California recently got its budget situation under control, but everyone figures the state is still in serious financial trouble.
And this news won't help, though it was probably inevitable.
According to the Sacramento Bee, CalSTRS (the big teachers retirement fund) is set to vote on Friday whether or not it should reduce its annual investment returns estimate from 8% to 7.5%, a move that will add hundreds of million to state debts (since the pension is guaranteed, and public taxpayers are on the hook).
That would be a huge decision, if they do it. 8% has been the level set since 1995 (talk about a whole other era), and artificially high return estimates are how the pension systems aren't (on paper) even more insolvent than they already seem.
The California State Teachers Retirement System, the second-largest U.S. public pension, will consider cutting its expected earnings rate on investments to 7.5 percent, increasing the need for higher contributions as it recovers from market losses.
The $132 billion pension fund’s governing board will consider approving a new rate of return, now 8 percent, at its Nov. 5 meeting in Sacramento, according to its agenda. The so- called assumed rate of return on investments is used to calculate the size of pension contributions from employers needed to pay retirees.
Public pension funds across the U.S. are adjusting their assumptions following losses in the recession that within three years may leave them $1 trillion short of the amount needed to pay benefits, according to a National Bureau of Economic Research report. The largest fund, the California Public Employees Retirement System, known as Calpers, uses a 7.75 percent assumed rate of return.
“The impact of reducing the assumed investment return and assumed inflation rates will result in a better representation of the fiscal condition of Calstrs benefit programs based on the current economic outlook,” the fund’s actuary Rick Reed said in a report to be presented to the board.
Calstrs, as the teachers’ fund is known, is 78 percent funded, meaning it is short by more than $42 billion. Reducing the assumed rate of return would lower that funding level to 74.2 percent, according to the report posted on the fund’s website.
The fund, which provides benefits for 848,000 public-school and community-college teachers, would need to ask lawmakers for an increase of as much as 16.8 percent in the amount the state and school districts pay toward employee retirement benefits if the board adopts the 7.5 percent assumed rate of return. Teachers are likely to be asked to pay more from their paychecks as well.
The teachers’ fund earned 12.3 percent in the year that ended in June, after losing 25 percent in fiscal 2009 and 3.7 percent in 2008.
Fewer than half of the public pension funds in the U.S. had assets to cover 80 percent of promised benefits in fiscal 2009, according to data compiled for last month’s Cities and Debt Briefing hosted by Bloomberg Link.
New York’s $124.8 billion pension fund, the nation’s third- largest, in September reduced its assumed rate of return to 7.5 percent from 8 percent. Calpers will review its 7.75 percent rate of return in February.
Pension reform has become a front-burner issue in California's gubernatorial race between Democrat Jerry Brown and Republican Meg Whitman. Reform measures are slated to appear on ballots in several California cities.
Other states and large cities have seen their public pension fund assets drop dramatically in the recession and housing crisis and are scrambling to plug funding gaps.
Here are some key facts about public pension reform:
CALIFORNIA'S PENSION WOES:
* Three big California public pension funds, the California Public Employees Retirement System (CalPERS), the California State Teachers' Retirement System (CalSTRS) and the University of California Retirement System (UCRS), face a collective shortfall of more than $500 billion over the next 16 years, well above the funds' own estimates of $55 billion, according to an April study by the Stanford Institute for Economic Policy Research.
* CalPERS, CALSTRS and UCRS combined administer the pensions of about 2.6 million Californians.
CALIFORNIA'S PROPOSED REFORMS:
* Jerry Brown favors renegotiating current pension formulas to require employees to contribute more toward their pensions and to work to a later age for full retirement benefits.
* Meg Whitman favors adopting a 401k-style defined contribution plan for new government hires and raising the retirement age to 65 from 55 for most state employees outside the public safety sector.
* Proposition B in San Francisco would increase employee contributions to their pensions to 9 to 10 percent from 7.5 percent to save the city $120 million a year. It is opposed by the city's unions but supported by some labor-friendly politicians, including former Mayor Willie Brown.
* A San Jose ballot measure would remove language from that city's charter that defines the rules for the age at which city employees can retire and how much the city must pay into their pension fund. It would apply to workers hired after 2011.
* Los Angeles Mayor Antonio Villaraigosa last week announced what he called a "landmark proposal" to reform pensions and retiree health benefits for newly hired police officers and firefighters. The reform would require new workers to contribute 11 percent toward their pensions, up from a current 9 percent, and would pare back the size of pensions. The measure is expected to save the city $173 million for every 1,000 new police officers and firefighters hired.
OTHER U.S. STATES:
* U.S. states face a total shortfall of at least $1 trillion in their funds for employees' pensions and retirement benefits, according to a report released by the Pew Center on the States in February. The report found that states did not save for the future or manage costs well, but they also typically expect an 8 percent return on investments.
* In August, Illinois said its public pension funds may have to shed $960 million in assets to pay retirees because the state has not come up with fiscal 2011 payments. In March, Illinois passed a bill to reduce benefits for new hires and raised the state retirement age, which it said would save $119 billion between now and 2045.
* Michigan in May passed a law requiring teachers to contribute 3 percent of their salaries to a new retiree health care fund.
* The U.S. Securities and Exchange Commission in August charged New Jersey with securities fraud for failing to disclose to municipal bond investors that it was underfunding its pensions. New Jersey agreed to settle the case without admitting or denying the findings. It was not required to pay any civil fines or penalties, but was ordered to cease and desist from future violations.
The US State of California is facing a Public Service pensions shortfall of $US500 billion ($A512 billion).
A long-running issue on the edge of public debate, PS pension reform has been promoted to centre stage due to California’s fast-growing Budget hole and a series of public payment scandals.
Chair of the group, Californians for Health Care and Retirement Security, Dave Low said the problem had been building up for some time.
Mr Low said California’s pension woes mirrored those of dozens of other American States and was less of a worry than some - Illinois, for example.
But as the largest US State, California’s top pension funds, including the Public Employees’ Retirement System and State Teachers’ Retirement System, rank among the biggest in the world.
A 1999 law that gave State workers generous pensions and pay raises is widely blamed for igniting the pension crisis.
While politicians are pledging to plug the funding gaps through higher retirement ages and increased worker contributions, accountants and commentators say it could be decades before the benefits of any reform are realised because the proposals can only apply to new employees.
Pensions expert Vladimir Kogan said this would not get to the crux of the liability, which was the unfunded liability for current employees.
It is generally agreed however that redesigning the benefits for current employees and retirees to save on costs was not an option.
Don't underestimate the contagion effects of state pension meltdowns. As state pension funds lower their return estimates, adding hundreds of millions to state debts, legislators will scramble to plug large pension gaps. And they will likely meet stiff opposition.
State pension funds are just coming to grips with the fact that their rosy investment assumptions are ridiculously optimistic. Worse still, their new investment return estimates are still way too high. What does this tell me? The Fed better come in big with QE2, a move that might fuel demand for riskier assets. But no matter how big QE2 is, it simply won't make a difference to US pensions heading on collision course with fiscal destiny. They've already reached their breaking point.
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