State residents could face higher taxes or reduced government services because more than $41 billion of investment losses this year have left the California Public Employees’ Retirement System at nearly the same precarious funding level reached during the Great Recession.
During the last economic downturn, assets of the nation’s largest pension system dropped over two years from 101% of what was needed to pay government workers’ retirement benefits to 61%.
This year, CalPERS was in much worse shape going into the recent downturn. Consequently, after just one month of coronavirus-induced stock market plunge, CalPERS must try to crawl out of another deep hole.
If the market doesn’t radically rebound by June 30, look for the pension system to turn to already-strapped local governments and their taxpayers to cover the shortfall over the next 20 years. Once again, we’re passing current pension costs onto a future generation.
Before the latest downturn, many local government agencies were already facing roughly a doubling of annual pension contributions over an eight-year period from 2018 to 2026, in large part to make up for past investment losses. Now it could be much worse.
The sudden economic downturn also places CalPERS uncomfortably close to the point of a financial death spiral, in which it lacks enough assets to invest. And it exposes the failure of the pension system’s board members during the past decade to fix structural problems.
California government workers are promised overly generous pensions. And public pension systems like CalPERS fail to require adequate funding, instead trying to buffer local governments from the true cost by relying on unrealistic forecasts of investment returns.
When those forecasts don’t pan out, local governments and the state must make up the difference. In the Bay Area, CalPERS provides pensions for employees of Santa Clara County and most cities except San Jose and San Francisco.
CalPERS actuaries bake in a rosy assumption that the system can earn 7% annual investment returns. For the current fiscal year, they’ve instead lost about 5%, as of Thursday. In other words, they’re 12 percentage points off their optimistic annual target.
CalPERS treats such a shortfall as long-term debt rather than recouping it quickly. Which helps explain why, even though the Great Recession ended more than a decade earlier, CalPERS had only 73% of the funds it should have had at the end of 2019, leaving it poorly positioned for the financial wallop it’s now experiencing.
As of the end of the day Thursday, even after four days of recovery that included a record single-day gain, CalPERS was only about 63% funded. That presents two major concerns.
First, if the funding level falls below 50%, the pension system would have little chance of recovering. That’s because a system that depends on investment returns for survival needs money to invest. And it must simultaneously pay out $24 billion a year in benefits to retirees.
Hence, the dreaded death spiral that CalPERS and other pension system administrators fear. The only thing that saved CalPERS from devastation during the Great Recession was entering the downturn fully funded, at 101% of needed assets. Otherwise, it would have never survived the ensuring 40-point drop.
That same drop would wipe out CalPERS today.
Second, CalPERS officials have no good options for shoring up the fund. They should tamp down the overly optimistic investment predictions, but that would mean asking already-strapped local governments to put even more money into the system.
State lawmakers could also stop digging the hole deeper by reducing the cost of benefits. Unfortunately, the state Supreme Court, with its so-called California Rule, has made that nearly impossible. Unlike in the private sector, once California public employees start work, the rate and the terms under which they accrue pension benefits cannot be reduced.
Specifically, benefits workers have already earned cannot be reduced, which is only fair. But the rate at which workers earn benefits for future labor is also locked in, which is ridiculous. The Supreme Court is currently reviewing the California Rule. Let’s hope they restore some sanity.
Meanwhile, without a strong recovery by June 30, CalPERS will have to recover the fiscal year’s losses. GovInvest, an actuarial forecasting firm, estimates that would require increasing local government pension contributions by 2026 by about an additional 25% — on top of the current doubling.
Once again, we see that California’s public employee pension system is unsustainable. Maybe someday, before it’s too late, we’ll fix it.
