What delaying a big rate increase cost CalSTRS

CalSTRS has been the great exception among California public pension systems, different from the others in two important ways. The state helps pay some of its pension costs, and the board lacked the power to set employer rates, needing legislation instead.

Five years ago legislation raised CalSTRS teacher, school district and state rates, switching its projected 30-year path from emptying the pension fund to full funding. And CalSTRS was given some power to raise rates, tightly limited unlike other pension systems.

But the legislation in 2014 came six years after massive losses in the stock market crash and financial crisis. As the investment fund plunged from $180 billion in October 2007 to $112 billion in March 2009, CalSTRS funding fell from about 100 percent to 60 percent.

Powerless to raise rates, the CalSTRS board urged legislation. In 2009 a delegation led by two board members, Dana Dillon and Jerilyn Harris, made the rounds at the Capitol, which faced major state budget cuts.

“Everybody came out a little bruised,” Harris told her fellow CalSTRS board members later.

Last week, as the CalSTRS board discussed a five-year report to the Legislature on the status of the funding plan due July 1, Dillon made a brief comment about the long wait for rate legislation as pension debt grew.

“Watching that $22 million a day debt, while nobody took any action, was really painful for this board,” said Dillon, the board chair.

To show the importance of acting quickly, the report to the Legislature will have a calculation of where CalSTRS funding would be if the rate increases enacted in 2014 had been promptly adopted after the 2008-09 financial crisis.

“If we had been able to raise the rates, we would now be about 70 percent funded instead of about 63 percent,” David Lamoureux, CalSTRS deputy actuary, told the board last week.

“And more importantly, although the employers and the state would have had to start contributing more earlier, today the contribution rates would be lower than they are this fiscal year, and they would be projected to remain at those levels,” he said.

Lamoureux added: “Every year that goes by when you don’t fund the unfunded liability it grows, in our case at 7 percent, and it compounds quickly.”

CalSTRS investments are expected to earn 7 percent. Debt or ‘unfunded liability’ is created when annual earnings fall below 7 percent or, as CalSTRS did two years ago, the earnings forecast is lowered (from 7.5 percent) and life expectancy increased (2 to 3 years).

When the rate increases were enacted in 2014, they were not immediately high enough to cover the interest on the debt. Actuaries call that “negative amortization.” So CalSTRS debt is expected to continue to grow until 2026 before a long decline to full funding around 2046.

Gov. Newsom’s proposed state budget would give CalSTRS an additional $5.9 billion, mainly to pay down debt. The impact of the extra funds on CalPERS funding will be added to the five-year report when the governor’s proposal is nearer approval.

The California State Teachers Retirement System is no exception to the big question facing public pension systems. Can the investment fund, expected to pay about 60 percent of future pension costs, earn enough money?

At this point the CalSTRS funding plan enacted five years ago remains on track to reach full funding around 2046, despite the lower earnings forecast and expected longer live spans. Statistical modeling shows several years of below-target earnings won’t knock it off track.

But after a record bull market, some experts are expecting investment earnings during the next decade to average below the CalSTRS forecast of 7 percent. A routine four-year study of the CalSTRS investment mix could lower the earnings forecast later this year.

A cloud hanging over CalSTRS and other pension systems is the possibility of another major market crash like the one a decade ago. Most pension funds, like CalSTRS at 63 percent funding, have not recovered from the huge investment losses.

The CalPERS board was told last month that its funding level is around 66 percent, down from the previously reported 70 percent. Needing no legislation, CalPERS did not choose to begin employer rate increases until 2012, four years after the market crash.

A built-in problem for pension systems is that when they are most in need of an employer rate increase, after a big market loss or economic downturn, employer budgets often are strained and least able to make higher pension payments.

And in downturns, unions that are a force on pension boards and in the Legislature may resist employer rate increases, if money available for pay raises is reduced. Employee rates are set by statute and labor contract and usually are not increased to pay for new pension debt.

The failure of CalSTRS and CalPERS funding levels to rebound after the last market crash and downturn leaves them more vulnerable to the next one. Experts say letting funding fall below 50 percent is a red line, making recovery to full funding difficult if not impossible.

Both systems have adopted modest “risk mitigation” strategies to reduce losses. When CalPERS earns 11.5 percent or more, half of the excess will be shifted to conservative investments. CalSTRS is shifting 9 percent of its fund to more protective investments.

Still, investment earnings well below the 7 percent forecast remains a major risk. If that happens, will the new CalSTRS rate-setting power be enough to stay on track to full funding by 2046?

The CalSTRS board can raise the state rate up to 0.5 percent of pay each year until the plan expires in 2046. The board was told last week the top state rate initially expected under the plan, 6.3 percent of pay, has already increased to 9 percent for various reasons.

Rates paid by school districts and other employers are doubling over a seven-year period, increasing from 8.25 percent of pay in 2014 to 19.1 percent of pay on July 1, 2020. The rate this fiscal year is 16.28 percent of pay.

The governor’s budget proposal would give school districts some relief by providing $700 million to reduce the last two scheduled rate increases by about 1 percent of pay, dropping them to 17.1 percent of pay next fiscal year and 18.1 percent in the final year.

Last week CalSTRS board member Harry Keiley said most media reports he sees focus on the pressure rate increases put on school districts, while ignoring that they are predictable, planned and come as the state provides more funds now and will have rate increases in the future.

He urged CalSTRS staff to think about “communicating a more balanced message about its impact and how it was planned and shared.”

Board member Nora Vargas, appointed by the governor to represent school boards, said she is hearing from school boards across the state that the rate increases are a challenge.

“I’m not saying they didn’t accept it as part of the deal, but I think there is a risk to us when school districts decide not to pay,” Vargas said, citing a charter school.

The board chair, Dillon, said she has heard of districts that paid less, from one year to the next, as rates went up because of salary schedules and labor agreements. She said some districts are wrapping rate increases over the whole budget, not just the salary portion.

Her proposal for a staff report on the impact of the rate increases on school districts that is “more data driven than anecdotal” was accepted by the board.

Dillon, a Weed intermediate school teacher who has served on the CalSTRS board since 2004, did not run for re-election. She will be replaced next January by Denise Bradford, a Mission Viejo elementary school teacher.

Reporter Ed Mendel covered the Capitol in Sacramento for nearly three decades, most recently for the San Diego Union-Tribune. More stories are at Calpensions.com. Posted 4 Feb 2019

12 Responses to “What delaying a big rate increase cost CalSTRS”

  1. larrylittlefield Says:

    “Debt or ‘unfunded liability’ is created when annual earnings fall below 7 percent or, as CalSTRS did two years ago, the earnings forecast is lowered (from 7.5 percent) and life expectancy increased (2 to 3 years).”

    It should be said again — debt increases when benefits are increased or payments are not made. The investment forecast isn’t about what pensions cost. It is about who is forced to pay — older generations, the richest in history, or those younger.

    In states such as New York and California, the debt also includes future retroactive pension increases that are not yet being pre-funded. Those should be estimated.

    The other factor that should be mentioned is that California teachers do not also get Social Security, while other public employees in the state do get Social Security.

    So when the state goes bankrupt as a result of retroactive pension increases for Generation Greed, tax cuts for Generation Greed, debts run up by Generation Greed, and infrastructure that was not invested in by Generation Greed, they should get priority for any money that is left.

  2. SeeSaw Says:

    @larry–is it not possible for you to opine and give advice without referring to public employees who received retroactive pension upgrades as “Generation Greed”. In the Amicus Brief that then Attorney General Jerry Brown wrote for the Orange County Sheriffs in their lawsuit vs. Orange County he stated that retroactivity of pension upgrades was standard procedure throughout the history of CalPERS. There was no crystal ball that told them there would be a world-wide financial collapse in 20008. PEPRA 2012 abolished such retroactivity and lowered pension formulas for employees hired after Jan. 01, 2013.

  3. moore Says:

    Larry: Most Ca. employees do not pay for or receive social security.
    The market crash is not the main cause of rate increases and greater deficits, increased liabilities, mainly from a “blue sky” salary increase system is the root cause.

    Agencies may file bankruptcy, but not the state. But if an agency files bankruptcy and does not leave the defined benefit system they are much worse off financially, in spite of what they say.

    Reducing the discount rate w/o reducing pensions is a rate increase, a sucker’s play, often encouraged by hopeless reformers.

  4. moore Says:

    Clarification: I meant most govt. agency employees do not receive social security.

  5. Tough Love Says:

    Quoting …………..

    “To show the importance of acting quickly, the report to the Legislature will have a calculation of where CalSTRS funding would be if the rate increases enacted in 2014 had been promptly adopted after the 2008-09 financial crisis.”

    Sure, WITH the benefit of HINDSIGHT of a rapidly rising Stock Market since 2009. And what if the Stick market did NOT recover.

    Making conclusions when one ALREADY KNOWS how the future will develop is ridiculous..

  6. Stephen Douglas Says:

    ” To show the importance of acting quickly…”

    See the Calpensions article of May 1, 2017…

    “New York pension systems outperform California”

    ” New York state pension systems are better funded than California state pension systems, currently take a smaller bite out of state and local government budgets, and still provide pension benefits well above the national average.”

    “DON’T PAY THE BILLS, THE DEBT GETS LARGER”

  7. larrylittlefield Says:

    Blaming the market crash is deceptive. Every downturn in the market has followed a bubble. You can’t retroactively increase benefits during the bubble and say it costs nothing, and then blame the market downturn for the fact that less well off people and generations are screwed to pay for it.

    https://larrylittlefield.wordpress.com/2018/12/16/sold-out-futures-by-state-public-employee-pensions-in-fy-2016/

    From 1987 to 2016, bubble peak to bubble peak (we are beyond bubble now), California pension plans reported assets and investment returns to the U.S. Census Bureau that calculate to an average return of 8.9%.

    “There was no crystal ball.”

    The historical average dividend yield is 4.3%. In 2000 it was 1.0%. There was no crystal ball? Are you kidding?

    The same stock market bubbles that were used to justify retroactive pension increases and (in other places) underfunding of the pensions public employees were promised to begin with were also used to justify the huge increase in executive pay. “We created shareholder value.” No you didn’t.

    What they have in common is people who negotiate secret deals with their cronies and have others pay the price. It’s the executive/financial class, the political/union class, and the serfs.

    https://larrylittlefield.wordpress.com/2017/11/26/the-executive-financial-class-the-political-union-class-and-the-serfs-redux/

  8. larrylittlefield Says:

    “New York state pension systems are better funded than California state pension systems, currently take a smaller bite out of state and local government budget.”

    New York City has its own, separate pension system that is nearly as large as the state system, which also covers local government employees in the rest of the state. NYC pensions are much worse off than California pensions, let alone the state system.

    Even though NYC residents have paid more than anyone else over the decades as a share of public employee wages, and as a percent of their own incomes. Even though the state legislature has sent the rules for both for more than four decades.

    Moreover, the damage is less for the city pension fund for most city workers (NYCERS). It is the separate systems for police, fire and teachers that are really deep in the hole.

    NYC residents are already faced with the kind of service degradation and tax levels California fears, and it is going to get worse — not even counting future retroactive pension increases, and any future underfunding.

  9. Stephen Douglas Says:

    “NYC pensions are much worse off than California pensions, let alone the state system.”

    Precisely. That’s why the NY State system is a meaningful comparison. It shows the importance of proper funding:

    “How do they do it?

    Part of the answer seems to be that the New York systems, following state law, more quickly pay down the debt or “unfunded liability” mainly created when pension fund investments earn less than expected.”

    2007-2008 was an extreme example, and there was a lot of pain playing catch-up immediately following the crash, but even so, and especially during “normal” economic cycles, as this article’s title says… delaying rate increases, increases costs.

    “DON’T PAY THE BILLS, THE DEBT GETS LARGER”

    The magic of compounding is no match for the curse of negative amortization.

  10. larrylittlefield Says:

    “That’s why the NY State system is a meaningful comparison. It shows the importance of proper funding.”

    1987 to 2016 average pension contributions as a percent of public employee wages and salaries:

    All pension funds in U.S. 9.8%

    California 12.0%

    New York State system 8.4%, plus 6.2% fir Social Security for virtually every worker (not so in CA, or U.S.).

    New York City system — 17.0% — plus 6.2% for Social Security for virtually every worker. Only Nevada was higher at 17.8%, but there no public employees get Social Security.

    Lesson — if some members of Generation Greed don’t destroy your future with (temporary) tax cuts and underfunding, others do so with retroactive pension increases. In most cases Generation Greed cut a deal to do some of both.

    And it isn’t just pensions, it isn’t just state and local, and it isn’t just government.

  11. jskdn Says:

    In response to a pro-Prop 30 column, I wrote:

    “Sent: Monday, October 15, 2012 12:44 PM
    To: [major newspaper state columist]
    Subject: Prop 30 and pensions

    All of the revenue from Prop 30 will not be enough to cover the interest on the current unfunded pension liabilities of the state for the past government employment. And every dollar of that revenue wouldn’t be spent on paying the interest will cause those existing liabilities to grow by that amount, barring the unlikely occurrence that the pension assets that are on hand grow faster than the rate of return that is being assumed. But most investment experts expect the opposite, meaning the unfunded pension liabilities are likely understated.

    The voters of California deserve to know this. Why don’t you tell them?

    Sincerely, Jeff”

    The columnist refused.

  12. Stephen Douglas Says:

    It’s a mixed bag in California. Most state workers are in social security. Safety employees are not. At the local level, that’s the general case also but there are a large number of exceptions. Generally teachers have no SS.
    Point being, NY State began backfilling the pension plan immediately. And their pension costs are much lower for it. Kudos, NYS.

    “It’s like a mortgage.”

    OK, not really, but picture using your credit card for all your personal expenses, then paying the balance in full at the end of the month. You are actually borrowing the banks money and paying no interest.*

    Now picture using the card for all personal expenses, and pay the minimum due each month. Not a pretty picture.

    * Don’t worry, the bank ain’t losing money either.

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