November 21, 2016
The state’s two largest public pension systems never recovered from huge investment losses during the deep recession and stock market crash in 2008. CalPERS lost about $100 billion and CalSTRS about $68 billion.
Now after a lengthy bull market, most experts are predicting a decade of weak investment returns, well below the annual average earnings of 7.5 percent that CalPERS and CalSTRS expect to pay two-thirds of their future pension costs.
The two systems are still seriously underfunded, CalPERS at 68 percent and CalSTRS at 65 percent. This is not money in the bank. It’s an estimate of the future pension costs covered by expected employer-employee contributions and the investment earnings forecast.
Last week, the CalPERS and CalSTRS boards got separate staff briefings on how the “maturing” of the two big retirement systems creates new funding difficulties. Both are nearing a time when there will be more retirees in the system than active workers.
The California State Teachers Retirement System board, for example, was told that in 1971 there were were six active workers in the system for every retiree. Today CalSTRS only has 1.5 active workers for every retiree, similar to the CalPERS ratio.
A wave of baby boom retirees that began around 2011, and the continuing increase in the average life span of retirees, have added to the growing cost of paying pensions, giving both systems what actuaries call “negative cash flow.”
The annual cost of paying pensions is more than the annual contributions from employers and employees. So, the pension funds are forced to “eat their seed corn” by selling some investments to cover the gap, thus reducing potential investment earnings.
The California Public Employees Retirement System had about $14 billion in contributions in fiscal 2015-16 and pension payments totaling $19 billion. By 2035, the board was told, contributions are expected to be $17 billion and pension payments $35 billion.
Mature pension funds also have another difficulty. The pension investment fund becomes much larger than the active worker payroll, which means that replacing an investment loss requires a larger employer contribution increase.
The CaSTRS board was told that replacing a 10 percent investment loss in 1975, when the teacher payroll and investment fund were about equal, would have required a contribution increase of 0.5 percent of payroll.
Replacing a 10 percent investment loss today, when the investment fund is six times greater than the payroll, requires a contribution increase of 3 percent of pay. CalSTRS has had losses of 10 percent (below the 7.5 percent forecast) four times in the last two decades.
Both systems recently adopted modest “risk mitigation” strategies to reduce losses. When CalPERS earns 11.5 percent or more, half of the excess will be shifted to conservative investments. CalSTRS is shifting 9 percent of its fund to more conservative investments.
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