Archive for the ‘Funding gap’ Category

CalSTRS wants to avoid another rate hike delay

November 12, 2018

It took nearly a decade for the Legislature to act on a CalSTRS request for a rate increase that is now more than doubling school district pension costs — a hard squeeze on funding for other school programs.

The California State Teachers Retirement System, unlike most California public pension systems, did not have the power to set an annual rate that employers must pay, needing legislation instead.

Prompt payment of pension debt or “unfunded liability” can keep systems at or near full funding, pass little or no long-term debt to future generations, and is a key part of examples of well-managed pension systems such as the Wisconsin and Dutch funds.

“Pay now or pay more later,” California State Teachers Retirement System officials said as they urged the Legislature to raise rates.

Last week the CalSTRS board was told that its actuaries are preparing an estimate of the cost increase from delaying a rate increase until 2014, six years after a massive investment loss during the financial crisis.

“One of the pieces of information we are probably going to show you in January is what having to wait 10 years actually did to contribution rates,” said David Lamoureux, CalSTRS deputy systems actuary.

Knowing timing is awkward, as schools absorb the big rates amid worry about the longevity of the record bull stock market, CalSTRS may begin politically sensitive talks with Capitol officials, teacher unions and other stakeholders about the timing of future rate hikes.

The CalSTRS investment fund dropped from $180 billion in October 2007 to $112 billion in March 2009. The funding level fell from about 100 percent of the projected assets needed to pay future pensions to about 60 percent.

CalSTRS funding never recovered. The funding level was about 65 percent last fiscal year, a new risks report said last week. The investment fund was valued at $229 billion as of Sept. 30.

The third annual CalSTRS risks report last week had some good news. The 2014 funding plan remains on track to reach 100 percent funding in 2046 and can withstand some hits.

During a 10-year period, a stress test found, if investments earned 5.25 percent in each year, well below the 7 percent target, the CalSTRS funding level would be about 90 percent in 2046, enough to remain stable in the following years.

Some think the 7 percent target is too optimistic and 5.25 percent or lower would be more realistic. Forecasting higher investment earnings lowers the projected long-term debt and the need for rate increases.

Like many public pension systems, CalSTRS expects to pay about 60 percent of future pension costs with investments that are often risky and unpredictable. So a 30-year projection of reaching 100 percent or full funding can be temporary.

The sudden steep plunge from 100 percent funding to 60 percent funding a decade ago is a leading example. Both CalSTRS and the California Public Employees Retirement System have since taken small steps to reduce the risk of investment losses.

A worrisome part of the new risks report is that, even with the new rate increases, there is still a 50 percent probability that the CalSTRS funding level will drop below 50 percent in the next 30 year, according to 5,000 simulations based on the current asset allocation.

“It would take only one or two years of lower than expected returns in the near term to push the funded status below 60 percent or even 50 percent,” said the risks report presented by Lamoureux.

Actuaries have told both CalSTRS and CalPERS that dropping below 50 percent funding can be a crippling blow that makes recovery to 100 percent very difficult. Employer rates might become unbearable.

“I would say if you get below 50 percent, it’s really hard to recover,” Nick Collier, a Milliman actuary, told the CalSTRS board last year. “Maybe the number is a little bit higher than that. But I wouldn’t go below 50 percent.”

CalSTRS funding level history from new risks report

Some have said 80 percent funding is good enough because, in addition to providing some cushion against big investment losses dropping funding to 50 percent, reaching full funding can create pressure to cut contribution rates and increase pension benefits.

Investment earnings from a high-tech boom around 2000 helped push the CalSTRS and CalPERS funds well above 100 percent. Contributions were cut and pension benefits increased for both of the big state pension funds.

Telling legislators it would not cost taxpayers “a dime,” CalPERS sponsored legislation for a large state Highway Patrol pension increase that spread to local police and firefighters, where it’s taking a big bite from local government budgets that critics say is “unsustainable.”

An annual CalSTRS actuarial valuation, which includes state contributions based on the 1990 benefit structure, shows that if there had been no contribution cuts and benefit increases around 2000, the CalSTRS funding level would have been 84.9 percent last fiscal year.

Among a half dozen CalSTRS bills was one that, for a decade, boosted pensions to encourage experienced teachers to stay on the job. A state contribution cut of 2 percent of pay, down from 4.3 percent, was matched by a 2 percent contribution cut for teachers.

A quarter of the teacher contribution to CalSTRS (2 percent of pay from the total of 8 percent) was diverted for a decade into a new teacher individual investment account with a guaranteed minimum return, the Defined Benefit Supplement.

Echoing CalPERS, a skimpy four-paragraph floor analysis of AB 1509 in 2000, which bypassed committees and went directly to the floors, said diverting 2 percent of teacher pay would have no “effect to the solvency of STRS” and the cost would be absorbed by the surplus.

Now as a maturing CalSTRS slowly rebuilds its funding, replacing investment losses is more costly than it was nearly a half century ago. The risks reports use the example of a 10 percent loss, a drop from the 7 percent target to an actual 3 percent loss.

In 1975 when the CalSTRS investment fund was about equal to the member payroll, an annual 10 percent investment loss could be replaced by a rate increase of 0.5 percent of pay over 30 years.

Today when the investment fund is six times larger than the payroll, replacing a 10 percent loss requires 3 percent of pay for three decades. And in 30 years when the fund is 11 times larger than the payroll, replacing the loss will require nearly 6 percent of pay.

For the first time, the new funding plan enacted in 2014 gave CalSTRS limited power to raise rates. Rates paid by teachers hired before a penson reform on Jan. 1, 2013, increased from 8 percent of pay to 10.25 percent and will remain frozen.

Teachers hired after the Public Employees Pension Reform Act are expected to pay half of the “normal” pension cost, the amount covering the pension earned during a year, excluding the debt or unfunded liability from previous years.

This fiscal year the rate paid by teachers hired after the reform, who receive a lower pension formula, increased by 1 percent of pay to 10.205 percent of pay, up from 8.15 percent in 2014.

School district rates are more than 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 18.23 percent of pay.

With its new but limited rate-setting power, beginning in fiscal 2021-22 the CalSTRS board can raise school district rates by up to 1 percent a year, but cannot exceed 20.25 percent of pay.

The new funding plan gave the CalSTRS board more power to set state rates. During each year until the plan expires in 2046 the state rate can be raised up to 0.5 percent of pay, reaching a total of 20.8 percent of pay.

CalSTRS has raised the state rate by the maximum 0.5 percent of pay for two years in a row. The total state rate this fiscal year is 9.8 percent of pay.

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 12 Nov 18

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