The Tragedy Of California's Public Pensions

Tyler Durden's picture

Submitted by C. Jay Engel via The Sullivan Group,

It is well known that California has a pension problem that offers a challenge for public officials and current and future retirees alike. Even if people aren’t aware of the details, it has been talked about for quite some time that there are underlying aspects of the public retirement system that need to be addressed, sooner or later. The fact of the matter is that such problems can’t be ignored by the State forever; and what is perhaps more important to me, as one who professionally helps people secure their financial futures, is that the beneficiaries of these public pensions need to understand what is going on and work to prepare themselves for what is ahead.

Thus, the purpose of this short overview of the problem is to help awaken people to their own unique scenarios, to inspire them to make the proper moves before it is too late.  Everyone is in a different situation and there is no one-size-fits-all approach to figuring out what one should do personally; but hopefully after considering the following, the reader will be encouraged to reflect deeper on how the pension crisis may affect their futures.

The first thing to understand is that California’s public pension system is made up of a conglomeration of “6 state plans, 21 county plans, 32 city plans, and 27 special district and other plans” according to the Independent Institute Senior Fellow Lawrence J. McQuillan (McQuillan, page 3). The majority of these operate on a “defined benefit” model, which means that, upon retirement, these plans pay a specific amount per month for the rest of the retiree’s life. By far, the three largest of these 86 CA pension systems are CalPERS (1.68 million retirees), CalSTRS (868k retirees), and UCRP (253k retirees). For the remainder of this article, we will refer to these as the Big Three.

The “defined benefit” for these retirees rests on a relatively complicated formula which includes the number of years employed with the employer, one’s age at retirement, and one’s “final compensation.” There are fluctuations and other variables within this formula as well and factors can also include the specific employer, the occupation, and even variations of contract specifics. However, as Jon Ortiz reports in the Merced Sun-Star:“the largest group of state workers is under a "2 at 55" formula. To give an example here, assume an employee has worked for 30 years before retiring at age 55, her final compensation being $100,000. The “2 at 55” formula would indicate that she gets 2% of her salary (100k) multiplied by the 30 years she worked. 2% of her salary is $2k, which multiplied by 30 giving her a total of $60k per year for the rest of her life.

As McQuillan explains (page 6), however, there are also a variety of COLAs (cost of living adjustments) and automatic “step increases” that can substantially effect the annual increase in pension benefits. These are a result of a variety of collective bargaining aspects that are part and parcel of the California pension system. Essentially, what these features allow is for the “final compensation” levels to be boosted above their actual levels so that “lifetime annual pensions for some retired government workers exceed their final year’s pay.” In other words, due to this practice of “pension spiking,” future state obligations can in many cases exceed the levels that existed while the retiree was still employed. This has a significant “snowball effect” on the obligations faced by the state (and future taxpayers).

There are two sources of funding for these pensions that are to be paid out to millions of California retirees: taxpayers and investment market returns. The taxpayer originated funds flow through both employer (the government agency) and employee payroll contributions. These contributions are invested and, at least in theory, both the contributions plus investment earnings are paid out as the defined benefits to retirees. In other words, the employer/employee contributions (originated as taxes) plus the investments gains needs to be at least equal to the pension obligation levels in order to be sustainable. Where things start to get interesting, and overwhelming, is that, according to McQuillan (page 12), over the last 20 years, “for every dollar paid in CalPERS pension benefits, CalPERS’s employer members contributed 21 cents, employees contributed 15 cents, and the remaining 64 cents came from investment earnings.” In other words, historically, 64 percent of the funds paid out needed to rely on the performance of capital markets.

Now, what happens when the total assets (contributions + investment earnings) are less than the pension promise? The answer is that a deficit is created and these deficits are referred to as an unfunded liability. This unfunded liability is the total amount between the assets of the pension and the liabilities of the pension. Whenever the liabilities (what are owed) are greater than the assets (the contributions + investment earnings), there is an unfunded obligation. It is the sheer level of CA’s unfunded obligation that is the primary face of the California Pension Crisis.

According to the U.S. Census Bureau, the pension obligations for the largest six pension systems in CA came to a stunning $613 billion in 2013. Of this, only a portion is covered by the pension’s current assets, resulting in a sizable unfunded obligation level. The specific dollar amount of these unfunded obligations depends upon which calculations are being used. According to the calculations of the Big Three pension systems themselves, the unfunded portions are as follows: CaPERS $85.5 billion, CalSTRS $50.6 billion, and UCRP $6.5 billion. These represent the amounts, calculated by the agencies themselves, that the pension plans are short what is needed in order to meet what they owe to retirees. Collectively, this number is $143 billion short of what retirees are expecting to live off of for the rest of their lives. To give the reader a sense of the absurdity of these numbers, these were calculated in 2011 and since that time the US stock market has experienced large multi-year rally; however, in that time, the assets have only gained $7 billion in investment earnings so that today the unfunded liability still sits at the impossible goal of $136 billion.  That’s $136 billion in the hole.

This, after a massive stock market rally!

This means that the “funding ratio” of assets and liabilities is such that CalPERS is only 77% funded, CalSTRS is only 67% funded, and UCRP is only 80% funded. McQuillan quotes the American Academy of Actuaries on the issue of funding ratios to say: “Pension plans should have a strategy in place to attain or maintain a funded status of 100 percent or greater over a reasonable period of time.”  McQuillian comments on this quotation by noting that “a lower funding ratio implies that a pension system has a greater potential not to pay its promised benefits.” And yet, as can be seen according to the pension’s own numbers, the funding ratio is troubling.

Unfortunately, the bad news does not stop here. As emphasized above, the numbers thus far have all been merely reflective of the pension fund’s own estimates. According to a 2011 study conducted by the Stanford Institute for Economic Policy Research (SIEPR), the unfunded obligation levels for the Big Three pensions in CA were as follows: $169.8 billion for CalPERS, $104 billion for CalSTRS, and $16.8 billion for UCRP. This means that the funding ratios too are in a much worse condition, according to the SIEPR calculations.

The chart shows the unfunded obligation levels and the funding ratios (in parentheses) for each pension according to both the agency and SIEPR estimates (remember, the greater the unfunded liability, the lower the funding ratio):

Needless to say, in the words of McQuillan, “by [the above] measure, California’s Big Three public pensions are dangerously underfunded, putting current and future taxpayers at risk.”

Without getting into too much detail, the reasons that there is such a severe discrepancy between the third party calculations and the agency’s estimates of itself have to do with the various assumptions that the agencies are making. Specifically, these agencies, in order to make their numbers look better (and, sadly, negative $136 billion is “better”) misrepresent the actual reality by massaging factors in the following ways:

  1. Overestimating investment return potential (they are assuming between a 7.75 and 8% average annual return— compare this to private pension assumptions between 3 and 4%).
  2. Implementing an abnormally large “smoothing recognition period,” which basically allows the potential market losses to be hidden in an average of many years (15 yrs, compared to the private sector smoothing period of 2 yrs).
  3. Refusing to include the reality of increasing life expectancy into their models, so that their numbers assume they will have to pay for a shorter “lifespan” than what the recent mortality data reflects. Even Governor Brown’s office calculated that “CalPERS needs an additional $1.2 billion a year to pay for added pension expenses due to longer life expectancy.”
  4. Overestimating the length to which public employees will keep working (therein overestimating how many years of contributions will be made and underestimating how many years these employees will be recipients of the pension system).

McQuillan quotes Stanford Professor Joe Nation to say: “In short, public pension systems utilize assumptions and methods supporting a consistent theme of understating liabilities, overstating assets, and pushing costs into the future.” McQuillan himself goes so far as to say: “The bottom line is that officials at California’s public pensions are permitted to engage in behavior that would be considered criminal under ERISA [Employee Retirement Income Security Act—CJE] if done by officials overseeing private-sector pensions.”

To bring things here to a close, let it be said that the systemic problems underlying the numbers themselves are such that there is no easy way to fix this. Even on their face, the numbers summarized above tell a frightening tale of severely underfunded pension obligations, problem which is growing worse and worse. 

What needs to be remembered too, and this is the thing that far fewer people talk about, is that we are on top of a major bull market that has only since January threatened to come back down. The chart below is of the “S&P 500” which is an index of stock market price levels.

As can be seen, we are at much higher levels than we were before both the 2000 “dot com” crash and the 2008 financial crisis. In other words, all these pensions that are relying on years of 7% returns in order to be, well, hundreds of billions of dollars in the hole, may in fact be facing an era of negative returns if we are confronted with the likely situation of a stock market correction.

Needless to say, far from having “their future taken care of,” those relying on public pensions for their retirement are not only going to be requesting funds that simply aren’t there, they are going to be requesting funds from pension systems who have yet to face the third recession in 15 years. A recent report from Casey Research wrote that:

"Public pensions are a slow motion train wreck that can’t be stopped. Millions of workers who expect a steady stream of income when they retire will get nothing. The U.S. public pension system is mathematically guaranteed to crash.


According to the National Association of State Retirement Administrators (NASRA), U.S. public pensions expect to earn 8% per year on average.


That’s a wildly optimistic number. They’re extremely unlikely to earn anything close to 8% per year.


Earning 8% per year in normal times is difficult enough. And as Casey readers know, we’re not in normal times.


Returns on both bonds and stocks will likely be low or negative for the next many years. With interest rates at historic lows, bonds barely pay anything. And U.S. stocks have very little upside because they’re so expensive today.


Expecting returns to average 8% per year going forward is foolish. And we’re not the only ones who think so. BlackRock (BLK), the world’s largest asset manager, says state and local pensions should expect to earn 4% per year or less going forward.


The average public pension earned just 3.4% last year. And Bloomberg Business reports that the California Public Employees’ Retirement System (CalPERS), the largest pension fund in the U.S., earned just 2.4% last year."

Moreover, while many assume these pensions can “just go to the taxpayers” to fulfill their obligations, the fact of the matter is that this is politically and financially impossible in the context of a recession, especially when the taxpayers themselves are facing the reality of this very same market downturn. It is one thing to attempt to siphon off a little bit from taxpayers during a  7 year bull market, but it is an entirely other thing to do the same during a painful downturn. The long and short of the situation is this: those relying on public pensions for their retirement are quite possibly not going to receive the full extent of what they are expecting. 

Practically speaking, therefore, any attempt to protect one’s non-pension assets, retirement accounts, and cash flows, is to be well heeded. This means that it is time to face the reality of the situation before retirement and before it becomes publicly obvious that there is a massive problem. There are many who are putting things off and looking to figure things out down the road. Unfortunately, I am not convinced that the prudent individual can afford this luxury. Some readers may need some creative strategies, capital preservation efforts, and an honest assessment of just how, exactly, one should minimize their dependency on public pensions. This is the key: separating one’s dependency on the pension system for retirement is the only way to avoid pain later on down the road.

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Joebloinvestor's picture

Any pension that isn't fully funded is a Ponzi scheme.

clooney_art's picture

The federal government will pretend there is growth and prosperity everywhere and print more money to fill the pension gaps. There is no way out. Why even think about all of these idiocies.

MagicHandPuppet's picture

Is it just me?  Or, is there a complete ethical breakdown with the entire concept of a "public pension"???

Save_America1st's picture

The Tragedy of California...



there...fixed it for ya ;-)

pods's picture

So a system that depends on compounding yields of 10% YoY to infinity isn't working?

Pensions are a ponzi. Either a human ponzi or a debt ponzi.

Either way, they will never work because the underlying assumptiions are not valid.


SuperRay's picture

Any system that is based on a presumption of future growth is a ponzi scheme, which is essentially every economic system in history.  Exponential growth is eventually unsustainable.  Aren't we lucky to be living witnesses of the truth of this?  :-)

LowerSlowerDelaware_LSD's picture
LowerSlowerDelaware_LSD (not verified) SuperRay Mar 3, 2016 1:36 PM

Just keep squeezing the productive tax payers (pension funders) until they quit and become part of the FSA.  Gubmint plan at its finest.

Mr. Universe's picture

We are in the 26th year of participating in a Ca. county program, with well over 100K invested. At the time the benefits seemed to outweigh the pay scale that was far less than the competition. The county though has done everything possible over the years to make sure people are not encouraged to stay.  If we were not so close to retirement , it would have been over long ago. One colleague told us "We got the Golden Handcuffs".   Now we are looking at a system that I hope we can collect even a dime of what we put in, let alone a lifetime monthly payment (offset by Social security of course).  The real killer in the system was the "spiking" of retirements of the 3% @ 50 safety crew and that whole fiasco. 3% base at 50 years, that's just crazy.  Contingency plans are in place and there is still time. It's not how I'd hope it go down

Lost in translation's picture

Can you pay the penalty and cash out, put the money in something else?

Mr. Universe's picture

Yes you can,

However you are only returned your portion of payments, not the matching funds or interest.

Bumpo's picture

" ...putting current and future taxpayers at risk"

Uhm, I don't think so. Pensions are just investments in the Market. There are no guarantees. Anyone who had a 401k and lost half of it twice knows they aren't going to get any taxpayer help. Time to crawl out of your 'Safe Space" , take your thumb out of your mouth, and deal with reality.

Syrin's picture

How is this a "tragedy"?   The land of the looney bins pay life guards $200,000 then lets them retire with a lavish pension after plugging away for a whopping 20 years.  Great f'ing economic plan.   And oh by the way, a third of the state is made up of illegals who get full benefits.   How can ANYONE do business in a state so corrupt?   It's only been named the worst state for business 8 years in a row.

847328_3527's picture

Moar bonuses and commissions and kickbacks for the pension plan administrators to boot!

MalteseFalcon's picture

"The land of the looney bins pay life guards $200,000 then lets them retire with a lavish pension after plugging away for a whopping 20 years."

Hey, dude, you ever see Baywatch?

Lifeguard/heroes face death everyday!!

August's picture

Yeah... there are sharks out there, man.  Sharks.

Just ask the Fonz.

Max Cynical's picture

Want to see some off the chart California Pensions...

any_mouse's picture

Transfer CA to Mexico for future promises?


holmes's picture

Maybe the Donald can build a wall around CA

NEOSERF's picture

Right, why is Madoff in jail if this is allowed to continue for pension plans?  Wasn't Madoff basically promising 10% every year, sending statements to unwitting investors saying "all is well" and then paying redemptions out of new money...what isn't the same?

lunaticfringe's picture

Government is allowed to break any laws that apply to individuals. They can run Ponzis', counterfeit, even kill people they deem appropriate. You on the other hand- get locked up.

swamp's picture

Employers pay 15 cents.


redd_green's picture

Then, is any ponzi that isn't pensioned, a fund?

Mick Shrimpton's picture

Don't worry, the Federal government would love to step in and help out.

Normalcy Bias's picture

Govt workers take notice. They're going to screw you, too.

MagicHandPuppet's picture

And when they do, there will finally be something worth celebrating.

VWAndy's picture

They already did. Its a done deal. They think all the illegals are paying taxes. lol

redd_green's picture


"We're here from the Government and We Are Here To Help!"

E.F. Mutton's picture

I case you wondered what happened to the Three Card Monte dealers that fled NYC under Giuliani, they now run CA pensions.

The ones that didn't stop in Chicago, that is.

Greenie's picture

Things might get really depressing if we start talking about Illinois.

Father Thyme's picture
Father Thyme (not verified) Greenie Mar 3, 2016 1:06 PM

Have they started paying on lottery ticket wins yet? Or does the Illinois Lottery remain a one-way scam?

TitleZ's picture

Connecticut is waking up to its shitshow now too.  It really is depressing.

JustObserving's picture

Good luck getting 7% returns in the era of NIRP.

US federal unfunded liabilities are well over $220 trillion today and growing at $8 to $10 trillion a year.  

gcjohns1971's picture

In California, you have regular Policemen who are collecting $300,000/yr pensions after 20 years.

You can't fix stupid.

Bastiat's picture

You don't suppose police and fire have any dirt on politicians, or that their unions might let that be known? 

Father Thyme's picture
Father Thyme (not verified) gcjohns1971 Mar 3, 2016 1:19 PM

Policemen who are collecting $300,000/yr pensions after 20 years

And "double-dipping."

Clesthenes's picture

See ‘Is social Security Shortchanging Taxpayers? for examples.

Lost in translation's picture

I know one, lives like a king in Prescott, AZ, now.  Like royalty.  Bought a super-sized McMansion outside of town and then added-on to/expanded it even further.  It's a real palace.  Opulent.

Whenever anyone asks what will happen to him if CA cuts his pension at all he gets real mad and yells, "we have a CONTRACT!"

Special guy. 

kumquatsunite's picture

You are forgetting one thing...The get their pension check on the 1st of the month and their Disability check on the 15th. That's cause all police, firemen, and teachers get disabled the week before they retire.

matagorda's picture

I read the retired sheriff of SLO county gets a cool $600,000. Not bad.

Max Cynical's picture

From 2010...probably higher today.

"Top two sheriff officials double and triple dipping"

San Luis Obispo County Under Sheriff Steve Bolts is taking home between $640,000 and $772,000 this year in retirement benefits and an hourly salary, while his boss, Sheriff Pat Hedges, takes home $340,000

Blankenstein's picture

The Naperville, Il police chief gets to collect both his salary and a pension at the same time for a total of $259,000 in 2013.



"The dismissal of the state's appeal allows Marshall to collect his salary and police pension, which stood at $154,775 and $104,109 respectively last year. The current year figures were not immediately available."


Lorca's Novena's picture

These types of A-holes will be the first to hang from a tree before the bankers IMO. Everyone on ZH knows at least one of these asswipes who had a civil service job that retired at 50 then double dipped, on disability, and has the damn nerve to look down on you.


Like stated above " We have a Contract".... LOL!!!! delusion is a bitch when reality comes a' knockin. (with a rope)

chinoslims's picture

All California govt (municipal, county, state, etc) employees salaries are listed here.

Soul Glow's picture

Growth is assumed in all financial models.  

TrustbutVerify's picture

Name the names of those that shouted down the rational voices that for decades spoke the truth saying the pension schemes wouldn't work.  

We can start with the MSM, the NYT, and WaPo. 

cwsuisse's picture

Rising stock prices are largely irrelevant. Pension schemes need fixed incoome to function. That is not the case. Therefore there won't be any pensions.

jakesdad's picture

what?  it's amost as if you're suggestting...  {GASP!}  cashflow matters?!?


he's a witch!  burn him!!!

2ndamendment's picture

Did anybody anywhere EVER think it was a good idea to allow someone to work for 20 years, contribute almost nothing to their retirement, and then allow then to retire with 80% of their salary for the rest of their lives? Welcome to the California and Illinois Pension systems!