Dubious Investments Further Imperil California Pension Plan Already in Crisis

pension-2The California Public Employee Retirement System, known as CalPERS, is in crisis. And it sure looks like things are going to get a whole lot worse before they can get a whole lot better.

The system already has a $153 billion unfunded liability, one of the largest shortfalls of any state, and it only has funds to cover 68 percent of promised benefits into the future. And because CalPERS is already cash negative, paying out $5 billion more in benefits to retirees each year than it takes in, there aren’t many scenarios whereby the system would be able to make good on those promises absent outside intervention (read: taxpayer bailout).

Lawmakers and the fund’s board should be considering reforms to improve the system, but California voters and taxpayers faced another setback recently. Overseers of the pension plan — the nation’s largest — passed a funding plan earlier this year that projects shortfalls over the next decade but assumes rosy investment returns in coming decades to make up the difference. Given the high market valuations today, that assumption seems dubious.

When the CalPERS investment committee reallocated its investments recently, it assumed a 7 percent annualized rate of return. While CalPERS has enjoyed some good years — for example, its 2017 return may exceed 11 percent — that’s not the norm. The fund has averaged a 4.6 percent rate over the past decade, and its 2016 rate was an abysmal 0.6 percent.

CalPERS’ strategy — and to a large extent that of the state in general — seems crafted first and foremost to advance the interest of public sector labor unions. The high compensation for state government workers and the state’s munificent retirement benefits make it difficult for local government officials to find the money necessary to meet their obligations. Rising contribution rates for local governments mean that municipalities and schools have less money to educate children, build roads or provide other essential government functions.

CalPERS’s school district contribution rates to the pension plan are projected to skyrocket in the near future. The rates have risen to 15.5 percent from 11.8 percent in the 2015-2016 fiscal year, and are scheduled to reach 22.7 percent in 2020. School districts have little power to fight the increases, which are mandated at the state level. The only way to reduce pension contributions is to cut staff. Some layoffs may make sense for districts facing declining enrollment, but they can also harm educational outcomes.

Fund managers should be laser-focused on increasing investment returns for its beneficiaries, which would lessen the fund’s burden on taxpayers. But its board is more interested in pursuing a political agenda. For the majority of California taxpayers who hold a portion of their retirement assets in the stock market, CalPERS’ activism means that some of their money will be used to support a political agenda that hurts their investment returns.

CalPERS has played an increasing role in politicizing annual shareholder meetings in recent years. These elections are on the horizon—a majority of U.S. public companies hold the mandated meetings between March and July—and CalPERS is already planning to force votes on proposals on environmental and social issues.

Traditionally, these proxy votes have been about improving corporate governance with one goal in mind: improving shareholders’ returns. But CalPERS and other activist investors have aggressively pushed proposals irrelevant to companies’ missions that could have a harmful impact on shareholder value.

CalPERS has prioritized relatively poor-performing environmental, social and governance (ESG) investments at the expense of other options more likely to optimize beneficiary returns. As a recent study by the American Council for Capital Formation shows, four of CalPERS’ nine worst performing funds were ESG-focused.

CalPERS responded to the criticism by noting that the plan’s private equity portfolio, which includes the funds, has performed well overall. But CalPERS would serve its beneficiaries—and taxpayers—better if it focused on investment returns and not politics.

Making investment decisions based on social issues has real consequences. Last year CalPERS’ board expanded its ban on investing in companies that produce tobacco products, against recommendations by its professional staff. In an analysis of the cost of divestment produced for CalPERS, Wilshire Consulting placed the system’s total foregone investment gains at more than $3.6 billion.

CalPERS is facing a serious, long-term crisis that could cripple school districts and local governments while forcing tax increases to pay for the pension system. Getting the fund out of politics won’t alone fix the system’s fiscal woes. But it would be a good first step.

Study confirms the California pension crisis is hitting now

Debates about California’s pension crisis almost always focus on the big numbers – the hundreds of billions of dollars (and, by some estimates, more than $1 trillion) in unfunded liabilities that plague the public-pension funds. For instance, the California Public Employees’ Retirement System is only 68 percent funded – meaning it only has about two-thirds of the money needed to pay for the pension promises made to current and future retirees.

Calpers headquarters is seen in Sacramento, California, October 21, 2009. REUTERS/Max Whittaker

CalPERS and its union backers insist that there’s nothing to worry about, that future bull markets will provide enough returns to cover this taxpayer-backed debt. Pension reformers warn that cities will go bankrupt as pension payments consume larger chunks of municipal budgets. They also warn that pensioners are at risk if the shortfalls become too great. The fears are serious, but they mainly involve predictions about what will happen a decade or more into the future.

What about the here and now? California municipalities and school districts are facing larger bills from CalPERS and from the California State Teachers’ Retirement System (CalSTRS) to pay for sharply rising retirement costs. Most of them can come up with the money right now, but that money is coming directly out of their operating budgets. That means that California taxpayers are paying more to fund the pension system, and getting fewer services in return.

The “bankruptcy” word garners attention. This column recently reported on Oroville, where the city’s finance director warned about possible bankruptcy during a recent hearing in Sacramento. The Salinas mayor also has been waving the bankruptcy flag. The b-word understandably gets news headlines, especially after the cities of Stockton, Vallejo and San Bernardino emerged from bankruptcies caused in large part by their pension situation.

But there’s a huge, current problem even for the bulk of California cities that are unlikely to face actual insolvency. They are instead facing something called “service insolvency.” It means they have enough money to pay their bills, but are not able to provide an adequate level of public service. Even the most financially fit cities are dealing with service cutbacks, layoffs and reductions in salaries to make up for the growing costs for retirees.

A new study from Stanford University’s prestigious Institute for Economic Policy Research has detailed the depth of this ongoing problem. For instance, the institute found that over the past 15 years, employer pension contributions have increased an incredible 400 percent. Over the same time, operating expenditures have grown by only 46 percent – and pensions now consume more than 11 percent of those budgets. That’s a tripling of pension costs since 2002. Contributions are expected to continue their dramatic increases.

“As pension funding amounts have increased, governments have reduced social, welfare and educational services, as well as ‘softer’ services, including libraries, recreation and community services,” according to the study, “Pension Math: Public Pension Spending and Service Crowd Out in California, 2003-2030” by former Democratic Assemblyman Joe Nation. In addition, “governments have reduced total salaries paid, which likely includes personnel reductions.”

These are not future projections but real-world consequences. The problem is particularly pronounced because “many state and local expenditures are mandated, protected by statute, or reflect essential services,” thus “leaving few options other than reductions in services that have traditionally been considered part of government’s core mission.” Many jurisdictions have raised taxes – although they never are referred to as “pension taxes” – to help make ends meet, but localities have a limited ability to grab revenue from residents.

The report’s case studies are particularly shocking. The Democratic-controlled Legislature and Gov. Jerry Brown often talk about the need to help the state’s poorest citizens.Yet, the Stanford report makes the following point regarding Alameda County (home of Oakland): Pension costs now consume 13.4 percent of the county’s operating budget, up from 5.1 percent 15 years ago. These increases have “shifted up to $214 million in 2017-18 funds from other county expenditures to pensions,” which “has come mostly at the expense of public assistance, which declined from a 33.6 percent share of expenditures in 2002-03 to a 27 percent share in 2017-18.”

The problems are even more stark in Los Angeles County. As the study noted, pension costs have shifted approximately $1 billion from public-assistance programs including “in-home support services, cash assistance for immigrants, foster care, children and family services, workforce development and military and veterans’ affairs.”

It’s the same, basic story in all of the counties and cities analyzed by the report. For instance, “the pension share of Sacramento’s operating expenditures has increased over time, from 3.2 percent in 2002-03 to 12.5 percent in the current year.” That percentage has gone from 3 percent to 12 percent in Stockton, and from 3.1 percent to 15.2 percent in Vallejo.

These are current problems, not future projections. But the future isn’t looking any brighter. “The case studies demonstrate a marked increase in both employer pension contributions and unfunded pension liabilities over the past 15 years, and they reveal that in almost all cases that costs will continue to increase at least through 2030, even under the assumptions used by the plans’ governing bodies – assumptions that critics regard as optimistic,” Nation explained.

So, yes, the public-sector unions and pension reformers will continue to argue about when – or even if – the pension crisis will cause a wave of California bankruptcies. But overly generous pension promises are destroying public services and harming the poor right now.

Steven Greenhut is a contributing editor for the California Policy Center. He is Western region director for the R Street Institute. Write to him at sgreenhut@rstreet.org.

This piece was originally published by the California Policy Center.

CA Threatened by Massive Unfunded Liabilities

Despite a concerted effort from Gov. Jerry Brown to keep California from slipping back into the financial abyss, the state’s finances remain threatened by massive unfunded obligations.

“It’s California’s debt and liabilities that are concerning financial analysts, particularly the state’s rapidly growing unfunded retiree health care costs, which grew more than 80 percent over the past decade. California has promised $74 billion more in health and dental benefits to current and retired state workers than the state has put aside,” the San Francisco Chronicle reported.

Adding to the concern, new reporting rules have cast new light on local debt burdens. Changes issued by the Governmental Accounting Standards Board caused California governments to begin reporting “pension debts differently in their 2015 financial statements, which is becoming a wake-up call,” Reason noted. “Medical costs and other non-pension benefits will be accounted for differently in the 2017-2018 fiscal year. As a result, localities are facing much larger pension debts than previously reported.”

Observers have also had their eye on final developments in the case of one of California’s municipal canaries in the pension coal mine. “The bankrupt city of San Bernardino, California, said in a court filing […] it had reached a tentative agreement with the creditor holding its pension obligation bonds on how the debt would be treated in the city’s plan to exit bankruptcy but did not provide details,” according to Reuters.

Burdening Brown

Calpers headquarters is seen in Sacramento, California, October 21, 2009. REUTERS/Max Whittaker

Calpers headquarters is seen in Sacramento, California, October 21, 2009. REUTERS/Max Whittaker

CalPERS, the fund at the center of the ongoing pensions controversy, remained a sticking point. Its refusal to secure higher servicing payments created “a heavy political lift from Brown,” as the Contra Costa Times wrote in an editorial. “If CalPERS had required higher payments, he could have simply planned for it in his state budget. Without the requirement, he must persuade the Legislature to free the money.” Amid the recession, its funded ratio, the board wrote, “plummeted to 61 percent” in two years. “If that happened today, it would be devastating.”

“CalPERS is especially vulnerable because it assumes it can earn returns of 7.5 percent annually. To try to hit that target, it must make aggressive investments. In other words, it must take risk, which comes with upside potential and downside dangers. The higher the investment target, the greater the exposure in a down market.”

Bond struggles

One of Brown’s would-be replacements in the governor’s mansion, state treasurer John Chiang, has sought to shift expectations around California’s budgetary reliance on bond measures. Bond use has “risen substantially in California, with the state’s reliance on borrowing for infrastructure resulting in 1 of every 2 dollars spent on those projects going to pay interest,” the Chronicle noted, citing figures from the Department of Finance. But although Chiang suggested earlier this month that the state should “rethink” its use of bonds, Chiang has embarked “on a national tour this month aimed at seducing investors with an environmentally friendly investment alternative,” according to the San Jose Mercury News. “Chiang wants to plant a full-fledged green bond market. Individuals and institutions, such as mutual funds and hedge funds, will have the opportunity to invest. The bonds promise to appeal to environmentally minded investors, as well as those looking to diversify portfolios overly dependent on fossil fuels — in case future climate change regulations sprout up.”

But in a sign of the inertia and perverse incentives that critics often associate with entrenched bureaucracies, the bonds have been built to stretch beyond their narrowly tailored confines if given the right kind of tug. “Instead of rules, green bond issuers rely on a set of nonbinding guidelines called the Green Bond Principles, drafted by an international group of issuers and investors,” the Mercury News noted. “The lack of third-party monitoring means issuers can label almost anything a green bond. If the bonds’ popularity outstrips the number of green projects, issuers could have an incentive to label bonds as green, even when they’re not.”

Originally published by CalWatchdog.com

How Government Unions Are Destroying California

Calpers headquarters is seen in Sacramento, California, October 21, 2009. REUTERS/Max Whittaker

California was once the state that everyone looked up to. With the best weather and natural resources, we were full of hope and innovation. We had the best public schools, a world class system of higher education, the best freeways, infrastructure to provide fresh water to our growing population, which also doubled as a source of clean energy through hydro-electric power, a business-friendly environment where entire industries grew in entertainment, aerospace and technology, making our economy virtually recession-proof.

Then in 1978, then-governor Jerry Brown signed an executive order that imposed union-shop collective bargaining on public agencies in California, and the rise of public-sector union power began.

Today, public-sector unions are the most powerful political force in our state. They control a majority of our state Legislature and might control a supermajority in November if a few swing districts fall their way. No politician, Democrat, Republican or Independent, acts without considering how it will affect the union agenda.

These government unions press 100 percent for a progressive agenda, and they consistently agitate for increased spending. In two areas, the quality of our public education system and the financial health of our cities and counties, the consequences of government union power have been catastrophic.

Public Schools

The teachers’ unions, usually a local affiliate of the California Teachers Association, control most of our school boards, leading to control of our public schools. It is more than a coincidence that our public schools rank near the bottom in every category among the 50 states.

As lobbyists for staff and teachers, who are paid to run our public schools, public sector unions fight to maintain the status quo. They protect incompetent teachers, they permit excellent teachers to be dismissed in layoffs, they actively oppose charter schools, they fight poor parents who try to employ Parent Trigger Laws, and they conduct an active campaign 24/7 against any form of school choice.

The financial power of teachers unions:

  • There are over 266,255 public school teachers in California.
  • Each pays at least $1,000 in union dues annually.
  • The CTA acknowledges spending up to 40 percent of those dues explicitly on politics. That is $106 million per year.
  • If the lawyers in Friedrichs are right — that all public union spending is political — the actual total is $266 million per year.
  • Unions for non-teacher staff also are active. There are 215,000 school staff employees who are members of the CSEA (California State Employees Association), who each pay approximately $500 annually in dues. If all of those dues are spent on politics, that adds $107 million more for political spending annually.
  • The total spent by public education unions alone is estimated to be $373 million per year – just in California.


Police and firefighter unions do the most damage at the local level. They have attained unsustainable pensions, known as “3%@50”, meaning that a member of that bargaining unit is eligible at age 50 for a pension equivalent to 3% of his highest salary times their number of years of service. While the age of eligibility has been raised for new public safety employees entering the workforce, the vast majority of active police and firefighters still retain these “3%@50” benefits. So at age 50, a 20-year veteran can retire with a pension equivalent to 60% of their highest year’s salary, which can be manipulated through spiking, and a 30-year veteran is eligible for 90% of his or her highest salary.

These pension requirements are held under the “California Rule” to be irreversible. In other words, once they have been adopted, democracy is incapable of turning off the spigot. With the spigot running constantly, communities go bankrupt. First, they cut other services. Then they increase taxes. Then they refuse to pay bondholders, so no one will invest again.

Current unfunded liabilities in California:

At CalPERS: $93.5 billion (ref. page 120, “Funding Progress,” CalPERS 6-30-2015 financial report).

At CalSTRS: $72.7 billion (ref. page 118, “Funding Progress,” CalSTRS 6-30-2015 financial report).

Local Unfunded Liabilities add considerably to this total, since CalPERS, with assets of $301 billion, and CalSTRS, with assets of $158 billion, only constitute 62 percent of California’s $752 billion in state and local pension fund assets. If all of these systems in aggregate were 75 percent funded, which is probably a best case estimate given the poor stock market performance since the official numbers were released, the total unfunded pension liabilities for California’s state and local government workers would be $256 billion.

And $256 billion in unfunded liabilities, a staggering amount, still understates the problem for two reasons: First, these pension funds may not succeed in securing a 7.5 percent average annual return in the coming decades. If not, then they will not earn enough interest to prevent their funding ratios from getting even worse. Also, this doesn’t take into account “OPEB,” or “other post employment benefits,” primarily health insurance. The unfunded OPEB liability just for Los Angeles County is officially recognized at over $30 billion.

A realistic estimate of the total unfunded liabilities for retirement obligations to state and local workers in California is easily in excess of $500 billion. These benefits, which are financially unsustainable and far more generous than the taxpayer funded benefits available to ordinary private sector workers, were forced upon local and state elected officials through the unchecked p0wer of government unions.

*   *   *

Bob Loewen is the chairman of the California Policy Center.