System would reach 100 percent funding in 30 years is daunting: nearly $4 billion.

The current total contribution to CalSTRS is about $5.2 billion — $2.3 billion from employers, $2.2 billion from teachers and other members, and $688 million from the state (plus an additional roughly $688 million for inflation protection for retirees).

Most of the money for a rate increase would presumably come from the state, which provides more than half of school district funds. A CalSTRS legal analysis concluded that teacher contributions cannot be raised without providing an equal benefit.

CalSTRS is one of the few public pension funds in California that lacks the power to set contribution rates that employers must pay. Legislation is needed to set the CalSTRS rate.

Ed Derman, CalSTRS deputy chief executive, told reporters yesterday that the pension fund board does not think it has the responsibility to directly seek legislation for a rate increase.

Instead, CalSTRS is working with teachers and other stakeholders and the new Brown administration to help them identify a workable solution, assuming legislation will be introduced when there is an agreement.

“There is no reason to do anything this year if it doesn’t seem to be appropriate, given the budget situation,” said Derman, “or it could happen this year or next year and it doesn’t take effect for a number of years.”

Gov. Brown has been trying to close a state budget gap of about $25 billion with spending cuts and an extension of temporary tax increases. Brown said this week that his attempt to get Republican votes to place a tax plan on the June ballot failed.

Now schools face even deeper cuts. The CalSTRS report said in the year ending last June 30 total salaries of members fell 3.8 percent to $26.3 billion, active members fell 3.8 percent to 441,544 and retirees and beneficiaries increased 4.8 percent to 243,796.

Meanwhile, said Derman, the new CalSTRS actuarial report makes two points emphasized in the past:

1) The longer a rate increase is delayed, the higher the cost of getting to full funding.

2) Even under optimistic forecasts, investment earnings will not yield enough to make a rate increase unnecessary.

To get to full funding now, the nearly $4 billion in additional funding is 14.3 percent of total pay. The amount steadily increases with time, reaching about 17 percent of pay by 2015.

A delayed plan to phase in CalSTRS rate increases could be difficult. In January a forecast from the nonpartisan Legislative Analyst showed major state budget deficits continuing for five years.

The earnings forecasts used by CalSTRS and other public pension funds have been controversial. Critics contend they are overly optimistic and conceal a huge pension debt owed by taxpayers.

In December the CalSTRS board lowered its earnings forecast from an annual average of 8 percent to 7.75 percent, with inflation accounting for 3 percent. The CalSTRS actuaries had recommended lowering the forecast to 7.5 percent.

The new actuarial report contains not only the rate increase needed to reach full funding under the CalSTRS earnings forecast, but also four additional forecasts that show the rate increase needed if earnings are above or below the target.

If earnings are 5.7 percent over the next 30 years, the rate increase needed for full funding would be over 30 percent of pay, more than twice the already formidable 14.3 percent of pay needed under the CalSTRS forecast.

If earnings are 8.5 percent, well above the CalSTRS target, the rate increase needed for full funding would still be nearly 10 percent of pay — making the point that CalSTRS cannot “invest” its way out of the problem.

Most of the CalSTRS problem is the result of investment earnings that averaged 2.5 percent during the last decade. The investment fund peaked at $180 billion in October 2007 and dropped to $112 billion in March 2009, before rebounding to $140 billion.

When the stock market boomed a decade ago, CalSTRS joined the California Public Employees Retirement System and UC Retirement in reducing contributions and raising retirement benefits.

A CalSTRS funding level that had been 29 percent in 1972 was over 100 percent for a three-year period from 1998 through 2000. Legislation that raised benefits cut the state contribution, which dropped from 4.3 percent of pay to about 2 percent.

For the first time a provision in 1998 legislation linked to underfunding is automatically triggering a 0.5 percent of pay increase in the state contribution, which could grow to 1.5 percent by 2015.

Another bill a decade ago diverted a quarter of the total teacher CalSTRS contribution of 8 percent of pay to a 401(k)-style individual investment plan with guaranteed earnings of at least government bond yields.

The diversion to the Defined Benefit Supplement program ended Jan. 1 after a decade, giving the struggling CalSTRS an unannounced funding boost of an additional 2 percent of pay.

While the funding level of CalSTRS using the market value of assets increased from 58 to 61 percent, the funding level using an actuarial value that “smooths” gains and losses over three years dropped from 78 to 71 percent.

A third of the losses from the 2008 stock market crash used in the actuarial value overshadowed strong investment earnings during the rebound. CalPERS uses a radical 15-year smoothing period for gains and losses.

A legislative committee recently was told that CalPERS using the market value of assets was 61 percent funded in June 2009, expects to be about 64 percent funded in the June 2010 valuation and is now nearing 70 percent.

A paper issued this month by the Center for Retirement Research at Boston College looks at whether a sample of 126 state and local pension funds can “muddle through” without running out of money until the economy and stock market recover.

In what the center regards as its most “realistic” exercise methodology, CalSTRS appears to be in better financial condition than CalPERS.

Reporter Ed Mendel covered the Capitol in Sacramento for nearly three decades, most recently for the San Diego Union-Tribune. More stories are at Posted 31 Mar 11

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