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California Still Facing Pension Crisis Even With Good Stock Market Returns

Unions try to use good years to deflect attention from a growing problem.

Foter.comFoter.comCalifornia's fiscal watchdogs are bracing for the forthcoming press statements from the nation's largest state-run pension fund, and from the public-sector unions that depend on the system to pay their members' generous retirement packages.

Expect something to this effect: "The California Public Employees' Retirement System's investment earnings for the fiscal year ending June 30 were above 9 percent, reconfirming the health of the state's pension system—and debunking the naysayers who claim that unfunded pension liabilities will obliterate municipal and state budgets."

There's no question that many investors will see returns approaching or even exceeding double-digit levels for the recently completed fiscal year, as the stock market has done exceedingly well in recent months. A pension crisis? As police officers often say at the scene of an accident, "Keep moving, folks. Nothing to see here."

Californians need to temper the glowing statements and shrug off the efforts to keep us from looking too closely at the wreckage. Of course, impressive stock-market returns are a good thing that reduce the amount of taxpayer-backed pension obligations. But one good year doesn't fix a problem that has been two decades in the making. For perspective, CalPERS' returns for the previous two fiscal years were 0.6 percent and 2.4 percent respectively.

It could take decades to make up not only for past years of poor stock-market performance, but for the massive and relentless retroactive pension increases that state and municipal governments have been granting their workers since 1999.

"CalPERS' funded ratio 20 years ago was 111 percent," explained Stanford lecturer David Crane, who was Republican Gov. Arnold Schwarzenegger's pension adviser. He notes that "despite a wonderful 6.7 percent annual return for 20 years, CalPERS' funded ratio fell 48 percentage points... because pension liabilities compound at high rates."

Crane was responding to a Sacramento Bee op-ed by a union president, who recently compared investment returns to the state's drought: "The funded ratio of pension funds has risen and fallen like the levels at Lake Shasta." The union official, Yvonne Walker of the Service Employees International Union Local 1000, has gotten an early start on the kind of argumentation we should expect. She blasts pension reformers' "doomsday predictions." Just like the drought, low returns won't go on forever.

Indeed, private 401(k) retirement plans and public "defined benefit" plans both are dependent on investment returns, but in significantly different ways. In a 401(k) plan, the employee contributes a set amount of money to the account, to which some employers offer full or partial matches. If the market soars, the employee's nest egg grows. If it falls, so does the account balance. There is no unfunded liability because the employee isn't promised any specified amount of retirement income.

In the public sector, employees are guaranteed an annual benefit based on a formula. California police and fire officials, for instance, typically receive 90 percent or more of their final years' pay until they and their spouse pass away. Nothing short of a municipal bankruptcy can legally reduce what they receive. The pension funds invest the dollars contributed by the agency and employees in the stock market. Even if the stock-market does poorly and the liabilities rise, the retirement pay stays the same.

That's why CalPERS and other union-controlled pension funds have a vested interest in celebrating up years and downplaying bad years. Good years let them hide the amount of taxpayer-backed debt that's accumulated. These pension funds also predict unrealistically high rates of return far into the future, which masks the size of the problem and reduces efforts to lower pension benefits.

But there is a steep cost to this approach. When public agencies spend more on pensions, they must cut services or raise taxes. Most are savvy enough to pitch the tax hikes as being for "public safety" or "transportation," rather admit they are needed to pay for pensions. "Deceptively-hidden pension liabilities are already ravaging education and other public services and already causing tax, tuition and fee hikes," Crane explained.

This is a national problem, although it hits California hardest because of the state's overly generous pension system. A recent national study by the well-respected Hoover Institution at Stanford University found that "pension promises are consuming state and local budgets."

The study says pension funds hide their costs through their investment assumptions: "What is in fact going on is that the governments are borrowing from workers and promising to repay that debt when they retire, but the accounting standards allow the bulk of this debt to go unreported through the assumption of high rates of return."

There are a few good reasons for doom saying.

Even a year of good returns will do little to correct the vast level of pension underfunding. After this year's returns, "the nation's largest public pension system will still be seriously underfunded," Ed Mendel reported in a recent Calpensions article. CalPERS is now only 65 percent funded and "is worried about a downturn that might drop funding below 50 percent, a red line actuaries think makes recovery very difficult."

Pension spending continues to consume local and state budgets and is leading to cutbacks. In a recent City Watch LA article, the California Policy Center's David Schwartzman detailed governmental cutbacks in California cities tied to growing pension costs. For instance, Santa Barbara County laid off 70 employees and remains unable to fund $546 million in infrastructure improvements. In a July 8 article, Crane detailed the woes of California's public school systems, which are struggling even during "an economic recovery and after a large tax increase." He pins the blame on "exploding spending on pension and retiree health-care obligations."

It's unrealistic to bank on this year's stock-market surge to be followed by additional surges. During his budget announcements each year, Gov. Jerry Brown (D) always features a chart showing that, since the turn of the millennium, the years with budget deficits outnumber those with surpluses. Brown's points deal with general-fund budgets rather than pensions, but the point is similar. It's more realistic to expect downturns than unending boom years.

Indeed, the Pensions & Investments article about the latest returns is aptly headlined, "Strong returns nice, but aren't expected to last." Ed Ring's May 2016 California Policy Center analysis concluded that public pension funds "will be hit much harder in a downturn than private pension funds" because they "are not subject to the same rules that private pension funds have to adhere to."

Because unions continue to control the state Capitol and many local governments, we will see a continued ratcheting of compensation levels. Here's one small example from the VoiceofOC, which reported this month that the Santa Ana City Council just hiked the pay for 477 police employees "amid staff projections of major funding shortfalls." Median police compensation there is now above $213,000, according to the news site. As we've seen many times before, good fiscal news typically leads unions to lobby for even higher pay and benefit levels.

By all means, let's toast the favorable stock-market returns. But a more reasonable press release would suggest that despite those returns, the pension crisis continues to be as pressing as ever. Let's not be misled by those with a vested interest in downplaying the problem.

This column was first published by the California Policy Center.

Photo Credit: Foter.com

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  • Glide||

    That would be a pretty generous spin on a 9% return, considering the S&P 500 got 13%.

    I know pension investing is not as simple as "dump it into an index fund" but I don't think you should miss the total market performance by that much.

  • damikesc||

    Especially when CalPERS is supposed to be one of the "well-run" investment funds out there.

    Then again, they got in deep with Enron, so they don't always do great due diligence.

  • Calidissident||

    Pension funds diversify into fixed income and other asset classes to reduce volatility, so it isn't necessarily that bad to be underperforming the S&P 500 in boom years. Although looking at the returns, it seems the S&P had a 15% return when you account for dividend reinvestment, so that is more significant underperformance than the raw number. The FY from July 2014 to June 2015 was utterly awful. A 2.4% return in a year the S&P 500 had a total return over 8%. There's no way they can meet the pension obligations if they're underperforming the S&P by 6% every year.

  • Richard Grieco||

    When people think about pension funds, they often compare them to their own 401ks. There's a fundamental difference - with the 401k, you're typically saving for future retirement. Meaning, you don't need cash right now, but you do need cash in the future. In a pension fund, you need cash not only right now (to pay current retirees) but also in the future. As society evolves away from defined benefit programs, the existing pension funds are going to see a higher and higher proportion of their members consisting of retired people (for which cash is needed right now) rather than future retirees.

    I'm not up on the specifics of CALPERS, but comparing it to an index fund isn't really fair, as you're using that index fund for your retirement in the future. It would be more fair to ask yourself how you would allocate your investments if your 401k had to support both yourself and was the sole source of income for your 80 year-old parents. You would need a big chunk of cash on hand for protection in case something bad happens (or if the market tanks - because while that wouldn't be a big deal for you at age 30, it would be a huge deal to your parents at 80).

  • a2plusb2||

    The sponsor of the pension plan puts money into the pension fund each year to support the pension obligation of each worker's work of that year. So by the time each worker retires, there is supposed to be money in the pot to support that worker's retirement, without the sponsor having to put any more money in FOR THAT WORKER. Not very different in concept from a 401k. So Richard Grieco's concern about whether a pension fund without current workers contributing can pay current retirees doesn't have basis. IF THE FUND is managed like it is supposed to be.
    -- We see much evidence that public pension funds aren't managed responsibly.
    So what follows won't be pretty.

    BTW, you 30 years old and your parents 80 years old... First, congratulations to your mother. Not every woman can have a kid at age 50. Second, you would have 3 401ks, one for each of you. Your parents' 401ks would be fully funded and in drawdown mode.

  • Conchfritters||

    For perspective, CalPERS' returns for the previous two fiscal years were 0.6 percent and 2.4 percent respectively.

    Who the fuck is their broker??? Has someone been stealing from this pot? I don't know anyone who only did 0.6% last year - you could have beat that owning a 5 year Treasury bond! Should we bailout everyone who makes poor choices in their 401(k)?

  • DaveSs||

    As I understand it, California has goofy rules requiring the pension fund must do 'socially responsible' investing.

    So it tends to invest heavily in things like 'green energy' and not to invest in things that tend to show long term strong growth because feels.

  • Rhywun||

    In a normal society, heads would be on pikes for less.

  • Sevo||

    "The Investment Beliefs are the framework for how we manage our investments and help us determine our priorities, such as:

    Asking the world's largest energy companies to look at their environmental risk assumptions
    Making sure the Boards of companies we invest in are paying close attention to the risks and opportunities of climate change
    Working with leaders across the globe at the UN Climate Summit to create an agreement that aims to protect us from the effects of climate change"
    https://www.calpers.ca.gov/page /investments/governance/ sustainable-investing/esg

  • Elias Fakaname||

    Fucking Christ, can we just all decide that CA is under construction ministry control and out the state under martial law? All this shit is ridiculous.

  • Elias Fakaname||

    "Communist control".........goddammit the squirrels are powerful this morning.

  • Calidissident||

    Second half of 2015 had poor performance, but the total S&P 500 return for that time period was still almost 5%, so that's still bad.

  • damikesc||

    Crane was responding to a Sacramento Bee op-ed by a union president, who recently compared investment returns to the state's drought: "The funded ratio of pension funds has risen and fallen like the levels at Lake Shasta." The union official, Yvonne Walker of the Service Employees International Union Local 1000, has gotten an early start on the kind of argumentation we should expect. She blasts pension reformers' "doomsday predictions." Just like the drought, low returns won't go on forever.

    Apparently ignoring it will require significant lengths of abnormally good returns to make up for the bad returns AND maintain the minimal level of return required to maintain the fund.

    If you're expected to chip in a million a year every year and you only chip in 200,000 for two years, you still have to make up the 1.6M you didn't chip in for those 2 years WHILE still churning out a million a year on top of that.

  • paranoid android||

    So if I have this right, the state of California is banking its future on the premise that the Trump presidency will produce an economic miracle.

    It's a bold strategy, Cotton, let's see how it plays out.

  • Sevo||

    They're certainly happy that Krugman is such a pathetic tout.

  • Enjoy Every Sandwich||

    The important thing is if the plan fails they can blame Trump. Nothing is more important than being able to shift the blame for failure.

  • Rich||

  • the other Jim||

    So basically, whenever the stock market tanks, as it inevitably will at some point, they're completely hosed.

  • a2plusb2||

    Since they will continue to assume returns greater than the market, and will also award pension sweeteners to their union workers, beyond what they can afford or the market can earn, they are completely hosed sometime in the future, even if the stock market doesn't tank.

  • Fat Stanley||

    The future income obligations are an easily estimated item. Obviously funding them is less easily done. But keep a close eye on the post-retirement medical. That's the one that can really bite you in the ass. As people use their benefits over the next 10, 20, 30+ years, CA has an obligation to pay, regardless of the high rate of medical inflation. That will further erode the solvency of CalPERS.

  • Elias Fakaname||

    So then the compulsory organ harvesting begins?

  • I can't even||

    How about a referendum question to prevent further damage by moving all future CA employees to defined contribution. It would probably lose but it would be their choice to live in a bankrupt state.

  • Bgoptmst||

    A couple things to note here:

    1) In a democratically controlled state (CA here, HI is another good example) with no republican interference they still can't build a utopian society. Probably because feels isn't a good way to govern, but I could be wrong.
    2) It's glossed over here but the amount of debt the US is carrying federally is well documented. What is scary is how much state debt is possible due to unfunded liabilities.

    Democracies can get brittle and break. At some point telling people to get fucked on the goods they were promised will cause some real social issues.

  • Longtobefree||

    Yawn. California. So secede already!

    Is there a way to force them out? Do we have to wait for them to secede?

    Maybe make the whole state a federal wilderness area and give everybody 30 days to vacate the premises? With a provision they can only go to other blue states?

    And I have always wondered, who got to pick the red of communism for the republicans? Is the blue for liberals to symbolize the snowflakes holding their breath until they get what they want this week?

    One last question; anybody got any coffee?

  • retiredfire||

    "Who got to pick the red of communism for the republicans?"
    That was the media.
    The first red/blue maps came out with the republicans as blue, but the media saw that their side was being identified with communist red and switched them around.
    Who else had that ability?
    Here's a site with the correct orientation: http://uselectionatlas.org/

  • MDP||

    Eat up little piggies. You will rot in a pile of your own excrement.

    :)

  • Old Monkey||

    CALPERS has more problems than you can possibly imagine! Prescient has already been set:
    http://www.sacbee.com/news/bus.....17413.html

    Unfortunately what hasn't been established are individual participant city's. county's, and special district's agreements with groups represented, and not represented by CALPERS.Some CALPERS jurisdictions screw the grunts, resent paying Management, and fear not paying top tier for Police, Fire, District Attorney, and Politicians. Last 4 should eat most of the pain. Most non-Calpers pensions organizations for decades, paying less to employees, with lower pension rates, are protected from FORCIBLY BEING RAPED AGAIN, from state transgressions including CALPERS. Only CALPERS, and non CALPERS participants receiving a pass should have pensions less 2% or less should get a pass. Only excuse to pay law enforcement, fire, or District Attorneys more is if they die in the saddle.None have a job in the highest 10 professions for mortality. Other than death in the saddle, their families shouldn't receive higher compensation than other Civil Servants.

  • Dread Pirate Roberts||

    I lived in California for 20 years. It's being reconfirmed pretty much daily that getting out of that state is one of the better decisions I've made.

  • Africanis||

    As Democrats say, they just need to raise taxes on the rich to pay for this. The answer to any problem and if you disagree you want old ladies to eat cat food.

  • Hank Phillips||

    Asset forfeiture numbers for California are getting harder to find. But the state was hit pretty hard by the grasping venality of its own armed ruffians. Nothing detroys an economy quicker than letting the unproductive hands of the Political State rob bank and brokerage accounts and toss people into the street while still burdened with mortgage liability. Majorities tend to get what they deserve in the way of government.

  • buybuydandavis||

    Progressivism is government of, by, and for the government

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