CalPERS is at it again.
Leaders at the nation’s largest pension plan, brimming with joy over recent strong investment gains, are choosing riskier bets on future returns rather than shoring up the underfunded system with more contributions from government employers and employees.
It’s not the first time. The retirement plan’s propensity for risk-taking left it badly exposed during the Great Recession. Assets of the California Public Employees’ Retirement System dropped over two years from 101% of what was needed to pay government workers’ retirement benefits to 61%.
That’s because, more than a decade after the Great Recession, and despite an exceptionally strong market this past year, CalPERS has only crawled halfway back to the fully funded target, and much of that gain has been in the past year. The pension system still has only 80% of the funds it should have on hand. It’s still roughly $120 billion short.
Californians are the losers when the pension system’s bets don’t pan out. Under CalPERS’ complex accounting, government agencies, not employees, must make up the shortfall through higher taxes or reduced services.
The solution is simple but politically difficult. To shore up the funding, the retirement system should require employers and employees to pour more money in. But labor unions and many local government managers resist, preferring instead to kick the proverbial can down the road.
And the CalPERS board, dominated by labor representatives and elected officials beholden to labor, continues to enable this risky behavior. They did it again earlier this month when the board set its investment return target.
It’s a highly technical process that the board undertakes every four years. But the consequences are profound for public employees, state and local government agencies, and taxpayers. In the Bay Area, CalPERS provides pensions for employees of Santa Clara County and most cities except San Jose and San Francisco.
The less money the retirement system anticipates receiving from investment returns, the more it must seek from employers and sometimes workers to ensure the system is financially solid. But the more the system seeks from public agencies, the less money is available for employee raises and other government operations.
So, there’s tremendous political pressure to keep employer and employee contribution rates low by keeping the investment return projections artificially high. But when those investments don’t pan out, the shortfall is essentially turned into a long-term debt that current and future generations of taxpayers must cover.
The employees don’t bear that burden. Instead, our children and grandchildren are left to pay part of the labor costs for public services we enjoy today.
This time, as the board started to set its investment return target, CalPERS policies tied to last year’s strong market performance automatically reduced the previous target from 7% set four years ago to 6.8%.
But board members were told that, under current expert projections, their current portfolio could only attain a 6.2% annual investment return over the next 20 years. If they wanted to reach the 6.8% target, they would have to shift investments and take on more risk. That’s because greater returns generally come with more risk of bigger losses.
Or, board members were told, they could lower the target to 6.5%, keep the risk lower and ask public employers and employees to kick in more money. The board rejected that, opting for the riskier option instead.
Just how risky? To put it in perspective, consider the chance that investment losses could plunge the system assets below 50% of what they should have on hand to cover the cost of pension benefits that had already been earned.
Fifty percent is considered a key, but somewhat arbitrary, benchmark. As the old saying goes, it takes money to make money. Or, put another way, a system that depends on investment returns for survival needs money to invest.
Without sufficient funds, the system risks a financial death spiral. Actuarial experts say that if a pension system slips below the 50% threshold, it’s very difficult to climb back out.
In CalPERS’ case, the board was told that if it chose the 6.8% investment target there was a 20% chance that pension funds for most local governments would drop below the 50% threshold during the next 30 years. But if it chose the 6.5% target, the risk of hitting that potential death spiral was reduced to 15%, but the contribution rates for local governments would be higher.
CalPERS board members chose the financially riskier option rather than asking workers and employers to pay a more appropriate share of the cost. They chose to gamble with your money.