The “unfunded liabilities” of state and local pension funds are California’s biggest unresolved political issue – at least in financial terms.
We know, with fair accuracy, how much money flows into and out of those trust funds now and into the reasonably predictable future, as well as the current value of their investment portfolios.
What we don’t know is what those investments in stocks, bonds, real estate and hedge funds will earn in the future. And while there’s no way to precisely predict those earnings, the assumption of how investments will fare determines the size of the pension debt.
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For many years, the California Public Employees’ Retirement System and other state and local pension systems have assumed earnings, technically called the “discount rate,” in the 7.5 percent to 8 percent range, and they seemed to be generally on target.
With that assumption, California’s unfunded pension liabilities – the gap between what the funds expect to have and what retirees will be owed – are roughly $450 billion.
That’s a big number, but investment earnings have stumbled in the last couple of years. CalPERS gained 2.4 percent in 2014-15 and a minuscule 0.6 percent in 2015-16. That generally was the experience of other California and national systems as well.
Were pension fund overseers to drop their discount rates to the 4 percent range, roughly the rate private corporate systems use, California’s unfunded liabilities would probably surpass $1 trillion.
A couple of years ago, the Governmental Accounting Standards Board began pressuring governments to report their pension debts more fully – and perhaps more realistically.
However, they’ve been reluctant to make big discount rate changes for the simple reason that dramatic decreases would ramp up pressure to either put more tax dollars into the systems to cover the debt, or modify workers’ pension benefits to reduce the fiscal impact.
Two national actuarial associations established a joint task force to study the thorny discount rate issue, but a dispute erupted over publishing the research project’s conclusions that public pension earnings assumptions are too high and should be sharply reduced. Were its recommendations to be followed, the nation’s unfunded pension liability would quadruple from $1.5 trillion to $6 trillion.
Last month, after much wrangling and debate in the financial media, it was agreed that the paper would, indeed, be published.
It will rekindle California’s pension debate, particularly since a state appellate court ruled recently that under some circumstances, pensions can be modified – essentially overturning the “California rule” that has long assumed pension benefits, once granted, are inviolate.
That rule, derived from a series of appellate court decisions over the last 61 years, does not prevent changes in pension formulas as long as retirees get “reasonable” benefits, the court ruled.
Even at $450 billion, California’s unmet pension liabilities are immense, with only about two-thirds of pension promises now covered by assets.
If pension debt is $1 trillion or more, as the new actuarial study suggests, it threatens to overwhelm state and local governments, crowding out vital public services. And without being addressed, it grows by millions of dollars a day.
If elected officials and pension fund overseers don’t do something about it, voters will someday have the last word via a ballot measure.