Move Puts Further Pressure on CalPERS to Do Likewise
In a move with huge implications, the governing board of the California State Teachers’ Retirement System (CalSTRS), the pension fund for teachers, lowered their investment return assumption from 7.75 percent to 7.5 percent.
According to a release on Thursday, “The change is part of a four-year experience analysis that sets the parameters for determining the financial health of the system.”
“Any funding plan the Legislature and Administration develops for CalSTRS should reflect the most realistic expectations for the future, in order to effectively plan for the payment of CalSTRS benefits to its members,” said Teachers’ Retirement Board chair Dana Dillon.
“We have to keep in mind that CalSTRS cannot set its own contribution rates – only the Legislature and Governor have the authority to do so. Also, teachers do not receive Social Security for their CalSTRS covered employment, so the defined benefit pension may be their only source of retirement security.”
The current experience analysis contains three significant recommended changes to CalSTRS assumptions:
- Lowering the investment return assumption from 7.75 percent to 7.5 percent annually.
- Changing the mortality assumption to reflect the fact that members are living longer.
- Lowering the assumption of wage growth from 4 percent to 3.75 percent annually.
“Of these, the most significant change is the investment return assumption, because the projected lower future returns makes it much more likely that we cannot invest our way to financial health. We’re still feeling the effects of the global financial crisis,” said CalSTRS CEO Jack Ehnes.
During the crisis, the CalSTRS portfolio shed $43.4 billion between July 1, 2008 and June 30, 2009. Since CalSTRS uses an averaging, or smoothing, process that recognizes gains and losses over a three-year period, this is the final year in which the negative impacts from the crisis are being felt.
The California State Teachers’ Retirement System, with a portfolio valued at $144.8 billion as of December 31, 2011, is the largest teacher pension fund and second largest public pension fund in the United States. CalSTRS administers a hybrid retirement system, consisting of a traditional defined benefit, cash balance and defined contribution plan, as well as disability and survivor benefits. CalSTRS serves California’s 856,000 public school educators and their families from the state’s 1,600 school districts, county offices of education and community college districts.
As we reported earlier this week, experts have already downwardly revised pension earnings forecasts for CalPERS, which runs the pension system for state and local governments including the City of Davis.
The California Public Employees’ Retirement System has steadfastly refused to revise their 7.75 assumed rate of return (ARR), despite experts’ claims that hitting the long-term earning target will be difficult, at best.
Ed Mendel, who runs the Calpensions website, reported on Monday, “While CalPERS reported weak earnings in 2011, a prominent private-sector investment manager, Robert Arnott of Research Affiliates, told the board last week he thinks the most they can expect from stocks and bonds next decade is 4 percent.”
“Consultant Girard Miller said in Governing magazine this month, while discussing 12 basic public pension issues, that earnings ‘closer to 7 percent’ are more realistic until global debt is reduced,” Mr. Mendel reports.
And yet, CalPERS has remained steadfast in not revising their earning assumptions, despite recommendations by actuaries who argue they should lower their forecast to 7.5 percent.
Davis’ new city manager is skeptical about CalPERS’ claims and their forecast.
In early January, he told the Chamber of Commerce that he strongly disagrees with the CalPERS claims “that they have enough money at the moment and that they’re not going to increase our rates over the next two years.”
He told the chamber in his State of the City address, “We think they’re wrong. We think they’re basically doing that so that they don’t have to give the state an increase in their rate this year so they don’t contribute to the state budget deficit.”
“But we think they’re in complete denial.” He said that they don’t anticipate any additional cost pressures from CalPERS at this point in time, but the city still plans to set additional money aside in case they change their mind, which he said happens “just about every year.”
“Long-term, what’s happening with CalPERS is completely unsustainable,” he continued. “There’s no way they can ever meet their obligations and so at some point in the next five years they’re going to come clean and there’s either going to be a ballot initiative or some legislative change and both future employees and existing employees are going to see some reduction in the accounting methods – it’s just not sustainable.”
He hopes this realization comes before they hit the city with a 30 to 40 percent increase in our contributions rates. “There is some point in time when the fiscal laws of nature are going to catch up with [Cal]PERS,” he said noting that non-PERS cities are having to increase their rates by as much as 70 percent.
That view is now bolstered by a growing criticism of CalPERS’ decision to leave the ARR untouched at 7.75 percent.
Ed Mendel notes, “Even a small drop in the earnings forecast could boost the annual employer payment to the pension fund.”
In fact, the City of Davis has projected that for each quarter percentage drop in the earning expectation, the city will have to make an additional $1 million in payment from all funds.
The good news that Mr. Mendel reports that CalPERS has a chance to revisit their forecasts in March, and they are “not turning a deaf ear to the experts.”
The news from CalSTRS is likely to be the death blow to CalPERS’ ability to maintain their current earnings projections, as their calculations may be proven to be highly political, and reaction to the governor’s pension plan may help shape their predictions, as well.
The City of Davis last June voted to set aside $2.5 million, in part to cushion any blows from a revised PERS earning assumption. While those cuts have yet to be implemented, the city council was clearly on the right path.
—David M. Greenwald reporting
This is huge. And alarming. And something I have been warning about for approximately 10 years. While we can’t budget based on guesses about the CALPERS rate of return, it is incumbent upon us to position ourselves for this eventuality.
One difference between CalSTRS and CALPERS is that the state directly funds the schools. If CALPERS earnings assumptions are lowered resulting in large rate increases, we could see a huge number of municipal bankruptcies. That is why I expect to see continued strong resistance to lowering the earnings assumption of CALPERS. There will be a temptation to kick the can down the road, and assume that inflation will drastically reduce the city’s real pension obligation, since our public pensions are only inflation adjusted to the tune of about 2% a year.
The downside of this, of course, is that all of us who depend on public sector pensions will be out of luck, which will devastating news for many, many citizens of Davis.
Years ago, I tried to reason with the head of our local firefighter union that if we didn’t show restraint in the pension formulas, that the whole system would collapse and inflation would eventually solve the problem by a drastic reduction in the real value of our pensions. I argued that a sustainable 2% at 60 (or even 2% at 64) was far better than a worthless nominal 3% at 50.
It was an appeal to “enlightened self-interest”.