Tuesday, February 13, 2018

CalPERS Hits a Milestone?

Adam Ashton of The Sacramento Bee reports, Pension fund hits milestone: It’s earning more money than it’s paying out:
For the first time in years, CalPERS is stable enough that it no longer expects to run deficits into the middle of the century.

Though still underfunded, the $345 billion pension fund has a better financial outlook because it’s collecting more money from employers and making the most of recent stock market gains, its chief investment officer said on Monday. That should help it avoid scenarios where it has to sell investment assets to pay pensions.

Read more here: http://www.sacbee.com/news/politics-government/the-state-worker/article199757439.html#storylink=cpy

It’s a milestone in the California Public Employees’ Retirement System’s recovery since it suffered severe losses in the recession that left it badly underfunded.

Since then, CalPERS has regularly had to sell off assets to pay pensions. In 2016, for instance, CalPERS paid out $20.5 billion in benefits – $4 billion more than it earned, according to its annual financial report.

That year the CalPERS board voted to lower its investment forecast, acknowledging that it expected to earn less money over time from its portfolio. The vote effectively required cities and other organizations that belong to CalPERS to kick in more money to fund their employees’ pensions.

CalPERS Chief Investment Officer Ted Eliopoulos said the higher payroll rates and recent investment returns put the fund in a better position to handle recent stock market swings that have swayed the value of its portfolio by billions of dollars.

CalPERS now expects to earn more money than it spends over the next 20 years. Previously, its financial outlook projected deficits through 2040.

“We are now forecasting neutral to positive cash flows, taking into account both contributions and investment income, which strengthens the fund and strengthens our ability to invest through volatile periods like this. Not only not having to sell assets during a downturn, but also to reinvest during downturns,” Eliopoulos said told the CalPERS board.

CalPERS has about 70 percent of the assets it would need to pay the benefits it owes to its members. Its decision to raise payroll contribution rates has stressed local governments. City governments especially have raised complaints recently that the higher rates are “crowding out” their ability to fund public services.
Laila Kearney of Reuters also reports, CalPERS loses 4.6 pct in recent market maelstrom:
California Public Employees’ Retirement System (CalPERS), the largest U.S. public pension fund, lost 4.6 percent in value during the stock market’s recent tumble, and investment risks are expected to persist, officials said on Monday.

The drop in stocks from an all-time high on Jan. 26 to Friday followed a booming year for the market and for CalPERS, which recorded a rate of return on investment of 15.7 percent in 2017.

The equities portion of CalPERS’ $345.39 billion portfolio, was up 24 percent in the last calendar year, CalPERS’ Chief Investment Officer Ted Eliopoulos said at a board meeting in Sacramento, California.

“Last week we were seeing the beginning of a market environment that may be shifting,” Eliopoulos said. “It looks like 2018 is likely to be more turbulent.”

CalPERS’ investment diversity helped it to avoid the nearly 9 percent drop seen in the stock market’s benchmark S&P 500 index over the recent two-week period, Eliopoulos said.

Rising interest rates, U.S. tax cuts and increased spending are top areas of concern in the next couple of years, CalPERS chief economist John Rothfield said during the meeting, which was broadcast over the internet.
It wasn't just CalPERS that got hit last week, every major pension fund that invests in public equities got hit.

But astute readers of my blog know that pensions are all about managing assets and liabilities. Stocks got clobbered over the last two weeks but interest rates have risen over the last six months, and it's the rise in rates which matters most because pensions have long-dated liabilities so if rates rise, pension liabilities go down significantly, more than offsetting the plunge in assets like stocks.

The problem is when rates stop rising and start falling -- my macro call going into year-end -- and assets get hit. That's the perfect storm for pensions, the double-whammy on assets and liabilities.

CalPERS did a good move to raise its contribution rate, it should raise it some more in my humble opinion but they use a long-term forecast on inflation based on the last twenty years so I doubt they will raise the contribution rate again anytime soon.

Go back to read some comments of mine on CalPERS doubling its allocation to bonds, big bonuses at CalPERS and CalSTRS and why CalPERS is rejigging its asset allocation.

There has been a lot of negative press on CalPERS recently but I think they're taking the right steps to address funding concerns and its long-term sustainability.

As usual, don't believe everything you read in the newspapers, they sensationalize stories to sell papers.

Below, California's two major public pension systems are underfunded and are asking local governments to pay more. Critics want to reduce benefits, while others say policymakers should allow time for recent changes to take hold.

Update: A wise actuary shared this with me after reading this comment:
Positive cash flow is better than negative cash flow but it's nothing of which a pension plan should be proud.

Saying that contributions plus investment income (which I assume includes capital gains and losses) exceeds benefits and expenses over the next 20 years means only that, if things go according to plan, the pension fund will be at least as big 20 years from now as it is today.

But what about the liabilities? If CalPERS is a mature pension plan, the liabilities should grow at the same rate as the members' payroll. Let's say this is 4% per annum (3% salary increases plus 1% population growth). Over 20 years the liabilities could grow from $500 billion to more than $1 trillion. If the pension fund stays the same ($350 billion) the funded ratio will decline from 70% to 35%.

The bottom line: CalPERS better hope that contributions plus investment income is significantly greater than benefits. Otherwise, its problems are far from solved. CalPERS should focus on whether the funded ratio, using reasonable assumptions, is rising or falling. If it is rising the problems are being addressed. If not, they are being ignored.
He also added this:
As to your question, if interest rates plunge the pension liabilities will soar (if the discount rate moves down with market interest rates). Typically, public sector plans will not reduce their discount rates because they don't want to admit that the funding situation is deteriorating, even though it is. US public sector plans stuck with an 8% discount rate for 15 years while long Treasury rates dropped by 300 basis points. This helped the optics while harming the financial condition of the plans.
I thank him for sharing his insights with my readers and I agree, more needs to be done to bolster CalPERS' funded status but I think this is a long process and I like what they've done so far.

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