State Pension Meltdown Coming

OCT. 21, 2010

By WAYNE LUSVARDI

The independent Milken Institute has just released a report “Addressing California’s Pension Shortfalls” that has an alarming finding: assuming no corrections are made, the combined liability of the three major state pension funds (Cal-PERS, CalSTRS, and UCRS) will swell to 5.5 times the total state tax revenue by as early as 2012!  The study states that a solution needs to be found quickly and equitably by all parties, including unions, to avert catastrophic cuts in state services.

The three pension funds are the California Public Employees’ Retirement System (CalPERS), the California State Teachers’ Retirement System (CalSTRS) and the University of California Retirement System (UCRS).

The Milken Institute report points out several demographic and accounting factors that will inevitably drive up pension liabilities:

1.   The conventional discount rate used by these pension funds (7.75 percent to 8 percent) artificially makes the amount of liabilities appear smaller.  It is unrealistic in this economic environment to base retirement fund investment returns on around an 8 percent per year when 30-year bonds are hovering a little over 5 percent.  If the lower and more realistic bond discount rate is used the actual magnitude of the pension liability will become more apparent.

2.   Demographic trends suggest there will be an undiminished, and probably increasing, demand for state services and goods. Seniors will grow from 11 percent of the population to 20 percent by 2050. As seniors live longer the number of benefit-receiving years will increase.

3.   The profile of the state workforce is also forecasted to drive up pension liabilities. The working age population will drop from 60 percent to 54 percent over the same period of time, thus shrinking the tax base.

4.   The proportion of school age children will rise slightly but their composition will rely more on public schools, thus making school cutbacks unacceptable.  Prop 98 requires 40 percent of the state general fund be dedicated to public schools.

5.   If action is not taken rapidly raising pension fund contributions for younger state employees will have less effect in lessening the problem.

6.   If nothing is done the combined pension liability for each working age adult in California will rise to $10,000, or about $24,000 per household.  This could trigger a deeper, longer recession.

The Milken Institute study recommends two solutions: (1) raising the retirement age and increasing employee contributions; and (2) shifting to a risk-sharing retirement plan which will lower the guaranteed level of pension.

The authors of the study point out that in October the SEIU agreed to include most of the above provisions, including work furloughs, in their contract covering 132,000 employees. But this only binds 16 percent of the members of CalPERS and only covers the next contract period.  What is needed is a long-term re-restructuring (risk-based pension plan) which would be difficult to pound out by 2012.

Unfunded state pension liabilities as percentage of total state general fund revenue

Year CalPERS CalSTRS UCRS Combined
2009 278% 184% 2.4% 464.4%
2010 279% 185% 6.8% 470.8%
2011 298% 197% 11.4% 506.4%
2012 328% 217% 17.3% 562.3%
2013 320% 212% 19.8% 551.8%
2014 312% 207% 19.9% 538.9%

14 comments

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  1. stevefromsacto
    stevefromsacto 21 October, 2010, 16:05

    It’s a bogus study from a “think tank” fighting to restore the environment that allowed Michael Millken, Bernie Madoff, Ken Lay and others to flourish. So they flatter the right-wing, whose fat cats help fund them.

    Reply this comment
  2. Whinenomore
    Whinenomore 22 October, 2010, 06:50

    So in 2014 the unfunded liabilities will equate to 5.4 years of revenues? That really doesn’t seem out of line for a long-term debt; especially when you have decades to pay it down. Once the stock markets return to normal, this ratio will improve even more as the unfunded amount is diminished and the revenues increase.
    So what’s the big deal?

    Reply this comment
  3. Fake OCO
    Fake OCO 22 October, 2010, 07:56

    So in 2014 the unfunded liabilities will equate to 5.4 years of revenues? That really doesn’t seem out of line for a long-term debt; especially when you have decades to pay it down.
    ==================
    What??

    Calper has $200 billion in assets and $500 billion in liabilities, they are therefor 40% funded, the minimum funding level to be considered SAFE ON LONG TERM DEBT is 80%, 65% is condisered critical/failing.

    Once the stock market improves??? What makes you think it will improve?? And even IF!! it did improve what makes you think that will cure the deficit?????

    Your comment has no basis in reality.

    Funding as a ratio to liabilities is the key, and Calpers is dramatically underfunded and the liabilties are rising exponentially.

    Reply this comment
  4. Burt
    Burt 22 October, 2010, 11:58

    California’s retirement systems are funded at over 80 percent. You just have to look at the annual financial reports, which comply with accounting and finance standards. The More You Know!

    Reply this comment
  5. stevefromsacto
    stevefromsacto 22 October, 2010, 14:07

    Hey, Burt, don’t bother trying to confuse them with the facts. Nothing will change their closed minds.

    Reply this comment
  6. Algernon Moncrief
    Algernon Moncrief 22 October, 2010, 14:44

    NO WORRIES: ADOPT THE SIMPLE COLORADO SOLUTION, CLAW BACK DEFERRED PAY

    Obviously, legislators around the country are not quite as sophisticated as their counterparts in Colorado. It has never occurred to them that they could just pass a bill stating “Oh, by the way, we are no longer bound by our contractual pension obligations.” Simplicity itself! This approach makes life much easier in difficult budgetary times, and takes the burden off of GASB, state and local governments, plan sponsors and the SEC!

    Under the Colorado pension “contract breachin’ plan”. . . . . you simply seize vested, accrued, earned, contracted benefits from retirees and pension members (incredibly, with the help of your local union lobbyists . . . . toss those retired union brothers under the bus) until your unfunded pension liabilities are sufficiently reduced to raise your funded ratio. This plan also improves the status of your bonded debt (keepin’ those SEC fellas happy).

    If you’re as brazen as we are in Colorado you claim that your goal is to achieve a 100 percent funded ratio, instead of the 80 percent level that is considered well-funded in the industry. May as well go for the full 100 percent, no one understands all this pension mumbo jumbo out here in the west.

    The 100 percent goal provides lots of wiggle room for unexpected investment shortfalls, or more convenient under-funding in the future. Also, here’s another ingenious provision that we invented. If it happens that God provides you with a lame pension investment staff, they consistently underperform their benchmarks (I estimate that last year we underperformed by about a billion), and accordingly you have an investment loss for the year, no problemo, just state in the bill you enact that retiree contracted benefits will be further cut to accommodate the loss! My guess is that when pension investment staff around the country hear about this sweet no-accountability gig they are going to beat a path to Colorado PERA. Where can I get that kind of a job? To be fair, credit for finding this solution should go to the bright administrators at Colorado PERA. You can imagine how difficult it is psychologically to advocate a course of action that you yourself have earlier declared illegal, (see this excellent Denver Post article.) http://www.denverpost.com/news/ci_11105271

    We know it’s burdensome for busy pension administrators (particularly short timers) to have to tell elected officials that they really ought to make their annual required contributions . . . it’s much easier to just let those unfunded liabilities build up year after year after year, until you have a good pile, and then wipe the slate clean with a good contract breachin’!

    Our Colorado PERA pension administrators are straight shooters. They’ve been telling us for a couple years now, “We can’t invest our way out of this.” Now they’re keeping their word . . . by missing their investment performance benchmarks by wide margins.

    Meeting contractual obligations? Performing your fiduciary duty? Acting in a moral fashion? No need to fret about these things. We’ve looked into it in Colorado and dang if these things haven’t been optional all along. Hello state and local governments . . . round up those rascally debt problems and herd ‘em out west to us in Colorado, we’ll fix ‘em right good fer ya!
    (Visit saveperacola.com for more info.)

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  7. Fake OCO
    Fake OCO 22 October, 2010, 15:23

    California’s retirement systems are funded at over 80 percent.
    ============
    CalTurds is at 47% funding, even less using a REAL discount rate on the ROI.

    Local 37 system PERS are in even WORSE shape.

    But dont let the truth kick you in the butt;

    In California actuarial methods show the Public Employee Retirement Fund (Calpers) at a funding ratio of 87 percent but when private sector market valuation is applied to Calpers, the funding ratio drops to 48 percent, according to the Bigg’s study. Likewise, California teachers’ funding (Calstrs) ratio under current actuarial methods is also 87 percent, as opposed to 46 percent when private sector market valuation is applied.

    Reply this comment
  8. Fake OCO
    Fake OCO 22 October, 2010, 15:24

    Hey, Burt, don’t bother trying to confuse them with the facts. Nothing will change their closed minds
    =================
    Actually Steve, I just destroyed you and Burt with the facts. Hope the above post helped 🙂

    Reply this comment
  9. SkippingDog
    SkippingDog 22 October, 2010, 20:38

    The Milken Institute report has a basic flaw. It uses the same assumptions upon which the Stanford reports are based, and those assumptions include an immediate stop to all employer and member contributions for current and future employees. If you cut off all input to the pension funds, they will grow at a much smaller rate and yes, eventually, they’re likely to run out of money in 20 or 30 years.

    If you apply the real world methods used to actually fund the pension systems, the continuing contributions of the employers and members will combine with existing assets to increase overall fund returns to a level that will support the fund’s long-term member obligations.

    Typical garbage in, garbage out analysis by both Stanford and the Milken Institute.

    Reply this comment
  10. stevefromsacto
    stevefromsacto 23 October, 2010, 10:02

    If you lie about my being a public employee, why should anyone trust your “facts”?

    Reply this comment
  11. Fake OCO
    Fake OCO 23 October, 2010, 10:07

    Steve, Im not lying about you being a public employee.

    Reply this comment
  12. Fake OCO
    Fake OCO 23 October, 2010, 10:10

    If you apply the real world methods used to actually fund the pension systems, the continuing contributions of the employers and members will combine with existing assets to increase overall fund returns to a level that will support the fund’s long-term member obligations.

    ===========================
    Yes, contributing 5 cents from the meployee, another 5 cents from the employer and a return of less than 1 cent will provide multi million dollar pension payouts, makes perfect sense to me Skippy 🙂

    Skippy, here are the facts about Calpers and Calstrs and their overall health;

    In California actuarial methods show the Public Employee Retirement Fund (Calpers) at a funding ratio of 87 percent but when private sector market valuation is applied to Calpers, the funding ratio drops to 48 percent, according to the Bigg’s study. Likewise, California teachers’ funding (Calstrs) ratio under current actuarial methods is also 87 percent, as opposed to 46 percent when private sector market valuation is applied.

    Reply this comment
  13. Giants fan
    Giants fan 25 October, 2010, 12:24

    Faker: If the stock market doesn’t improve, we’re all toast, not just the pension funds.

    Reply this comment
  14. Chuck Dushek
    Chuck Dushek 27 October, 2010, 08:07

    This study is completely authentic and correct on its assumptions. The 7.75 to 8.0% anticipated Rate of Return on pension fund assets is extremely out of touch with reality.

    Most public pension funds are investing approx 60% of their assets in US Govt guaranteed bonds and Agency securities that have maturity duratiuons of about 5 years. In 2006, the 5-year maturity US Trasury bond yield was 5%…whereas today it is at only 1.3%. The Federal Reserve is in a long term policy of Quantitative Easing that is pushing down medium and long term US Treasury interest rtaes…this is killing yield returns to public pension fund assets on 60% of their holdings.

    Further, most public pension funds are positioning approx 40% of their assets into common stocks that have very low dividend yields of near 2% per year (growth stocks). For near the past 11 years, the S&P 500 index has been below its year 2000 high of 1500….at 1172 currently. That is 22% below its past peak. It is clearly indicated that the US economy has a slow GDP growth rate of approx 2% per year going forward, that US unemployment is stuck at 9.6% with the Govt spending near 9% in fiscal deficit spending stimulus that is not sustainable. There is a small growth in private sector payrolls that is being offset by redustions in employees at State and Municipal levels from their chronic budget deficts of the past two years…CA included. Low sales tax receipts, lower state income tax collections, and eroding assessed valuations of real estate valuations are all reducing State revenue potentials across the US except for only the farm-belt states.

    In summary, there is little hope for a “rate of return” recovery to the 8% annual level for public pension funds that typically invest 60% of assets into Govt bonds at about 2% interest yields today and the remaining 40% of pension assets into low dividend common stocks at 2% average dividend yields. The stock market is flat for past 10 years and likely entering another “Lost Decade” of flat performance, like Japan is experiencing.

    Public pension funds “must” change their investing strategy to utilize more high dividend common stocks in place of too much reliance of “growth stock investing”. In fact, the 100 highest dividend paying stocks in the S&P 500 currently yield about 5%, which is 2.5 times the “average div yield” of the Index. Further, public pension funds need to make bond investments for long maturtiies that match the remaining life spans of retirees that retire at age 50-55 and live on a pension for 30 years or longer. Long term Investment Grade Corporate Bonds can provide annual interest income yields of near 7% per year. This is much higher than just using US Govt bonds, where the FED is pushing yields down to the 1.5 to 3% level.

    Anyone reading my analysis can learn a lot more about constructive “public pension fund investment strategy” by clicking to my blog “Pension Fund Rescue” http://www.PensionFundRescue.com

    What I am seeing from public pension fund Trustees across my home State of Illinois, is that they are oblivious/apathetic to changing their low-yielding pension fund investing strategies. They are fully ignoring the obvious reality that low annual pension fund yields of about 3% per year, will sink their funds to insolvency in 3-5 years. Trustees have the mistaken belief that it is the “taxpayers respoinsibility to bailout the underfunded conditions”, that are rising year after year. The day of reckoning is getting close. Without higher annual investmemnt returns from more constructive investment strategy employed by Trustees of pension plans…total insolvency is just a few years away. Readers: Unfortunatly we are in the age of “Crisis Economics”…when major macro economic and financial conditions are breaking down…such as, underfunded public pension funds…the problem will not be realistically addressed until “blood is on the doorstep”…Public Retirement Funds become insolvent.

    Chuck Dushek, President, Capital Management Associates Inc
    Email: [email protected]

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