A new study of the 100 largest U.S. public pension funds shows CalSTRS reports a below-average funding level and the CalPERS funding level is a wobbler — higher than average if its assets are radically “smoothed,” much lower if assets are at market value.
Though notoriously difficult to measure, debt is a key issue in the national debate over whether pensions are “unsustainable” and need cost-cutting reforms to avoid eating up state and local government budgets and, in the worst cases, seeking a federal bailout.
The study issued last week by an actuarial firm, Milliman, concluded that the largest pension funds are not, as critics have charged, using overly optimistic earnings forecasts and other methods to hide massive debt.
Milliman said the funds report a combined long-term debt or “unfunded liability” of $895 billion and a funding level of 75.1 percent, not significantly different from a Milliman review that found $1.2 trillion in debt and a funding level of 67.8 percent.
“On the whole we conclude there are only a small number of plans whose interest rate assumptions are causing a sizeable underreporting of liability relative to what would be calculated based on current forecasts of future investment returns,” said the Milliman report by Rebecca Seilman.
“In fact, there are a surprising number of plans whose interest rate assumptions and accrued liability reporting are conservative in light of current forecasts,” said the report.
The California Public Employees Retirement System and the California State Teachers Retirement System have lowered their earnings forecasts to 7.5 percent, below the 8 percent used by most funds and the 7.65 percent derived by Milliman in its study.
The study lists a surprising funding level for CalPERS, 83.4 percent of assets needed to meet 30-year pension obligations. CalPERS publicly has been saying its funding level is around 70 percent, up from about 60 percent after the market crash.
The difference between the two funding levels: CalPERS emphasizes funding based on the market value of assets. The Milliman study lists the CalPERS funding level based on actuarial “smoothing.”
Smoothing spreads investment gains and losses over several years to avoid big year-to-year changes in employer contribution rates. CalPERS uses a 15-year smoothing period, well beyond the 3 to 5 years used by most pension funds.
The Milliman study lists the funding level based on the actuarially smoothed value of assets reported in the CalPERS Comprehensive Annual Financial Report last year.
The CalPERS report (see chart at bottom of this post) shows a big gap between the actuarial value funding level, 83.4 percent, and the market value funding level, 65.4 percent.
The market value of CalPERS assets was $201.6 billion. The actuarial value was much larger, $257.1 billion, because the impact of big losses in the 2008 stock market crash was offset by big gains during the 15-year smoothing period.
In sharp contrast, CalSTRS, with a three-year smoothing period, had a small gap last year between the funding levels based on the actuarial value of assets, 69.1 percent, and the market value, 67.2 percent.
A 15-year smoothing period was adopted by CalPERS in 2005, when former Gov. Arnold Schwarzenegger briefly advocated a statewide switch of new hires from pensions to 401(k)-style investment plans.
CalPERS was under fire for telling legislators a major state worker pension increase, SB 400 in 1999, would not cost taxpayers more money. Annual state CalPERS payments had soared from about $50 million to $2.5 billion in five years.
The lengthy smoothing period was intended to reduce the temptation to give employers a contribution “holiday” in good economic times (the state CalPERS contribution had been $1.2 billion prior to 1999) and avoid soaring rates in bad times.
CalPERS took another unusual step to keep rates low. After the investment fund had a 24 percent loss during the 2008 stock market crash, the cost of the loss was isolated from the rest of the fund to be paid off with a rate increase phased in over three years.
Now the market value funding level of CalPERS, roughly 70 percent, is similar to the 67 percent market value funding reported last year by CalSTRS, which is said to be seriously underfunded and has been seeking a contribution increase for five years.
So, here’s the question:
Have the smoothing policies chosen by CalPERS, which has the power to set employer contribution rates, allowed it to slide into the same financial difficulty as the powerless CalSTRS, which needs legislation to set contribution rates?
The answer from the CalPERS chief actuary, Alan Milligan, is that CalPERS can raise employer contributions when needed to keep its funding level moving up, but CalSTRS needs legislation for a rate increase to correct a falling funding level.
“It’s the contribution level, not the funding level,” Milligan said last week. “That’s the issue for STRS. In terms of funding status, it’s not that bad — yet.”
As for CalPERS, Milligan said: “If the market doesn’t recover and give us back some of the ‘08-9’ losses we still have, we are going to keep raising employer contribution rates and eventually we will start cutting away at that unfunded liability.”
A problem for CalSTRS has been a legislative view that a recovering market will solve its problem. A resolution this year, SCR 105, asks CalSTRS to consult with stakeholders and submit three options for closing a 30-year funding gap, $64.5 billion.
In the debate over pensions, the debt or unfunded liability is sometimes viewed as a mortgage or bond with a fixed amount that must be paid over time. But pension debt has big variables, making the amount changeable and in some ways illusory.
Smoothing can change the funding level and the debt amount. The debt calculation is based on reaching 100 percent funding, desirable but seldom obtained. And investment earnings, expected to provide most of the pension revenue, are unpredictable.
For example, CalSTRS actuaries said last April the total contribution to the pension system, 19.4 percent of pay, would have to increase an additional 12.9 percent of pay (about $3.25 billion) to fully fund pensions promised over the next three decades.
That assumes investments will earn 7.5 percent. Without a contribution increase, the actuaries estimated, full funding could be reached if earnings average 9.6 percent for 30 years or, even more unlikely but not impossible, 16 percent for five years.
Beginning in 2014, new Governmental Accounting Standards Boardrules make several changes in pension reporting. A lower earnings forecast will be used to report debt not covered by projected assets, which may have limited impact in California.
Pension funds currently are more concerned about a proposal byMoody’s, a bond rating service, to report public pension debt using an earnings forecast based on corporate bonds, 5.5 percent, which would triple the national total to $2.2 trillion.
CalPERS has joined about 50 other pension systems in urging Moody’s to take another look at the proposal issued last July to give investors a better way to compare pension funding.
“We are hopeful the significant responses that they have received will cause them to rethink at least some of what they are suggesting,” the CalPERS federal lobbyist, Tom Lussier, told the board last week.
Ed's Note: Ed Mendel covered the Capitol in Sacramento for nearly three decades, most recently for the San Diego Union-Tribune. More stories are at http://calpensions.com/