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State's pension liability tops $500 billion, Stanford study finds

In post-recession, post-stimulus-program America, we’ve gotten used to some frighteningly big numbers being thrown around in the discussion of public finance.

Nevertheless, it was difficult not to be alarmed at the bottom line in a study of California's pension obligations conducted by Stanford graduate students and touted Monday by Gov. Arnold Schwarzenegger.

Joe NationCampaign photo from FlickrJoe Nation

The study concluded that the state’s unfunded pension liability has topped half a trillion dollars – six times the present state budget.

Put another way, future California taxpayers are going to be on the hook for more than $500 billion simply to make up the difference between the pensions we’ve promised to today's state workers and the money we’ve invested to pay for them.

That’s tax money that will have to be shelled out before a nickel is spent on the public services of the future.

The study was the work of the Stanford Institute for Economic Research. It was supervised by former Assembly Democrat Joe Nation, who represented Marin and Sonoma counties from 2000 to 2006 and who has run unsuccessfully for Congress and, most recently, the state Senate.

Today, Nation is a public policy instructor at Stanford.

The research project sought to put a realistic dollar figure on the state’s pension liability, which ballooned during the market turndown that drove the recession.

The study contends that the California Public Employees' Retirement System, California State Teachers' Retirement System and the University of California retirement system are understating the burden facing future taxpayers. That’s because the rules by which they calculate pension liabilities are unreasonably optimistic, the study says.

When using a more realistic set of assumptions about the size of the state’s obligations and the return the pension funds are likely to get on their investments, the study comes up with a grim fiscal scenario.
As of July, 2008 – before the worst part of the stock market slump – the state’s pension funds were reporting an unfunded liability of $55.4 billion.

Actually, the study contends, the funds already were running in the red by about $425 billion.

Tack on the $109.7 billion that the California funds reportedly lost when the market carnage was at its worst, and “we estimate the current shortfall at more than half a trillion dollars,” the students write.

To recover their fiscal health, the state pension funds need to be more consistent and prudent in making per-employee contributions, the study claims. That means putting in even more money.

The funds also must seek out less volatile investments, the study urges. Finally, it recommends cutting benefits for future state workers – and converting from a fixed-benefit plan to a hybrid-style pension system that is partly a 401(k)-style investment account.

CalPERS didn’t respond to a request for comment. UPDATE: Response below.

The governor has been trying for months to get the Legislature to bear down on what he calls “our staggering pension debt.” It’s an extraordinarily difficult political problem, made worse by the budget crisis and by the disagreement over just how bad the pension problem really is. Still, it’s an issue he says he wants to address before leaving office.

CalPERS issued the following fact sheet as its response to Nation:

Stanford’s Institute for Economic Policy Research released a policy brief “Going For Broke: Reforming California’s Public Employee Pension Systems” that relies on outdated data and methodologies out of sync with governmental accounting rules and actuarial standards of practice.   The report fails to take the following into account:
Investments

    * Over the past 20 years, we have earned an average annual investment return of 7.9 percent – which includes the past two years when we suffered significant investment losses due to the Great Recession.  Thus, our assumptions, from actual experience, have proven valid.    

    * The study relies on data when the system had $45 billion less in assets than it has today. CalPERS assets are valued at $260 billion – a gain of more than $45 billion since the market downturn.

    * Additionally, its findings are based on a mathematical model that uses current interest rates, which are very low and make liabilities appear to be much higher.  That method is inconsistent with the Governmental Accounting Standards Board and current actuarial standards.

    * The study recommendations are based on bond returns over the past 25 years of 7.25 percent for investment grade corporate bonds, which are only 0.66 percent lower than CalPERS total return of 7.91 percent but with much lower volatility. CalPERS experts believe that this reasoning is flawed. Prospective returns on bonds are much lower today since yields are at an historic low and the return to bonds will equal the current yield to maturity which is around 4 percent for most broad band indeces. Also bonds could be more volatile than the past if economic conditions are more uncertain as in the recent period.

    * CalPERS is taking steps to modify its asset allocation approach and better allocate assets according to their macro risks and fundamental characteristics. This could result in addressing inflation and interest rates as macro risks.

    * It ignores our diversified investment portfolio that has been time-tested during our 78 year history.  If CalPERS had followed the recommended approach in the study, we would have given up billions of investment earnings, that have helped finance pensions rather than tax dollars.

    * The study misstated some of the benefit formulas in Table 3 and seems to suggest that CalPERS violate the California Constitution by using surpluses to "reduce state debt". Pension raids were determined to be unlawful during the Wilson Administration.

    * To adhere to some of the changes suggested in the report, CalPERS would be violating actuarial standards of practice and undo 50 years of governmental accounting rules in favor of an approach that would be "zero" risk.

    * Funded status should not be viewed as a long-term irreversible trend. A pension fund’s funded status – whether a liability or surplus – is constantly changing, depending on current economic circumstances.  It is a snapshot in time that can change dramatically over a fairly short period of time due to the health of the overall economy. Funded status snapshots are useful in showing how far or how near one is to full funding. Experts agree that a funded status of 80 percent is the mark of a very healthy plan. CalPERS notes that the Stanford Report acknowledges that using the data selected, CalPERS was more than 80 percent funded. 

    * Benefit formulas are not set by CalPERS. They are determined through the collective bargaining process, between the employer and the employee representatives. CalPERS recently held the California Retirement Dialogue, and information on the various viewpoints on benefit formulas is available on the pension fund’s Web site CalPERS Responds.com

FUTURE STEPS

    * CalPERS regularly evaluates its assumed rate of return every three years. At our May investment committee meeting, the Board will hold a workshop on capital market assumptions, finalize those assumptions in September, hold an asset-liability workshop in November, and take final action on an asset mix in December. In February, the Board will take the final step in the process by setting the actuarial assumed rate of return/discount rate. These meetings are open to the public and CalPERS is committed to obtaining all viewpoints on these issues.  We invite the authors of the study to participate in the discussions. For more information, go to CalPERS Responds and click on pension financing.
 

 

Tags: budget, pensions

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dukedog53's picture
Does anyone have similar information for New York?
heng2bai's picture
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