State on the hook for $200 million boost to CalPERS

Annual state pension payments to CalPERS are expected to increase $200 million to a total of $4 billion in July. But the rate may go higher as the powerful pension board takes a new look at its risks and policies.

The nation’s largest public pension fund last week gave a joint legislative committee an update on its funding status and plans for the future, as required by recent legislation.

“For the year 2012-13 our state contribution rate was $3.8 billion,” Anne Stausboll, CalPERS chief executive officer, told legislators. “That is projected to be $4 billion in the coming fiscal year. That rate will be finalized in May, and we have a very open process leading up to that.”

The giant pension fund covers 1,576 local governments and non-teaching employees in 1,488 school districts, but the annual payment for state workers draws the most attention.

When former Gov. Arnold Schwarzenegger briefly backed a proposal to switch new state and local government hires to 401(k)-style plans, he cited soaring state worker pension costs.

CalPERS dropped the state rate from $1.2 billion in 1997-98 to less than $160 million in 1999-00 and 2000-01. A booming market yielded a brief surplus, and CalPERS spread the wealth by sponsoring a major state worker pension increase, SB 400 in 1999.

But the market fell and the surplus vanished, causing CalPERS to push the taxpayer-paid state rate to $2.5 billion in 2004-05. Schwarzenegger cited skyrocketing pension costs as he urged a switch to debt-free individual investment plans.

Then a recession and market crash punched a huge hole in CalPERS investments expected to provide two-thirds of pension money. After peaking at $260 billion in 2007, the fund dropped to $160 billion in 2009 and now has climbed back to $255 billion.

The state payment to CalPERS jumped from $2.7 billion in 2007 to the current $3.8 billion. But this 40 percent increase over five years is far short of the eye-popping “2,000 percent” increase over five years cited by Schwarzenegger.

This time, employers had not been given a contribution “holiday.” State workers aided by agreeing to increase their pension contributions, though Schwarzenegger had to hold up the budget for 100 days to get a boost from 5 percent of pay to 8 percent for most.

CalPERS adopted actuarial policies aimed at avoiding rate “shock,” a big jump in annual employer costs. And CalPERS did not impose the big rate increase, probably several billion dollars, needed to project 100 percent funding over the next 30 years.

The funding level for state worker plans dropped to 58 percent in 2009 but is now moving in the right direction: 63 percent in 2010 and 70 percent last June. The amount of the shortfall last year, the “unfunded liability,” was $38.5 billion.

How worrisome is that?

A pension unfunded liability is sometimes viewed as if it’s a firm debt that must be paid, much like a bond or a mortgage. But it’s a 30-year projection of the gap between assets and liabilities, which can change a little or a lot and may never be closed.

A big variable is the earnings forecast. Stanford graduate students showed what happens when the earnings forecast of three state pension funds, then 7.75 percent, was lowered to a “risk-free” bond rate, 4 percent. The unfunded liability ballooned tenfold.

Actuaries say the California State Teachers Retirement System, with a $64 billion unfunded liability, would be fully funded if earnings averaged 17 percent for five years and then hit the 7.5 percent earnings target in the long run, unlikely but not impossible.

Other variables: actuarial methods for valuing assets, recording gains and losses and setting the length of time for paying off debt. The unfunded liability is based on full funding over 30 years, but pension funds rarely reach full funding.

When a retirement system reaches full funding, it’s often been regarded as a celebratory occasion for splitting a “surplus,” cutting contributions for employers and giving employees a pension increase.

The negatives of a big unfunded liability: little cushion if another deep recession wipes out a quarter of the investment fund, fewer investment earnings to reduce employer contributions and passing on more debt to future generations.

At the legislative committee last week, the new chairman of the Senate retirement committee, Jim Beall, D-San Jose, asked about the plan for handling the CalPERS unfunded liability, noting that he had worked on one as a county supervisor.

Stausboll said Gov. Brown’s pension reform last year, AB 340, was originally estimated to save CalPERS $40 billion to $55 billion over 30 years. Most of the cuts are for new hires, taking decades to help narrow the funding gap.

“As we think of heading toward 100 percent funded status as our goal, that’s not something that’s going to be happening in a few years,” said Stausboll, who listed three CalPERS priorities.

1) Implementing the pension reform. The staff work includes computer and publication changes. A followup bill, SB 13, will clarify technical issues. With a lot of “stakeholder input,” CalPERS plans to issue regulations this month and in March.

2) State and local government fiscal challenges. CalPERS works with employers on costs and estimates for future budgets. In the Stockton and San Bernardino bankruptcies, the goal is preserving a sound retirement system while hoping the cities stay in CalPERS.

3) Strengthening the retirement fund. Over the next 12 months CalPERS will review actuarial policies, investment allocations and the 7.5 percent earnings forecast to ensure “appropriate risk levels” and be “an honest broker of information.”

As CalPERS develops a better understanding of risk and makes the review, said Stausboll, “it’s possible the employer contributions will go up, and those are the types of things that need to be balanced.”

John Bartel, an independent actuary, gave the committee a report from the California Actuarial Advisory Panel on the status of CalPERS. The panel is still working on policy and practice guidelines for public pensions and retiree health plans.

Bartel said the goal of actuaries is to reach 100 percent funding. But future events are unknowable, he said, so the goal is “a movable target” requiring contribution adjustments. He made a comparison with seeing a rainbow while driving in a car.

“It’s very difficult to find the bottom of that rainbow, no matter where you go,” he said. “You sort of chase after it. That’s the nature of paying the unfunded liability.”

Bartel said the CalPERS “amortization” period for paying pension debt is twice as long as the average worker is expected to remain on the job. He said CalPERS may shorten the amortization, aligning the debt with payments from current taxpayers.

A shorter amortization could lead to higher contributions. Among other factors: a rapidly growing number of state and local government retirees during the last decade, increasing the ratio of retirees to active workers.

“I think what you are going to see is a trend toward increased contribution rates,” Bartel said. “That is exactly the issue I think that CalPERS is looking at in this analysis — what’s the best way to address that.”

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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/