Credit to the Sacramento Bee for a good explanation of PERS funding issues and how we got where we are. In retrospect, the current problem began in 1999 when the legislature and then-Governor Davis created the higher tier pension benefit formulas, with retroactive credits. Although many, many of our members also benefited from the better pension formulas we now know they were not funded properly and probably should not have been retroactive without proper funding. The skeptic in me thinks that those in power, advising the Governor, wanted the better pensions for themselves but the only way to attain that goal was to offer to all. Self interest is a powerful motivator.
California’s largest public pension fund is in its best shape in more than a decade. The California Public Employees’ Retirement System tripled its earnings target amid a stock market boom in the last fiscal year, notching a record-high value of $477 billion.
The retirement system has injected a dose of reality into its forward-looking return assumptions, reconfigured its portfolio to expand higher-returning asset classes and added predictability for local governments, the state and public employees who pay into the system.
But markets have been slipping, and are still reacting to Russia’s invasion of Ukraine. After topping $500 billion in December, CalPERS’ investment fund dropped at the end of February below $477 billion, its value at fiscal year’s end. Inflation keeps rising, and finance experts are awaiting corrective action from central banks.
The uncertainty has renewed questions about when the next slide is coming and how bad it will be for the retirement system, which administers pensions for about 2 million people.
“We might be in the middle of (the downturn) now,” said Lodi city manager Steve Schwabauer. “If this isn’t it, it’s coming.”
CalPERS remains underfunded. As its assets gained value over the last decade, its liabilities climbed faster. As of June, the system estimated it owed current and future retirees an estimated $600 billion.
That leaves CalPERS with 80% of the assets it needs to cover all its long-term obligations. The percentage, a common measure of pension fund health, sits well below its level going into the last two major downturns.
That makes some pension experts uncomfortable. “If you’re underfunded going into a recession, it’s just going to get worse,” said Chuck Reed, who was San Jose’s mayor during the Great Recession.
But the percentage doesn’t tell the whole story. The changes made by the system, state lawmakers and local government leaders have all helped prepare for the next downturn, said CalPERS CEO Marcie Frost.
“Generally I would say the answer is yes, we’re in a much better position to really withstand any kind of significant draw-down than we ever have been before,” Frost said.
The changes have also added risk to the system’s investment fund, and they are straining cities and other local governments that have been shoveling increasing loads of taxpayer money toward pension debt.
Some city managers say the rising payments, which are partly tied to CalPERS’ investment performance from year to year, are at risk of becoming unsustainable.
CALPERS’ FINANCIAL SITUATION The pension fund is in its best shape in years, but remains underfunded. Assets vs. liabilities, as of the June 30 end of the 2020-21 fiscal year:
The Bay Area city of Hayward expects to spend about 20% of its $185 million general fund budget on pensions this year, a figure that has kept going up.
“The taxpayers don’t have money to give, the jurisdiction doesn’t have money to give, and the bill is rising faster than we can do anything about,” said Sara Lamnin, a Hayward City Council member.
HOW CALPERS GOT HERE At the height of the dot-com boom, the system’s assets were worth 137% of its liabilities.
In the late 1990s, things were so good following years of double-digit investment returns that many local governments took pension “holidays,” skipping years of payments to CalPERS.
Public employee unions pressed for a share of the bounty, and in 1999, then-Gov. Gray Davis and the Legislature delivered, enacting retroactive benefit enhancements that ballooned the state’s retirement liabilities.
At the time, CalPERS representatives said the system’s “superfunded” status meant the benefit expansions wouldn’t cost taxpayers anything. Local governments rushed to offer the same benefits as the state, growing the liabilities more.
The bust followed almost immediately. As markets cratered in 2001, CalPERS told city managers and state administrators they would have to pay more for their employees’ pensions. The higher payments meant less money for things like roads, parks and programs.
From 2002 to 2007 the system logged gains, earning enough to reach a funded status of 101% before the Great Recession.
The figure sank to 61% during the recession. Had it dropped below 50%, CalPERS would have been at risk of entering what’s known as a “death spiral,” when it becomes nearly impossible to earn enough on a shrunken pool of investments to cover obligations.
The vast majority of local California governments avoided bankruptcies, but pension liabilities contributed to filings in cities including San Bernardino, Stockton and Vallejo.
From 2009 to 2020, markets went on an average-length bull run, and CalPERS’ funded status ticked upward. Then the coronavirus arrived, plunging markets into the steepest bear market correction on record, followed by the third-fastest recovery in market history. CalPERS grew from 71% funded to July’s figure of 80% in a year.
The unusual cycles left market experts with lots of room to argue about what comes next. But CalPERS’ liabilities are sure to keep going up.
CALPERS’ LIABILITIES CalPERS’ assets have grown and shrunk from year to year while angling upward over the last two decades. But its liabilities have plodded continuously in one direction.
From 2011 through 2020, the retirement system’s investments grew about 44%, according to the system’s latest annual financial report. Its liabilities increased about 69% over the same period.
Some of the growth in liabilities is due to changes in the way CalPERS calculates them. But the debts have also grown due to Davis’ benefit enhancements, longer lifespans and a reduction in the number of active employees paying into the system per retiree.
Before Davis and the Legislature enhanced pensions, a police officer who worked for a local government for 30 years and then retired at age 60 would have received a pension worth 60% of their highest salary. After the changes spurred by SB 400, the same officer can receive 90% at retirement.
Also adding to the long-term costs are increasing lifespans. CalPERS’ retirement formulas allow state and local police officers to retire as early as age 50, depending on when they were hired and how long they’ve worked. Employees in other state and local jobs must reach ages of 55 to 62 to receive maximum retirement benefits.
The lifespan of the average man in the CalPERS system grew from 81.4 to 85 years from 2004 to 2021, according to the system’s experience studies. The average woman’s lifespan increased from 85 to 87.4, according to the studies.
Using a rough average of three more years of life per person, and taking last year’s total pension payments of $27.4 billion, three additional years of payments would cost CalPERS around $82 billion.
Lifespans are projected to keep going up. And as retirement-age Californians make up a larger share of the population, there are fewer public workers per retiree.
According to an analysis by the Public Policy Institute of California, there were two active CalPERS members per retiree in 2001. Now there are about 1.25 active members per retiree, according to CalPERS figures.
EVERYONE PAYS MORE FOR PENSIONS Former Gov. Jerry Brown led the first major changes to the pension system in 2012, when he and the Legislature passed the Public Employees’ Pension Reform Act.
The law required employees hired after Jan. 1, 2013, to pay more for their pensions, eliminated some pension “perks” and made retirement formulas less generous for new hires: Affected employees must work roughly four years longer to earn the same pension at retirement.
The law directs local public employers and their employees to split normal annual pension contributions 50-50. The state has moved toward a similar split with state workers.
Most public employees contribute from 5% to 15.5% of their pay toward their pensions, depending on job classification and the benefits they receive at retirement (police and California Highway Patrol officers pay the most). Their employers pay roughly the same amount, plus a separate payment toward the system’s long-term debts.
The law is expected to save $28 billion to $38 billion over 30 years. By last June, about 49% of public employees in California were subject to the lower level of benefits, according to the latest figures from CalPERS.
After Brown signed the law, known as PEPRA, CalPERS took additional steps aimed at improving long-term sustainability.
The system shortened the period over which it measures its debts, to 20 years from 30, and it reduced its annual investment earnings target from 7.5% to 7%. The changes raised pension costs for the state and local governments — and public employees — but it made the payments more predictable and put the system on a path to full funding.
The system also diversified its holdings and adopted a defensive posture in its portfolio, said Frost, the CEO.
As a result, CalPERS didn’t perform as well as other pension funds last year, earning 21.3% compared to an average of 25.7% for state pension funds, Frost said. But CalPERS also didn’t perform as poorly as most other state-level pension funds in the fiscal year affected by the pandemic, when it logged a 4.7% return.
“The decision and the trade-off we made was we will be willing to shave off a bit of performance on the top of the market,” Frost said.
The board also adopted a new policy aimed at reducing risk. After years of especially good returns, the policy requires CalPERS to shift some of its holdings into safer investments and automatically reduce its forward-looking investment return target.
The policy was triggered for the first time last year, reducing the system’s earnings target to 6.8% from 7%.
The target is still higher than what consultants told the board last year is realistic: 6.2%.
CALIFORNIA CITIES STRUGGLE When CalPERS misses its investment return target, cities have to pay more to make up for the shortfall. A lower target means less risk, but higher upfront costs.
The reduction to 6.8% will increase the upfront costs. That feels unfair to some city managers.
The reduction to 6.8% will increase the upfront costs. That feels unfair to some city managers.
The City of Sacramento’s pension bills have been going up. For the 2021-2022 fiscal year, the city is paying about $118.3 million: $48.2 million in “normal cost” obligations and $70.1 million toward the long-term debt. Pensions consumed about 17% of the city’s $682 million general fund and Measure U sales tax budgets for the year.
“It’s a heavy lift, for a city, when you’re taking up that much of your budgets to pay for pensions,” said Sacramento Assistant City Manager Leyne Milstein. “On the other hand it’s an obligation and a commitment that we made to our employees.”
More and more, taxpayers are hesitating to approve tax increases they suspect are going toward pension debts, said Lamnin, the Hayward City Council member.
“The more we go to people for tax increases, the more the conversation comes up about, ‘is this paying for new programs or other programs, or unfunded liabilities?’” Lamnin said.
She said CalPERS should initiate conversations about benefit reductions — an intensely controversial topic that faces legal headwinds in California.
The state of California and some cities have been paying extra toward their pension debts to better position themselves for a downturn.
The state has paid an extra $12.7 billion over the last four years into CalPERS and the California State Teachers’ Retirement System. The extra payments come on top of an annual pension bill that for the year ahead is projected to be $8.4 billion.
Among the city-level savers is Lodi. With an annual budget of about $67 million, the city is paying about $16 million this year toward its employees’ pensions and pension debts.
On top of that, Lodi pays extra to CalPERS toward its long-term debts, which saves money over time, and it has put aside about $20 million in a pension-dedicated fund run by a private company called Public Agency Retirement Service, said Schwabauer, the city’s manager.
“We in the city have put a great deal of money over and above the pension bill into our pension fund, because I truly believe the public employees deserve their pension,” Schwabauer said.
Frost acknowledged the struggles.
“We’re trying to get this pension plan back to full funding,” she said. “And once we’re back to fully funded, a lot of other options are on the table. But it’s going to be bumpy. The next 10 to 12 years are going to be bumpy.”