Brace yourself taxpayers: CalPERS is about to bury you deeper in debt.
The nation’s largest pension system is expected to adopt a funding plan this week that anticipates shortfalls during the next decade and then banks on exceptional investment returns over the following half century to make up the difference.
It’s an absurd strategy designed to placate labor unions, who want more public money available now for raises, and local government officials who are struggling to make annual installment payments on past debt CalPERS has rung up.
And it highlights why the California Supreme Court, which is currently considering a key case on pension rights, and state lawmakers must do more to rein in public employee retirement costs. We can’t afford the current system.
That doesn’t mean that traditional pensions should be eliminated; it means future benefit accruals should be reduced to affordable levels that don’t continue saddling current and future generations with debt.
The California Public Employees’ Retirement System currently has a $153 billion unfunded liability, with only 68 percent of the assets it should have, largely because of similar, past hubris about investment returns.
The action this week will affect pensions for state workers, and hence all California taxpayers. In the Bay Area, it affects pensions for employees of Santa Clara County and most cities except San Jose and San Francisco.
Specifically, the CalPERS board will re-allocate its portfolio and make a critical forecast of the return on those investments. The higher the expected return, the lower the contributions required from employers and employees. But if the prediction doesn’t pan out, taxpayers must cover the shortfall.
CalPERS staff predicts the investment mix it’s recommending will earn 7 percent annual returns. That just happens to match the earnings forecast that CalPERS is already phasing in. Thus, the staff suggests the rate should not be lowered, and contributions should not be further increased.
But that 7 percent forecast is problematic. Ted Eliopoulos, CalPERS chief investment officer, estimates CalPERS will only earn 6.1 percent annually over the next 10 years. To reach 7 percent, the system’s actuaries “blended” the 10-year estimate with a projection for the subsequent 50 years of 8.3 percent annual returns.
That’s right. CalPERS, like many retirement systems, makes decisions about funding pensions today based on estimates of what market returns will be for the next six decades.
To do that, CalPERS assumes the future economy will eventually mirror the past. “But the future economy will be a lot different than the past,” says Bob Stein, a retired Ernst & Young managing partner and chairman of the national Society of Actuaries Blue Ribbon Panel on Public Pension Funding.
“It requires a belief that equity returns are going to jump back up to the 8 percent level or even higher in the out years here. I don’t think anybody expects (that).”
CalPERS’ portfolio includes stocks, bonds and real estate. Eliopoulos acknowledges the spread between CalPERS’ 6.1 percent annual forecast for the first decade and the annual 8.3 percent predicted for the following 50 years is “as wide as we’ve seen.”
Asked whether he thinks CalPERS’ portfolio can earn an average 8.3 percent annual earnings over a half century, Eliopoulos told me, “I don’t have a crystal ball. I think the projection for the next 10 years is reasonable.”
Exactly. He doesn’t have a crystal ball. Nor does anyone else at CalPERS.
Board members with a fiduciary duty to responsibly administer the pension system shouldn’t use highly questionable half-century forecasts to justify underfunding pensions for the next decade.
In the shorter term, if CalPERS sets contribution rates assuming 7 percent annual returns and Eliopoulos’ 6.1 percent 10-year forecast proves right, the pension system for the next decade will under-collect from employers and employees.
Whereas workers and employers share the upfront pension contributions, government agencies, and ultimately taxpayers, must cover the shortfalls. That debt is treated just like a giant credit card bill, paid off with decades of installment payments.
The escalating payments are already requiring cutbacks in government services and/or higher taxes. CalPERS’ expected action this week is designed to avoid additional immediate payment increases. But it adds to the shortfall that must eventually be paid.
Political pressure from unions and local governments makes it likely the CalPERS board this week will keep the earnings assumption at 7 percent. But if that’s the plan, board members should at least admit that easing the pain now will require piling on debt for taxpayers to cover in the future.
They shouldn’t claim that wishful speculation about market returns decades from now makes it all right.
