Politics trumped prudent fiscal management when CalPERS, labor and Brown administration officials held a closed-door confab last month to set the pension system’s key investment return rate.
The rate, which should be based on professional market forecasts, is the most critical determinant of how much state and local governments must contribute each year.
A lower rate means the pension system anticipates earning less on investments and consequently will need more from employer contributions. That, in turn, leaves less money for workers’ salaries and benefits, which is why labor leaders push to keep the investment rate as high as possible.
But if the rate is set too high, and investment returns fail to meet the forecast, the pension fund will come up short, leaving debt for taxpayers to bear. That sort of inaccurate forecasting largely explains why CalPERS is already about $170 billion short, with only 63.5 percent of the assets it should have.
That’s also why the debt will likely get worse after the privately brokered deal, which was reached on the morning of Sunday Dec. 18 in the office of state Finance Director Michael Cohen and ratified by the CalPERS board three days later.
Before the meeting, CalPERS staff had suggested, but never formally recommended, lowering the return rate from 7.5 percent to 7. The three factions agreed to the change – but decided to phase it in over eight years.
That’s right: Eight years. Until then, even if investments earn 7 percent annually, the pension system will continue to rack up more taxpayer debt.
Moreover, the 7 percent target is not low enough. CalPERS announced last month that it hadn’t hit that average over the last 20 years and, going forward, it estimates that there’s only roughly a 1-in-4 chance that it will do so.
The pension system’s consultant warned last summer that CalPERS should anticipate an average 6.2 percent annual return for the next 10 years, which would further exacerbate the debt.
How much more debt? We don’t know. The closed-door decision was made without forecasts of how much the taxpayer burden would grow. Indeed, those forecasts still haven’t been done, according to CalPERS.
Word of the deal leaked out the day after the private meeting. Dan Carrigg, legislative director for the League of California Cities, sent an email to key city officials with details.
He said Cohen had advised him that “a deal on the (return) rate had been struck with labor representatives, and will become the staff recommendation at tomorrow’s PERS Finance and Administration Committee meeting.”
As usual at CalPERS, the labor tail was wagging the dog. The committee backed the deal Dec. 20, before the full CalPERS board ratification it the next day.
Along the way, the public was kept in the dark. When CalPERS released a written summary of the details, it omitted key details of the phase-in.
The deal calls for lowering the investment return rate for state calculations to 7.375 percent in fiscal year 2018, 7.25 percent in 2019 and 7 percent in 2020. The changes for local governments would be one year later.
But each step down would be phased in over five years, delaying the full effect until 2024 for the state and 2025 for local governments.
The governor immediately touted the deal, which will require greater contributions from state and local governments, as a major step toward “a more sustainable system.” In fact, it was an incremental adjustment that kicks the proverbial can further down the road.
The investment rate change will increase annual pension costs for state government by 33 percent by fiscal year 2024, to $7.4 billion, according to a CalPERS estimate. For the state’s most costly pension benefits, at the California Highway Patrol, the state will pay 71 cents for every dollar of salary.
It still won’t be enough to stop the hemorrhaging.
This “will not cure the challenges to the sustainability of the fund,” Dane Hutchings, lobbyist for the League of California Cities, told the CalPERS board. “We encourage the board to rise to the challenge with a more meaningful solution.”
That must begin with realistic numbers that reflect the true costs of pensions.