California’s Public Pension Debt About to Worsen?




Forecasts of the future cost of public pension programs offered by states, cities, counties, school districts and other government entities have for the last few years been identifying a problem. The problem is that forecast future costs exceed forecast future funding, leaving a gap called an unfunded liability. This has caused much consternation among most everyone – taxpayers feeling this gap means the promised retirement benefits are too generous – public sector retirees and employees feeling a sense of betrayal that their employer seems to have made retirement benefit promises that they did not fund.

There is a lot of room in the process of projecting future retirement program costs for wide variation. Such projections are based upon myriad assumptions covering 30-50 years in the future. Assumptions like at what age public sector employees will be when they are hired, how many years they will work for the public agency, how old they will be when they retire, what their wages will be that are going to be used to eventually calculate retirement pay, and what the rate of return will be for the monies on deposit in the retirement system are just a few.

The rate of return on investment is the focus of but one controversy.  I sure do not know what my savings will be returning a year from now, much less 30-50 years from now (if, that is, I am still alive).  The retirement systems have to estimate a rate of return to estimate their total revenue, so they tend to assume a rate of return based upon past experience, in many cases over a 10 year period.   Currently there is considerable debate about whether the investment world has changed so much that assuming a future rate based on past experience is wise.

Many public sector retirement systems are revisiting their assumptions, and among them the state employee retirement system known as CalPERS and the state teachers retirement system known as CalSTRS.  CalPERS is considering changing from a currently assumed rate of 7.75% to either 7.5% or 7.25%.  CalSTRS currently assumes an 8% rate of return, and is considering moving to 7.5%.  According to a publication called the California Public Retirement Journal such a move by CalSTRS would add $ 800 million in new unfunded liability to the system, and to cover that employers (school districts) would have to increase their retirement system contributions by 1.9% of payroll annually going forward.  If CalPERS moved to a 7.5% assumption, state payroll costs would have to increase by anywhere from 1.5% to 5% a year depending on the bargaining unit (Public Safety is at the higher end, rank and file at the bottom).

So, does prudent judgment warrant a reduction in the assumed rate of return?  Are our elected leaders, including our new Governor, ready to deal with this kind of change?  Can California, already facing a $26 billion (or more) 18 month deficit deal with increased payroll costs that a change in investment assumption would trigger?  I guess it could be worse –a recent study released by the Stanford Institute for Economic Policy Research used a 4% rate of return, arguing that is a risk free assumption.  The result?  Unfunded liabilities for most public sector retirement systems would rise dramatically – for instance, the CalPERS retirement system would change from a current funding level of 88.3% to only 44.7%.  If anyone thinks accountants and their assumptions don’t matter, I suggest they re-read this post.

About Over But Not Out

A retired Orange County employee, and moderate Republican. The editor seriously does not know OBNO's identity as did not the former editor, but his point of view is obviously interesting and valued.