CalPERS gets candid about ‘critical’ decade ahead

Once CalPERS could shrug off low funding and rising employer costs as just another downturn, staying the course in the long-term strategy of getting most of its money from market investments that go up and down.

This time is different.

CalPERS is still only about 70 percent funded after a record decade-long bull market. State and local government CalPERS costs are at an all-time high and growing, amid warnings some cities may face bankruptcy.

And as recession looms after years of growth, the failure of funding to recover to the traditional 80 percent or better leaves CalPERS more vulnerable to a big investment loss that drops funding below 50 percent, a red line experts say makes recovery unlikely.

CalPERS is hearing from workers worried about whether their pensions are secure, Marcie Frost, CalPERS chief executive, told the board last week, and a frequent question from employees and employers is: “Why does the fund remain at 70 percent?”

A letter from Frost posted on the CalPERS website last month, “Our Plan to Protect Our Members’ Retirement Security,” is a response to the concern among CalPERS members about whether their promised pensions will be there when they need them.

After a look back at what caused the shortfall, the letter outlines some of the steps that raised employer rates to put more money into the system, after funding fell to 61 percent a decade ago, and a new focus on increasing investment returns.

“The benefits of the changes we’ve made are taking hold, but the next decade is critical,” the three-page letter said in the conclusion. “Pension costs are rising, and we must do all we can to control them.”

A critic could find things to pan in the letter. The opening refers to “changes in retirement benefits and lower contributions” when CalPERS was 128 percent funded 20 years ago during a high-tech boom.

Not mentioned is CalPERS dropping employer contributions to near zero for two years and sponsoring a state worker pension increase, SB 400 in 1999. Its generous Highway Patrol formula, adopted by local police and firefighters, is said by some to be unsustainable.

A CalPERS pamphlet told legislators SB 400 would not cost “a dime of additional taxpayer money.” State contributions expected to remain for a decade below the fiscal 1998-99 level, $766 million, actually turned out to be $3.9 billion in 2009 for various reasons.

The letter said CalPERS has lowered its expected annual investment return, used to discount debt, from 7.75 percent to 7 percent. Critics say the return target is still too high and conceals the need for a massive employer rate increase.

A CalPERS consultant, Wilshire, has been forecasting that the CalPERS portfolio, valued at $378.7 billion last week, will earn 6.2 percent during the next decade. Last week a new Wilshire report lowered the forecast to 5.9 percent.

Still, CalPERS members may be reassured by the prompter payment of new debt, a drive for higher investment returns led by a new chief investment officer, Ben Meng, with new private equity models, other examples of action, and a new attitude.

“The financial world is changing, and we must change with it,” said the letter. “What we’ve done over the last 20 years won’t take us where we need to go in the future. New thinking and innovation are in order.”

The CalPERS Pension Buck

If hitting the 7 percent investment target will be difficult and rising employer rates are taking too much of government budgets, what about the other source of CalPERS funding — the employee or member share of pension costs?

The “CalPERS Pension Buck” on the CalPERS website main page, based on income during the last 20 years, understates the growing gap between contributions to CalPERS from employers and members since the huge investment loss a decade ago.

Over the last 20 years, the Buck shows members contributed nearly half as much as employers. But last year, member contributions were less than a quarter of the rapidly growing employer contribution, according to the CalPERS annual financial report. (see below)

In 2009 the employer contribution to CalPERS was $6.9 billion and the member contribution $3.9 billion. By last year, the employer contribution had soared to $19.9 billion, while the member contribution only increased to $4.4 billion.

An explanation of the Buck on the CalPERS website said some believe taxpayers fund the total pension cost, when in fact “72 cents out of every public employee pension dollar is funded by CalPERS’ own investment earnings and member contributions.”

A critic might argue that the Buck, by looking back two decades, obscures the fact that the annual cost government employers pay for CalPERS pensions has nearly tripled during the last decade, making it a larger part of the pension buck income.

As for any worry that CalPERS may soon run out of money, the chart below shows total employer and member contributions last year, $24.3 billion, exceeded pension payments, $22.7 billion, thanks to the big employer contribution increase.

The positive cash flow means CalPERS at this point does not, as it has in the past, need to dip into its giant investment portfolio to make annual pension payments, reducing the holdings that can yield earnings.

Member contributions to CalPERS are usually set by union contract bargaining and statute. Current rates paid by employees can be as high as 15.5 percent of their pay. But most rates are about 8 to 10 percent of pay.

Importantly, only employers are required to pay off pension debt or the “unfunded liability,” which for CalPERS was $139 billion last year. Paying off the debt is the reason that employer contributions soared during the last decade and member contributions did not.

Debt can result from several things, such as expecting longer average life spans that increase total pension costs. But the big one is changes in the investment earnings expected to pay most of the pension costs.

Lowering the investment target or discount rate, as CalPERS did from 7.75 to 7 percent, resulted in debt paid off by higher employer rates. Even investment returns slightly below target, like CalPERS earning 6.7 percent last fiscal year, produced new debt.

Most large corporations have switched employees to 401(k) individual investment plans, making an annual “defined contribution” that unlike a “defined benefit” pension produces no debt. In a time when equality is a political issue, public pensions fear the trend.

“We told the CalPERS story across the state,” Frost said in the letter, “fiercely defending defined benefit plans and highlighting their economic impact on local communities large and small.”

Some reformers who think 401(k)s provide inadequate retirement, while shifting investment risk to employees, advocate giving public pensions the flexibility to cut the pension amounts workers earn in the future — notably a Little Hoover Commission report in 2011.

But a series of state court rulings known as the California Rule prevent cuts in the pension offered at hire unless offset by a new benefit. The state Supreme Court, avoiding the issue in a ruling earlier this year, may address the California Rule in a pending case.

Even if the California Rule is modified, it’s not clear any local governments will rush to cut pensions. Stockton and San Bernardino did not try to cut pensions in bankruptcy, saying they are needed to be competitive in the job market, particularly for police.

Meanwhile, a line in Frost’s letter is a reminder that CalPERS remains at the mercy of the market, as when the stock market crash and recession struck a decade ago: “The value of the CalPERS fund fell 24 percent in a single fiscal year, to about $180 billion.”

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 26 Aug 2019

12 Responses to “CalPERS gets candid about ‘critical’ decade ahead”

  1. Kirk Brown Says:

    Don’t expect the taxpayers to bail out CalPERS.
    We are all trying to build our own retirement and it’s not fair that I have to put less in my retirement just so an irresponsibly conceived pension can be made whole to the CalPERS recipients.
    My wife’s retail clerks union pension was cut in half. No bailout. Same should apply to state pension funds. You payout based on what’s available.
    Bad contracts and fiscal mismanagement of the funds should not ba an additional burden to the taxpayers.

  2. SeeSaw Says:

    Kirk, my spouse’s carpenter pension was frozen in 1986, due to the illegal invasion, whereby the builders declined to sign new union contracts for residential construction. I don’t blame the illegals–I blame the contractors who hired them–against the law. The carpenter, pension did not collect another penny of interest until my spouse’s retirement in 2008. His DB pension must be used exclusively to cover the cost of medical insurance. Without my CalPERS pension to combine with his carpenter pension we would be on Medicaid . We all have our issues–please don’t take your ire out on CalPERS recipients who happen to be taxpayers, just like you, and who put most of their pension dollars right back into the economy. I empathize with your wife, by the way.

  3. Kirk Brown Says:

    No ire from me on CalPERS recipients. I just don’t want to be held responsible to fund it if it’s underfunded.
    No one is going to make sure my 401k is funded if I don’t have enough at retirement. My wife got screwed by the fiscal mismanagement of her union.
    Basically what I’m saying is that we are all on our own. Don’t expect people that are trying to fund their own retirements to put that off so they can make sure CalPERS is funded. CalPERS needs to figure it out, and if it means cuts to their members, than that’s the answer. I shouldn’t have to pay for it.

  4. SeeSaw Says:

    Nobody is asking you to put the funding for your own retirement off in order to fund CalPERS. I have a 457b and I funded it via my own salary just as you are doing with your 401k. It serves as a supplement to my pension, because I would never have been able to put away enough in that plan, alone, to sustain myself for the rest of my life. CalPERS is trying to make the right decisions to bring in sufficient returns without having to charge the member-entities more and more; it does not have the authority to make cuts to the members on its own, if the premiums are up-to-date. It would take legislative action by statute or a constitutional amendment by voter-initiative to make cuts to the members.

  5. Kirk Brown Says:

    Cool, as long as taxpayers aren’t called upon to make up any pension deficiencies, I have no problem.
    I am 2 years away from retirement and will be selling my properties and leaving this rotting state with the money I earned and will no longer be subject to subsidizing the never ending taxes and fiscal mismanagement that defines California.
    Have a nice day.

  6. SeeSaw Says:

    Be careful; you will continue to pay taxes, regardless of which state you choose.. In some states the property taxes are higher than those in CA and food and clothing is higher in some other states also. I do agree though, that it is very important that you are happy wherever you reside. Just don’t burn a bridge that you cannot reconstruct if you should so decide that you want to return to CA..

  7. jayesouthworth Says:

    Leaving California to go to another State is a big move. I have a relative that moved to Texas. She’s paying twice the property taxes I’m paying, they think they are still living in California. With many people moving to different states, they’ll be paying higher taxes for the needed infrastructure to sustain an increasing population. Roads, schools, government. No one is going to cut a fat hog in the butt.

  8. Kirk Brown Says:

    The worst financial move anyone can do is buy real estate in Texas. it literally never appreciates except in very select areas. Also, Texas is a hot/humid miserable place to live. I’m looking elsewhere.
    Given the super-majority in the California legislature its a matter of 1-3 years before Prop 13 is rolled back and Texas real estate taxes will look like a cakewalk compared to California. All they have to do is put it before the voters, most of whom rent and it will be overturned.
    As for paying for government services, California has the highest state taxes in the country, the highest gas taxes, and the most crushing regulation. And the roads still look like crap, the schools rank worst in the nation, and the population coming in takes more than it contributes. It doesn’t take a rocket scientist to see what the future of California looks like….. More taxes.
    I am simply part of the exodus of people protecting their income by moving away from this once great state. California can tax all the newcomers to make up for the deficit of high income/asset people leaving.

  9. SeeSaw Says:

    Kirk, we are not going to let the voters overturn Prop.13. You and many others are wrong about the cost of state income taxes. Once people reach the age of 65, they get double credits, and higher standard deduction. And, SS income is not taxed by the state of CA. The CA state income tax for my spouse and me has run about $1700 for the last several years. Would you leave CA to save that much on your state income tax?

  10. althink81 Says:

    re: “The state Supreme Court, avoiding the issue in a ruling earlier this year, may address the California Rule in a pending case.”

    History shows that it is likely hopeless that the CA Supreme Court will correct its past rulings. Every ruling it makes, it just keeps digging. Instead of making a clear principled ruling, it gets lost in the weeds and creates complexity that protects the status quo.

    Not only has the Supreme Court failed to do it job with clear rulings, the glacial speed at which it processes pension reform cases is another way it protects the status quo.

  11. SeeSaw Says:

    althink81, it looks like you don’t believe in following the Constitution of the State of CA. The Supreme Court made a very proper decision on the issue of “air time”, by not commenting on the “California rule”. The “rule” was not the issue before it. Why should it rule any differently on the upcoming pension cases?

  12. althink81 Says:

    SeeSaw: The CA Constitution contract clause is identical to the Federal Constitution but interpreted differently. You will not find the CA rule in Federal Courts. It is also interpreted different from CA in many other states. Shortly after the original California Rule decision the State of Maine looked at the CA ruling and said it was clearly wrong. Other states adopted the ruling; but, suspecting it was wrong, added new provisions to state constitutions. That has not been done in CA. The CA Rule is absolutely wrong but the system is rigged to not correct it.

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