Pension debt: ticking time bomb or myth?

A new study of the 100 largest U.S. public pension funds shows CalSTRS reports a below-average funding level and the CalPERS funding level is a wobbler — higher than average if its assets are radically “smoothed,” much lower if assets are at market value.

Though notoriously difficult to measure, debt is a key issue in the national debate over whether pensions are “unsustainable” and need cost-cutting reforms to avoid eating up state and local government budgets and, in the worst cases, seeking a federal bailout.

The study issued last week by an actuarial firm, Milliman, concluded that the largest pension funds are not, as critics have charged, using overly optimistic earnings forecasts and other methods to hide massive debt.

Milliman said the funds report a combined long-term debt or “unfunded liability” of $895 billion and a funding level of 75.1 percent, not significantly different from a Milliman review that found $1.2 trillion in debt and a funding level of 67.8 percent.

“On the whole we conclude there are only a small number of plans whose interest rate assumptions are causing a sizeable underreporting of liability relative to what would be calculated based on current forecasts of future investment returns,” said the Milliman report by Rebecca Seilman.

“In fact, there are a surprising number of plans whose interest rate assumptions and accrued liability reporting are conservative in light of current forecasts,” said the report.

The California Public Employees Retirement System and the California State Teachers Retirement System have lowered their earnings forecasts to 7.5 percent, below the 8 percent used by most funds and the 7.65 percent derived by Milliman in its study.

The study lists a surprising funding level for CalPERS, 83.4 percent of assets needed to meet 30-year pension obligations. CalPERS publicly has been saying its funding level is around 70 percent, up from about 60 percent after the market crash.

The difference between the two funding levels: CalPERS emphasizes funding based on the market value of assets. The Milliman study lists the CalPERS funding level based on actuarial “smoothing.”

Smoothing spreads investment gains and losses over several years to avoid big year-to-year changes in employer contribution rates. CalPERS uses a 15-year smoothing period, well beyond the 3 to 5 years used by most pension funds.

The Milliman study lists the funding level based on the actuarially smoothed value of assets reported in the CalPERS Comprehensive Annual Financial Report last year.

The CalPERS report (see chart at bottom of this post) shows a big gap between the actuarial value funding level, 83.4 percent, and the market value funding level, 65.4 percent.

The market value of CalPERS assets was $201.6 billion. The actuarial value was much larger, $257.1 billion, because the impact of big losses in the 2008 stock market crash was offset by big gains during the 15-year smoothing period.

In sharp contrast, CalSTRS, with a three-year smoothing period, had a small gap last year between the funding levels based on the actuarial value of assets, 69.1 percent, and the market value, 67.2 percent.

A 15-year smoothing period was adopted by CalPERS in 2005, when former Gov. Arnold Schwarzenegger briefly advocated a statewide switch of new hires from pensions to 401(k)-style investment plans.

CalPERS was under fire for telling legislators a major state worker pension increase, SB 400 in 1999, would not cost taxpayers more money. Annual state CalPERS payments had soared from about $50 million to $2.5 billion in five years.

The lengthy smoothing period was intended to reduce the temptation to give employers a contribution “holiday” in good economic times (the state CalPERS contribution had been $1.2 billion prior to 1999) and avoid soaring rates in bad times.

CalPERS took another unusual step to keep rates low. After the investment fund had a 24 percent loss during the 2008 stock market crash, the cost of the loss was isolated from the rest of the fund to be paid off with a rate increase phased in over three years.

Now the market value funding level of CalPERS, roughly 70 percent, is similar to the 67 percent market value funding reported last year by CalSTRS, which is said to be seriously underfunded and has been seeking a contribution increase for five years.

So, here’s the question:

Have the smoothing policies chosen by CalPERS, which has the power to set employer contribution rates, allowed it to slide into the same financial difficulty as the powerless CalSTRS, which needs legislation to set contribution rates?

The answer from the CalPERS chief actuary, Alan Milligan, is that CalPERS can raise employer contributions when needed to keep its funding level moving up, but CalSTRS needs legislation for a rate increase to correct a falling funding level.

“It’s the contribution level, not the funding level,” Milligan said last week. “That’s the issue for STRS. In terms of funding status, it’s not that bad — yet.”

As for CalPERS, Milligan said: “If the market doesn’t recover and give us back some of the ‘08-9’ losses we still have, we are going to keep raising employer contribution rates and eventually we will start cutting away at that unfunded liability.”

A problem for CalSTRS has been a legislative view that a recovering market will solve its problem. A resolution this year, SCR 105, asks CalSTRS to consult with stakeholders and submit three options for closing a 30-year funding gap, $64.5 billion.

In the debate over pensions, the debt or unfunded liability is sometimes viewed as a mortgage or bond with a fixed amount that must be paid over time. But pension debt has big variables, making the amount changeable and in some ways illusory.

Smoothing can change the funding level and the debt amount. The debt calculation is based on reaching 100 percent funding, desirable but seldom obtained. And investment earnings, expected to provide most of the pension revenue, are unpredictable.

For example, CalSTRS actuaries said last April the total contribution to the pension system, 19.4 percent of pay, would have to increase an additional 12.9 percent of pay (about $3.25 billion) to fully fund pensions promised over the next three decades.

That assumes investments will earn 7.5 percent. Without a contribution increase, the actuaries estimated, full funding could be reached if earnings average 9.6 percent for 30 years or, even more unlikely but not impossible, 16 percent for five years.

Beginning in 2014, new Governmental Accounting Standards Board rules make several changes in pension reporting. A lower earnings forecast will be used to report debt not covered by projected assets, which may have limited impact in California.

Pension funds currently are more concerned about a proposal by Moody’s, a bond rating service, to report public pension debt using an earnings forecast based on corporate bonds, 5.5 percent, which would triple the national total to $2.2 trillion.

CalPERS has joined about 50 other pension systems in urging Moody’s to take another look at the proposal issued last July to give investors a better way to compare pension funding.

“We are hopeful the significant responses that they have received will cause them to rethink at least some of what they are suggesting,” the CalPERS federal lobbyist, Tom Lussier, told the board last week.

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 22 Oct 12


CalPERS 10-year performance (CAFR 30 Jun 11, p. 116)

16 Responses to “Pension debt: ticking time bomb or myth?”

  1. Tough Love Says:

    Taxpayers need a new mantra …

    “NO FURTHER (Taxpayer) funding”
    “NO FURTHER (Taxpayer) funding”
    “NO FURTHER (Taxpayer) funding”

    We’ve been ripped off by a collusion between the Public Sector Unions and our self-serving, vote-selling, contribution-soliciting politicians long enough.

    It’s Plain & Simple:
    Public Sector pensions ARE TOO GENEROUS …. REDUCE THEM !

    And for CURRENT, not just new workers.

  2. Al Moncrief Says:



    The Colorado Court of Appeals has reversed and remanded an initial District Court ruling that denied the contractual status of public pension COLAs in Colorado. The Court of Appeals confirmed that Colorado PERA pension COLA benefits are a contractual obligation of the pension plan Colorado PERA and its affiliated public employers. A huge victory for public sector retirees in Colorado! The Colorado Legislature may not breach its contracts and push taxpayer obligations onto the backs of a small group of elderly pensioners.

    The lawsuit is continuing. Support pension rights in the U.S. by contributing at Friend Save Pera Cola on Facebook!

  3. Shane Patrick Connolly Says:

    The most telling quote: “As for CalPERS, Milligan said: “If the market doesn’t recover and give us back some of the ‘08-9’ losses we still have, we are going to keep raising employer contribution rates and eventually we will start cutting away at that unfunded liability.””

    CalPers market-value funding level: 65.4 percent
    CalPers asset value: $201.6 Billion
    Having the taxpayers to pick up the tab for your shortfalls: Priceless.

    The real issue is not the long-term liability, it’s the question about who pays that liability. Given that when times were good government employees were handed generous benefits and some, like pensions, were retroactively applied to prior years of service, it would make sense that the beneficiaries of that unrealistic largess kick in to stabilize THEIR retirement system. Instead, the public employee unions want to push all of the extra cost onto the taxpayers through higher taxes (Prop 30, etc.) and reduced services (cuts to education, parks, etc.).

  4. Tough Love Says:

    No Al,

    Taxpayers must support the end of Post-retirement COLA increases in ALL Public Sector Plans.

    Private Sector Plans RARELY include it, so why should we (the Taxpayers) pay for a benefit for YOU that WE don’t get ?

    Going forward the Taxpayers must ask at EVERY step when it comes to Public Sector Plan formulas & provisions ….. DO THE TAXPAYERS GET AS MUSH IN THEIR PLANS. If not, neither should Public Sector workers.

    And that “going forward” must apply to future service of CURRENT, not just new workers.

  5. jskdn Says:

    As I understand it, a fully funded pension is one that has enough assets on hand that, if those assets earn the assumed rate of return, will be sufficient to pay the actuarial pension obligations for employment that has already been completed. When it isn’t fully funded, the shortfall becomes like a loan whose interest rate is the same as the assumed rate of return. If interest is not paid on that loan, then that unfunded liability, not inclusive of any additional unfunded liabilities that may be added for employment going forward, grows by the amount of interest not paid. Paying the interest keeps the unfunded amount from growing but the debt never goes away. Amortizing it requires paying in more than just the interest.

    While it’s true that earnings in excess of the assumed rate of return on the assets the fund does have on hand can reduce the unfunded liability, the reverse is also true. The later seems to be what many investment experts think is more likely. But assuming that CalStrs were to earn its 7.5% on the assets it has as well as paying the full cost of new pension obligations as they accrue, the unfunded part would still grow by 7.5% on a compounded basis absent additional payments to offset that interest.

    I figure that CalStrs $64.5 billion funding shortfall requires an additional 7.5% interest payment or $4.8 billion a year for an interest-only payment or about $5.5 billion a year for 30 years to pay it off. CalStrs own consultant reports seems to confirm this manner of thinking. Table 14, “Amortization of Unfunded Actuarial Obligation” on page 44 of “Defined Benefit Program Actuarial Valuation as of June 30, 2011” by Milliman shows the how the unfunded actuarial obligations grow when very little of the interest cost is paid. Take a look here:

    Click to access db_valuation_2011.pdf

  6. joes Says:

    Just remove the taxpayer guarantee to make up for any pension shortfall and then we as taxpayers would not care. If the pensions are so well managed and well-funded then calpers and calstrs should not have any objection to removing the taxpayer guarantee.
    If the pensions are short, then they can be taken over by the PBGC, with the same pension reductions experienced by the private sector. Public employee pensions are going to lead to revolution.

  7. Tough Love Says:

    joes, Your last sentence is telling.

    There isn’t now, and never will be sufficient funds to pay anywhere near the grossly excessive pensions & benefits “promised” Public Sector workers….. by our self-serving, vote-selling, contribution soliciting Politicians.

    Public Sector workers are in for a rude awakening.

  8. Nes Says:

    This is why 30 must pass, so that the pensions can be funded. And then down the road if other pensions are funded, another proposition can be passed to make sure the rich pay their fair share.

  9. Tough Love Says:

    Wrong Nes,

    We need to very significantly REDUCE these pensions (for CURRENT as well as new workers).

    To the extent that Public Sector pensions exceed (as a % of pay) the pensions of Private Sector workers, Taxpayers should provide no further funding of these ridiculously excessive pensions ….. that nobody in the Private Sector would even dream of getting.

  10. Shane Patrick Connolly Says:

    But I thought Prop 30 was for education? I suspected this was simply a ruse to guarantee passage so the legislature could continue with business-as-usual and kick the can down the road on more serious reforms.

  11. jskdn Says:

    “But I thought Prop 30 was for education?”

    Does spending it on the pensions for the PAST employment of government education employees count as spending on education?

  12. spension Says:

    TL, as we’ve discussed before, by `nobody’ you mean `nobody other than the executives in the’ private sector.

    You can argue that the enormous golden parachutes given to executives are small in $ compared to the liabilities of the public pension system. I’d agree.

    But it is simply false to say `nobody’ in the private sector gets excessive pensions. Executives do.

    And I agree, pensions must be reduced in the public sector, for existing retirees, existing employees, and new accruals and new employees.

    But I don’t think there is criminality or collusion. The voter voted all the politicians who cut these deals in. It is with the voter that the buck stops, not the politicians… they were all duly elected.

  13. Tough Love Says:

    Spension, I’ll make it easy for you to understand …

    1,000 Corporate CEO each taking $5 Million more than their fair share (total = $5 Billion) won’t bankrupt the Corporation paying it or the customers buying their products. Not even if was 10 times greater.

    But, $20 Million Civil Servants EACH getting on average $500,000 MORE than they should have been granted as a direct result of the Union/politician collusion, total = $10 Trillion would indeed indeed bankrupt this country if paid.

    But it won’t be paid………. Taxpayers are fed-up.

  14. spension Says:

    Well, I disagree… corporations are most certainly bankrupted by venal executives and their excessive pay packages. But that is OK with you…. unethical behavior in the private sector, like price-fixing (remember ADM?), Enron, not to mention AIG, Bear Sterns, WM, etc, is not a problem with you Tough Love.

    But you rant about duly elected politicians. The fault for electing the people who cut the pension deals lies with the voters, and the voters alone. Not a single politician who cut a deal would have been able to cut the deal had they not been elected.

    That should be as easy for you to understand as your undying love for the utterly criminal executives of Enron, ADM, AIG, WM, etc.

    Did I forget to mention that many on wall street got $10 million bonus contracts paid by… the TAXPAYER? You love that part, Tough Love, as long as it is a private sector executive swindling the taxpayer, you overlook that activity.

    I suppose you could get Arthur Andersen to do the accounting, TL.

    And remember: I’m in favor of cutting pensions for existing public retirees and employees, also future ones. So don’t claim I harbor some sort of unconditional support for public employees.

    It is you who unconditionally wants public funds to go to wall street execs. Oh… how about restricting the pensions of any company that takes a single dollar of public funds in contracts of any sort? Doubt you’d support that. But why should any taxpayer dollar ever pay any pension of an executive that is excessive.

  15. Tough Love Says:


    You must be quite insecure to decide (for me) what’s OK with me, to tell me what easy and not easy for me to understand, where my undying love lies, and where I want public funds to go.

    I suggest you seek professional help as clearly you need it.

  16. spension Says:

    Naturally, because you never complain about the $10 million bonuses by the taxpayer to the wall street execs, or the excessive pensions given to private sector execs, it is fairly obvious that they are just what you want.

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