A few weeks ago we asked whether CalPERS would rely on sound financial judgement and math to set their rate of return expectations going forward or whether they would cave to political pressure to maintain artificially high return hurdles that they'll never meet but help to maintain their ponzi scheme a little longer (see "CalPERS Weighs Pros/Cons Of Setting Reasonable Return Targets Vs. Maintaining Ponzi Scheme"). The decision faced by CALPERS was whether their long-term assumed rate of return on assets should be lowered from the current 7.5% down to a more reasonable 6%. Well, we now have our answer and it seems the board erred on the side of maintaining the ponzi with a decision to reduce the fund's discount rate by only 50 bps, to 7%, to be phased in over 3 years.
Of course, this decision should come as little surprise to our readers as we concluded our previous post with the following prediction:
We've seen this battle between math/logic and politicians played out numerous times in states all across the country. Somehow we suspect that "math/logic" will continue to lose...better to bury your head in the sand for a couple of more years and pretend there is no problem.
Per The Sacramento Bee, the CalPERS board approved the discount rate adjustment with a vote of 6-1 and the reduction will be phased in over 3 years starting next July.
CalPERS moved to slash its official investment forecast Tuesday, a dramatic step that will translate into billions of dollars in higher annual pension contributions from the state, local governments and school districts.
Employees hired after January 2013, when a statewide pension reform law took effect, will also have to kick in more money. Older employees could see higher contributions, too, although that would be subject to contract bargaining.
CalPERS’ Finance and Administration Committee voted 6-1 to lower the forecast from 7.5 percent to 7 percent in phases over three years, starting next July. Although the committee’s vote must be ratified by the entire board Wednesday, most other board members indicated they support the move as well.
It would be the first adjustment to the forecast in four years.
The move is a recognition that investment returns are falling and that the California Public Employees’ Retirement System, which is just 68 percent funded, needs higher contributions from government agencies to solve its long-term problems.
“We’re in a low-growth (investment) environment, and it’s expected to remain that way the next five to 10 years,” board member Henry Jones said.
While a 50bps decrease to a 7% discount rate will still trigger roughly $1 billion in incremental annual contributions from various California government entities according to Eric Stern of the California Department of Finance, it is still a long way from the fund's estimated returns of just 6.2% over the next decade which happens to match exactly their returns from the past decade.
Of course, mathematical realities have to be weighed against the risk of disrupting the ponzi scheme and forcing several California cities to the brink of bankruptcy.
But a CalPERS return reduction would just move the burden to other government units. Groups representing municipal governments in California warn that some cities could be forced to make layoffs and major cuts in city services as well as face the risk of bankruptcy if they have to absorb the decline through higher contributions to CalPERS.
“This is big for us,” Dane Hutchings, a lobbyist with the League of California Cities, said in an interview. “We've got cities out there with half their general fund obligated to pension liabilities. How do you run a city with half a budget?”
CalPERS documents show that some governmental units could see their contributions more than double if the rate of return was lowered to 6%. Mr. Hutchings said bankruptcies might occur if cities had a major hike without it being phased in over a period of years. CalPERS' annual report in September on funding levels and risks also warned of potential bankruptcies by governmental units if the rate of return was decreased.
Meanwhile, Richard Costigan, chairman of the CalPERS finance committee, who vowed that "this is just a start," more or less admits that the decision was politically motivated to allow "municipalities and other government agencies some breathing room before they absorb the impact."
Board members, however, defended the action as a compromise; it will help stabilize the fund while giving municipalities and other government agencies some breathing room before they absorb the impact. Richard Costigan, chairman of the finance committee, said CalPERS officials will continue to look at the fund’s investment strategies over the next year.
“This is just a start,” Costigan said.
Now all eyes will turn to the 37.6% funded Illinois pension fund, as well as many others, to see if they follow suit.