By Ed Mendel
August 24, 2015
CalPERS took another step last week toward a gradual long-term rate hike, a move to lower the risk of big investment losses as the maturing pension system enters a new era.
Retirees are beginning to outnumber active workers. Pension payments to retirees are no longer covered by employer-employee contributions and investment income. Now “negative cash flow” forces the sale of some investments to cover annual pension costs.
The new need to routinely sell some investments (see two charts at bottom) is one of the reasons the California Public Employees Retirement System is expected to have even more difficulty recovering from investment losses in the future.
After a loss of $100 billion in the recent recession, the CalPERS funding level dropped from 100 percent in 2007 to 61 percent in 2009. It has not recovered, despite a major bull market in which the S&P 500 index of large stocks tripled.
“Even with the dramatic returns we have seen over the past six years, because the demographics of plans in general have changed and plans are now by and large cash-flow negative, it’s been very challenging to dig out of that hole,” Andrew Junkin, a Wilshire consultant, told the CalPERS board last week.
The funding level of CalPERS in fiscal 2013-14 was 77 percent of the projected assets needed to pay pensions promised in the future. But investment returns last fiscal year were below the forecast, 7.5 percent, causing the funding level to fall again.
“With the estimated 2014-15 investment returns of 2.4 percent, that funded status is expected to drop to a range of 73 to 75 percent,” said Cheryl Eason, the CalPERS chief financial officer.
In a loss equaling the state general fund budget at the time, the CalPERS investment fund dropped from about $260 billion in the fall of 2007 to $160 billion in March 2009, before climbing a little above $300 billion early this month.
CalPERS won’t soon run out of money. Its main fund paid $18 billion last year to 594,842 persons, up from $11 billion to 462,370 in 2007. Employers contributed $8.8 billion and members $3.8 billion, up from $7.2 billion and $3.5 billion in 2007.
Critics say the CalPERS earnings forecast, an average of 7.5 percent a year, is too optimistic and conceals an even larger funding gap. The board is working on a “risk mitigation” strategy that could slowly lower the forecast to 6.5 percent over 20 years.
When the earnings forecast goes down, some of the pension fund can be shifted to less risky bond-like investments. The yield is likely to be lower, but so is the chance of big losses in an economic downturn.
A lower earnings forecast also means that contribution rates are likely to go up, offsetting the lower earnings assumed in the future. That’s what happened when the CalPERS board in 2012 lowered the earnings forecast from 7.75 percent to 7.5 percent.
The CalPERS chief actuary, Alan Milligan, recommended lowering the forecast to 7.25 percent to provide a cushion or “margin for adverse deviation” as in the past. The board phased in the rate increase over two years to ease the impact on employer budgets.
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