CalPERS must stop sticking taxpayers with pension debt

To shore up rapidly deteriorating finances, CalPERS will consider significantly reducing its investment forecast in a long-overdue move that could shake up government retirement funds across the country.

The reduction would mean that local governments and the state would be required to contribute more to the California Public Employees' Retirement System, the nation's largest pension plan.

Public employee unions object because that would leave government agencies with less money for salaries and benefits. But the move would slow the soaring growth in pension debt for which California taxpayers are liable.

“This is the most important issue facing this system today and for the foreseeable future,” said Richard Gillihan, a CalPERS board member and director of the state Department of Human Resources.

“If you care about this system, if you're concerned about the payment of benefits to members, the most important thing we can do is shore up the funding. And we can't wait to do that. It's pay now or pay more later.”

CalPERS currently assumes that its investments will earn 7.5 percent annually. But its consultant warns that it should anticipate only an average 6.2 percent in each of the next 10 years.

This week, CalPERS staff will issue its recommendation on how far to reduce the investment assumption. They won't suggest a one-step drop to 6.2 percent because the corresponding increase in contributions would financially devastate state and local governments.

But some expect a recommendation of around 7 percent annually. If the board agrees, that would set a new national benchmark.

“The signal that sends to other pension systems around the country is they need to follow the same steps,” says former state Assemblyman Joe Nation, a pension expert and public policy professor at Stanford.

Last year, the forecasts of the top 25 state pension systems averaged 7.64 percent, according to Nation's data. Only one state system, Virginia, used a 7 percent forecast.

CalPERS has consistently undercollected from government workers and employers, instead counting on overly optimistic investment forecasts to help fund retirees' pensions.

That's in large part why CalPERS has only 68 percent of the assets it should have. CalPERS' paltry 0.61 percent investment return last fiscal year left the system with a record $139 billion shortfall. That's $46 billion more than just two years ago.

Meanwhile, the pension system's investment consultant this year radically adjusted its projections of future earnings, dropping its forecast from 7.1 percent annually to 6.4 percent and then to 6.2.

CalPERS' investment officer, financial officer, actuary and consultants all warn that the system must stop using the rosy 7.5 percent prediction and instead seek more money from workers and employers.

Unfortunately, the 13-member board, dominated by labor interests and public officials politically dependent on unions, routinely overrides its professional staff.

In 2011, the board kept the assumed return rate at 7.75 percent, ignoring its actuary's recommendation to lower it. In 2012, facing a recommendation of 7.25 percent, the board lowered the rate to only 7.5 percent.

Many academics argue that even 7 percent is way too high. They say that public pension systems should stop assuming they can make a killing in the stock market and instead rely on more-secure bond investments.

That's sage advice, especially as most pension systems are “maturing.” With a larger percentage of members retired, the systems are more vulnerable to significant investment losses.

Moreover, most still suffer financial hangovers from the Great Recession. The only thing that saved CalPERS during the downturn was that it was fully funded in 2007.

Within two years its funded ratio plummeted to 61 percent. Now, seven years later, CalPERS has only partially recovered. A similar major economic downturn today would cripple the system.

Despite overwhelming evidence that CalPERS must invest more conservatively, lower its return forecast and ask employers for larger contributions, the board remains divided.

Most employee representatives argue to maintain the status quo while Gov. Jerry Brown's appointees advocate for lowering the investment assumption.

The swing votes include state Controller Betty Yee and Treasurer John Chiang, who plans to run for governor in 2018. They both rely on union campaign backing.

We'll soon find out if politics once again trumps fiscal responsibility.

Daniel Borenstein is a columnist for the East Bay Times.