LAO: CalSTRS massively underfunded

by CalWatchdog Staff | March 26, 2013 9:02 am

March 26, 2013

By Katy Grimes

SACRAMENTO — The state’s Legislative Analyst released another stinging report[1] last week showing the California State Teachers’ Retirement System [2]suffers $73 billion of unfunded pension debt. But CalSTRS is using doubtful figures to minimize the billions in debt.

[3]

As with most systems managed by the state of California, the pension rate of return practice is at odds with reality, as are the contribution rates by state employees.

CalSTRS is not accounting for expenses it should, instead pushing expenses off into the future. This is what creates the unfunded liability. But this cannot go on indefinitely.

The numbers published in the LAO study are not new, and definitely not the result of the 2008 recession, as some say. “A couple of years ago that annual contribution need was $3.5 billion,” said Jack Dean, the publisher of PensionTsunami.com[5]. “The 2008 recession only exposed the debt — it made it more dramatic.”

Dean said California’s pension debt is like when a tsunami hits — the winds suck the ocean water way out, exposing everything on the ocean floor. Then a massive wave comes in, crashes, and destroys everything.  “The oncoming wave of public pension debt is even bigger than it seems,” the Pension Tsunami website[6] says.

But as the California Taxpayers Association reported[7], “The retirement system’s defined-benefit program was fully funded in 1998. Then, under Governor Gray Davis, the state increased member benefits and reduced state contributions. By 2003, the unfunded liability was $23 billion.” That was well before the recession struck in 2007-08.

Money was promised that was just not in the fund. And the rate of return is suspect.

Pension math is ‘New Math’

“Discount rates, or investment rates of return, have a substantial impact on pension system funded status, defined as the ratio of assets to liabilities,” Stanford Professor Joe Nation found in his 2011 study, “Pension Math[8].” “Generally, pension systems strive for a funded status of 100 percent over the long term. At a 6.2 percent discount rate, equal to a 100-year rate of return for a hypothetical mix of equities and fixed income investments, the funded status for CalPERS [the California Public Employees’ Retirement System] is 58.3 percent. At the same rate, the funded status for CalSTRS is 60.6 percent; it is 72.0 percent for UCRP [the University of California Retirement Plan]. Even at a 7.75 percent discount rate, the funded status for CalPERS and CalSTRS remains below 80 percent. Private-sector pension plans are labeled ‘at risk’ if their funded status falls below 80 percent.”

Nation correctly identified solutions to the pension crisis that would include revenue increases and reforms to public employee pension systems. But both solutions are highly unlikely to happen any time soon.

“Revenue increases are unlikely to be approved absent pension reforms,” Nation wrote[9] in the study. “Required pension system reforms include benefit reductions, such as prospective reductions for current employees, greater cost sharing, and governance reforms, particularly changes in pension system accounting methods and assumptions.” This is also quite unlikely because it is politically unfeasible.

The LAO explained[10] just how the CalSTRS pension system works:

“For many decades, CalSTRS has administered its main pension program, which (1) receives contributions from members, school and community college districts, and the state; (2) invests those contributions; and (3) uses its assets to provide a specific monthly pension benefit to retirees and their beneficiaries. Retirement programs of this kind are known as Defined Benefit programs.

“Estimated $5.7 Billion of Contributions in 2012-13. In 2012-13, school and community college district employees, districts, and the state are expected to contribute a total amount of $5.7 billion to CalSTRS. Contribution rates set in current law are as follows:

“* Employees ($2.1 Billion). Employees contribute 8 percent of their pay to CalSTRS’ DB Program.

“* Districts ($2.2 Billion). Districts contribute 8.25 percent of payroll to the DB Program.

“* State ($1.4 Billion). The state currently pays about 5 percent of teacher payroll (measured on a two-year lag) to the DB Program and a companion program—the Supplemental Benefit Maintenance Account—combined. (This percentage will grow slightly in future years, but not enough to address a substantial part of CalSTRS’ funding problem.)”

The worse news

According to the CalSTRS actuary, the fund’s defined-benefit program is estimated to deplete its assets by 2044.

The LAO recommended restoring solvency to the CalSTRS retirement system before repaying some obligations in Gov. Jerry Brown’s “wall of debt,” yet more money the state owes. The LAO urged the Legislature to begin additional funding by 2014-15, and even more interestingly, recommended shifting funding for the CalSTRS program to teachers and local school districts.

Yet if California’s statewide pension systems are any benchmark, the funded ratio for the aggregated 24 statewide systems is 53.6 percent, as of June 2011, according to Nation’s study[11].

And the unfunded liability for the 24 systems is $135.7 billion.

Just as with CalPERS and CalSTRS, “[T]he 24 systems discount their liabilities at an expected rate of return, typically 7.75 percent,” Nation found. That number since has been dropped a little, to 7.5 percent. “This practice is at odds with that used in the private sector, and it is also at odds with standard practice in economics, which holds that pension liabilities are full-recourse obligations that must be paid without regard to the performance of pension fund investments. As such, each of the systems substantially understates liabilities and overstates funded ratios.”

Private sector funds generally expect only about 4 to 5 percent annual growth, at most. The state’s pension tsunami is rolling in and is just off shore.

Source URL: https://calwatchdog.com/2013/03/26/lao-calstrs-massively-underfunded/

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