Managers of some of Californian’s biggest public employee pension funds will face difficult decisions this year to shore up chronically underfunded pension systems. By anyone’s account both CalPERS and CalSTRS are significantly underfunded. That means that the pension systems do not have sufficient money, even assuming a set investment return rate, to pay the pension benefits to its workers that have already earned. Today, even after the stock market has regained all of its losses since 2007, CalPERS is only funded at approximately 71%. And numbers for CalSTRS are even worse. CalPERS chief Actuary Alan Milligan is concerned enough that he warned CalPERS that it faces “a significant possibility” of serious future funding short-falls and a high probability of large single year rate increases during a turbulent economy. To fix the problem, Milligan recommended various accounting changes to help prop up CalPERS funding.
So why are Pension Fund Managers and Chief Actuaries concerned? Well this is where the tough decisions come into play that, as you will see, can be highly politically. The Actuaries argument is that it is very important for a pension system to be funded as close to 100% as possible so that the pension system is able to meet the obligations it’s promised especially to its existing retirees. Remember, those pension payments increase over the course of time with mandatory cost of living increases. In addition, most pension benefits have a survivor benefit such that the pension system continues to pay until both the retiree and his or her spouse are deceased. With life expectancy soaring, most Actuaries recognize that this longevity puts a significant additional pressure on the pension system. But more importantly, some Actuaries argue that once a pension system becomes chronically underfunded (approximately below 50%) the pension system is doomed for insolvency because it cannot raise enough money fast enough to avoid default.
Pension Managers worry because they have a fiduciary duty to retirees and if their management of a system results in a default it would clearly be a breach of that fiduciary duty and may result in individual criminal and civil liability to the Managers themselves. So the Pension Managers are inclined to listen to the advice of their chief Actuaries very closely.
On April 16th CalPERS approved new policies designed to improve its funding percentage which will require state and local governments to pay billions more over the next few years. The policy change would require CalPERS to spread its gains and losses over 5 years instead of its current 15 – year “smoothing”. In addition, CalPERS will calculate its obligations on a fixed 30 – year payoff schedule. For the last several years CalPERS has rolled those liabilities forward instead of setting a date to pay them off. This new accounting method will force CalPERS to send much bigger bills to the State of California, local governments and school districts in the system. There are approximately 2,200 government entities that belong to CalPERS.
In most cases, the State as well as Cities, Counties and Districts will have a very difficult time paying the increase pension costs. Most Cities, Counties and Districts are still suffering greatly from the effects of the recession and do not have it in their existing budgets to pay significant additional pension costs. In many cases they will not be able to pass much, if any, of those additional costs along to the employees.
For their part, the public employees unions have initially reacted in a contradictory fashion. Some have argued against aggressive funding of the pensions systems and, therefore, the additional costs to the government agency because it will be harder for them to get wage and benefit increases in coming years. Others have reacted that protecting the pension system is an absolute priority above all else. And then many, as well as the government entities, have immediately looked at passing these new costs somehow along to the tax payer. Yes the beleaguered tax payer, who has already endured 2 tax increases in less than 6 months on both the state and federal level.
So the question really boils down to a simple but very difficult one: do the pension systems implement policies short term pain or do they worry about stability later?