CalPERS is about to take a more cautious approach to investing, a move that could stabilize its finances but will likely force government agencies and their employees to pump millions of additional dollars into the nation’s largest public pension fund.
The CalPERS finance and administration committee on Tuesday approved a risk-reduction strategy that will gradually lower the pension fund’s forecast of annual investment profits. The plan, which would take an estimated 19 years to implement fully, is still subject to approval of the full CalPERS board, which will vote Wednesday.
While it will be up to the CalPERS investment staff to flesh out the new policy, cutting the annual forecast will translate into safer investments and, in all likelihood, lower returns in most years. In an era of increasing market volatility, that would help buffer the California Public Employees’ Retirement System from steep losses in lean years. But if annual returns do diminish as anticipated, the strategy would force state and local taxpayers, along with employees themselves, to pick up the slack by contributing more to the $291 billion system.
“We all recognize there is a cost to lowering risk,” said committee vice chair Dana Hollinger.
The pension fund’s up-and-down investment performance is at the heart of the discussion. Although CalPERS has averaged 11 percent annual profits on its investments for the past five years, it earned just 2.4 percent in its most recent fiscal year. The pension fund has plenty of cash on hand but is only 76 percent funded, which means it has 76 cents for every $1 in long-term obligations.
Going forward, CalPERS can’t count on “an extraordinary string of returns,” actuary Alan Milligan told the committee.
Other public pension funds also are taking steps to reduce investment risks, including CalSTRS, the California teachers’ system, which recently agreed to carve out 9 percent of its portfolio for Treasury securities and other safe investments. CalPERS, meanwhile, is selling off $3 billion worth of comparatively risky real-estate assets and will plow the money into safer properties.
While the trend is clear, charting a safer strategy remains a balancing act for public pension funds. They want to reduce risk but also are weighing how quickly they can impose higher contributions on their member agencies and workers to compensate for the anticipated lower returns. As it is, CalPERS is already in the midst of a plan that hikes pension contributions by hundreds of millions of dollars a year to make up for the billions it lost in the 2008 market crash and to reflect expected longer lifespans for retirees. CalPERS took in $8.8 billion in 2014 from government agencies and $3.3 billion from workers.
Pension politics are at play, too. CalPERS’ board tends to favor labor interests and is wary of jacking up government contributions so quickly that it provides ammunition to conservative groups seeking changes in pension benefits for government workers.
For their part, those reform advocates said CalPERS’ plan to lower its risk over 19 years changes nothing.
“They’re kicking the can down the road,” said Carl DeMaio, a former San Diego city councilman and co-sponsor of a ballot initiative to put newly hired government workers into 401(k)-style retirement plans. “Nineteen years? That’s just passing the problem on to the next generation.
“They’re trying to give the appearance of being more conservative, but this is really just continuing the Ponzi scheme,” he added. DeMaio, a Republican, and former San Jose Mayor Chuck Reed, a Democrat, also are pushing a ballot initiative that would cap pension benefits for new workers at a set percentage of their salaries.
CalPERS’ Richard Costigan, chairman of the finance and administration committee, insisted the pension fund is facing up to its obligations to improve the system’s finances. “Years ago we probably would have done nothing,” he said in an interview after the meeting.
The plan approved Tuesday is a novel approach. It revolves around the CalPERS “discount rate,” an official forecast of annual investment returns, currently set at 7.5 percent.
Over the past 20 years, CalPERS returns have averaged 7.76 percent, although year-to-year results have varied widely. The new strategy assumes that really strong years will be followed by down periods that will cancel out much if not all of the profit earned in the good years. So every time CalPERS has a year in which it beats the forecast by at least 2 percentage points, the discount rate will come down a little. The maximum drop is a quarter-point a year. In 19 years, according to estimates by CalPERS staff, the discount rate would fall to 6.5 percent.
The plan, introduced just a month ago by committee member Bill Slaton, passed by a 4-3 vote. The committee rejected a somewhat more gentle approach that would have lowered the discount rate only when CalPERS beats the forecast by 4 points. The discount rate would probably fall to 6.5 percent in 21 years under that arrangement.
The gentler plan had been discussed for some time and had the support of public employee unions. Given the comparatively pro-labor bent of the full CalPERS board, the 4 percent approach could get approval at Wednesday’s meeting.
Board members had little appetite for Gov. Jerry Brown’s more muscular approach, which would simply reduce the discount rate to 6.5 percent in five years. They said it would have created too heavy a financial burden on stakeholders, especially local government agencies that are struggling already to make their annual CalPERS payments.
“To add more strain to them could actually ... put them into bankruptcy,” Hollinger said.
Critics of CalPERS said Brown’s approach makes sense.
CalPERS should lower the discount rate “when the governor wanted. They should have done it faster than the governor wanted,” said David Crane, a former adviser to Gov. Arnold Schwarzenegger and a pension-reform advocate.