CalPERS is preparing more pension rate hikes, and they could cost government agencies billions of dollars.
With consultants predicting long-term declines in investment earnings, the big California pension fund is considering substantially higher contribution rates for the state and the thousands of municipalities and school districts that rely on CalPERS to serve their retirees. Workers could get hit with higher contributions, too, although that would depend on contract negotiations.
A decision isn’t likely until February, but CalPERS’ deliberations are already causing anguish to employers, employees and the pension fund itself. The move will surely cause more budget strain for government agencies, particularly at the local level, even though the higher rates are likely to be phased in over a number of years.
Union officials worry that higher pension contributions will leave less money for pay raises – and could increase political pressure for major reforms in the pension system. Dave Low, who runs a group called Californians for Retirement Security, told CalPERS board members last week not to fall for pessimistic financial forecasts.
“We don’t see enough data that shows us an immediate change is warranted,” said Low, also executive director of the California School Employees Association. “I think the train needs to be slowed down.”
But several CalPERS board members, speaking at a meeting of the fund’s finance and administration committee, said the fund needs to face up to its financial realities.
“The most important thing we can do is shore up the funding,” said Richard Gillihan, who serves as representative of Gov. Jerry Brown’s Department of Human Resources. “We can’t wait to do that. It’s pay now, or pay more later.”
Said board member Priya Mathur, a BART official who represents employees of local government agencies: “We all find ourselves in an uncomfortable position.”
CalPERS collected $13.8 billion from employers and employees last year, with the biggest contribution – $5.4 billion – coming from the state. The pension fund raised contribution rates two years ago, largely because of forecasts showing retirees are expected to live longer. Unlike CalSTRS, the teachers’ pension fund, CalPERS has the authority to impose rate hikes without permission from the Legislature.
This time around, it’s the pension fund’s own troubled finances – combined with predictions of a gloomy investment climate – that is pressuring the board to raise rates.
The $300 billion pension system is 68 percent funded, meaning that while it has enough cash for the foreseeable future, it has only 68 cents on hand for every $1 in long-term pension obligations. Over the past year, CalPERS has become “cash flow negative,” meaning it’s taking in fewer dollars than it’s spending on pension benefits.
A rescue from Wall Street doesn’t seem likely. While historically CalPERS gets about 60 percent of its money from investments, the most recent results aren’t strong. The California Public Employees’ Retirement System earned just a 0.61 percent return on its investments in the 2015-16 fiscal year, following a subpar 2.4 percent the year before.
The latest investment returns mean CalPERS has earned an average of just over 7 percent over the past 20 years. That’s below CalPERS’ current “discount rate” of 7.5 percent.
The discount rate sounds arcane but plays a crucial role in pension fund financing. It serves as an official forecast of yearly investment earnings and generally guides how much investment risk CalPERS is willing to take. Lowering the rate means charting a more cautious approach, which usually means lower returns. That forces CalPERS to demand higher contributions from the state and other employers.
Now, outside consultants are urging CalPERS to lower its investment forecast. CalPERS’ investment adviser Wilshire Consulting said last week that CalPERS can expect to earn just 6.2 percent a year over the next decade as global economic growth continues to slow. Andrew Junkin, the firm’s president, told board members to expect “a very painful decade.”
CalPERS has been cautious about adjusting the discount rate. Last fall it adopted a complicated mechanism that could reduce the rate to 6.5 percent – over 20 years.
Brown blasted the plan as “irresponsible.” The governor said CalPERS should have slashed the discount rate in five years, despite the budgetary pain it would cause.
Local officials, mindful of recent municipal bankruptcies in Stockton and San Bernardino, are nervous about more rate hikes from CalPERS but said they want the pension system to be financially sound.
Fatter contributions to CalPERS would be “a hard pill to swallow,” said Dane Hutchings of the League of California Cities in an interview. But he added: “Our members are prepared for it.”
CalPERS officials indicated the higher contribution rates are likely to be phased in, although it isn’t clear how quickly.
Pension politics could play a role in the decision. The CalPERS board generally has a pro-union tilt; six of its 13 members are elected by public workers or retirees. Another big cost increase could provide ammunition for those advocating major pension reforms. Although Brown signed a law that cuts benefits for new workers starting in 2013, critics note that it doesn’t touch benefits for those already in the system.
Dan Pellissier, the head of a group called California Pension Reform, said the CalPERS board is struggling with the looming decision.
“They’re confronted with their system being substantially out of whack,” Pellissier said in an interview. “The consequences of doing the right thing are going to be significant.”
Those sensitivities were on full display at last week’s meeting. Board member Theresa Taylor, a vice president with Local 1000 of the Service Employees International Union, which represents thousands of state workers, was among those warning that CalPERS was in danger of rushing to judgment.
“We need to step back and breathe,” she said.