CalSTRS’ funding gap widens

The CalSTRS board last week adopted a lower earnings forecast, making it more likely that a century-old tradition of underfunding at one of the nation’s oldest public pension funds is likely to continue.

Closing a wider funding gap, the result of expecting less money from future investment earning, would require nearly doubling the current annual payments to CalSTRS if the goal is to reach full funding in the usual 30 years.

But a half dozen ways to increase CalSTRS funding shown to the board last week seem to suggest that reaching full funding in three decades is now impractical, if not politically impossible.

Only one of the scenarios would get CalSTRS to 100 percent funding — but not until 2085. The other five scenarios never get the California State Teachers Retirement System to full funding, ranging from 32 to 14 percent funding after 75 years.

“They don’t necessarily result in full funding,” Ed Derman, CalSTRS deputy chief executive, told the board. “But we wanted to sort of test the ability of those approaches to allow us to pay benefits for at least the next 75 years, without having a massive infusion of money from a source because we run out of assets.”

The notion that full funding is not the target differs from the current rules of the Governmental Accounting Standards Board, which expect pension debt or “unfunded liability” to be paid off in 30 years.

The small change in the earnings forecast, from 7.75 to 7.5 percent, adds an estimated $500 million to the additional $4 billion a year already said to be needed for CalSTRS to be fully funded in 30 years.

The new funding gap, $4.5 billion, moves closer to equaling the total $5.3 billion currently being paid into the CalSTRS pension fund from all sources: teachers $2.4 billion, employers $2.3 billion and state $600 million.

As contributions flowing into the CalSTRS pension showed little change last year (the rates are set by legislation), pension payments going out to retirees increased to $10.1 billion, up 7.8 percent.

What makes CalSTRS unusual is not a low funding level, about 70 percent of assets needed for future obligations. Most pension funds, hammered by recession and a market crash, had big losses in investments expected to pay two-thirds of future pensions.

The CalSTRS fund, said to be nearing $150 billion last week, is still well below its peak of about $180 billion in the fall of 2007. The California Public Employees Retirement System was at $234 billion, below its 2007 peak of $260 billion.

Unlike CalPERS and other pension funds, CalSTRS lacks the power to set annual contributions paid by employers, needing legislation instead. The state general fund that provides most school funding continues a decade-long struggle to close huge deficits.

Some of the competing tax initiatives aimed at the November ballot are intended to reverse a decline in per-pupil spending in schools, not cover a gap in assets needed to pay teacher pensions decades from now.

The funding scenarios prepared by CalSTRS staff and actuaries, after talks with legislative staff and teacher unions, would not begin slowly phasing in a funding increase until 2016, when the state budget is presumably healthier.

Derman said the easy-to-change scenarios are a “framework” for discussion. They were requested by a legislative committee considering, among other things, Gov. Brown’s 12-point pension reform plan, which did not include the CalSTRS unfunded liability.

In addition to needing more money from a state budget awash in red ink, CalSTRS also faces limitations from teachers, who currently contribute 8 percent of their pay to the pension fund.

CalSTRS regards the teacher contribution as a vested right, protected under contract law by court decisions, that can only be increased if teachers are given a new benefit of equal value.

The maximum increase for current teachers in the scenarios is 2 percent of pay, bringing the total to 10 percent. The increase would be offset by guaranteeing a 2 percent annual cost-of-living adjustment, now routine but not required under current law.

The scenario projected to reach 100 percent funding in 2085 assumes that new teachers, not vested like current teachers, would eventually contribute 14.2 percent of pay.

Since CalSTRS members do not receive Social Security, the contributions of the new members would be similar to the contributions of most state workers in CalPERS: 8 percent of pay to pensions and 6.2 percent to Social Security.

The powerful California Teachers Association reportedly dislikes “two-tier” pension systems where members, working side by side, would be paying sharply different amounts to receive the same pension benefit.

A little more than a year ago, the CalSTRS board agreed with the go-slow recommendation of the CTA and two other unions, lowering the earnings forecast in December 2010 from 8 to 7.75 percent, not 7.5 percent as recommended by actuaries.

The forecast had last been lowered in 1995, dropping from 8 to 8.5 percent. The unions said a lower forecast could reduce member benefits, apparently referring to the cost of purchasing annuities, service credits and other impacts listed in a staff report.

Last week the only opposition to lowering the forecast to 7.5 percent came from a board member, Pedro Reyes, a representative of the Brown administration’s Department of Finance that must propose balanced state budgets.

The CalPERS board, despite a recommendation of 7.5 percent from actuaries, decided last March to leave its forecast at 7.75 percent. Because of its rate-setting power, a lower CalPERS forecast could increase employer costs.

Some experts think even a 7.5 percent earning forecast is too optimistic. One of two new Brown appointees on the 12-member CalSTRS board, Paul Rosensteil, said the actuary report seems to make the case for a forecast of 5.8 to 7.3 percent.

Nick Collier, a Milliman consulting actuary, told Rosenstiel it was a “tough call and it‘s one we definitely battled.” He said the actuaries thought about recommending an earning forecast of 7.25 percent.

“If we set it as a conservative assumption and then you go to the Legislature and ask for money,” said Collier, “they say, ‘You’re telling us this number based on an assumption you yourself said is conservative.’”

In the 1970s the CalSTRS funding level was about 30 percent. A decades-long stock market boom and legislation increasing state contributions resulted in CalSTRS briefly reaching 100 percent funding around 2000.

Then CalSTRS joined CalPERS and UC Retirement in what public pensions tend to do when reaching full funding — lower contributions and increase pension benefits, making future funding problems more likely. (See “State pension funds: what went wrong,” Calpensions 10 Jan 11)

When CalSTRS was formed in 1913, teachers were given retirement credit for past years of service. But no contributions were required from employers or employees to pay for the prior service.

“This caused the retirement plan to have an unfunded obligation from the beginning,” said a CalSTRS Overview published last year.

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Ed’s Note: Reporter 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/