CalPERS Weighs Pros/Cons Of Setting Reasonable Return Targets Vs. Maintaining Ponzi Scheme

In just a couple of months, the largest pension fund in the United States, the California Public Employees' Retirement System (CalPERS), will have to decide whether they'll rely on sound financial judgement and math to set their rate of return expectations going forward or whether they'll 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.  The decision faced by CALPERS is whether their long-term assumed rate of return on assets should be lowered from the current 7.5% down to a more reasonable 6%. 

As pointed out by Pensions & Investments, the decision has far-reaching consequences.  First, a lower rate of return will equate to higher contribution levels for municipalities throughout California, many of which are on the verge of bankruptcy already.  Second, given that CALPERS is the largest pension fund in the United States, a move to lower return hurdles could set a precedent that would have to be followed by other funds around the country in even worse shape (yes, we're looking at you Illinois).

The stakes are high as the CalPERS board debates whether to significantly decrease the nation's largest public pension fund's assumed rate of return, a move that could hamstring the budgets of contributing municipalities as well as prompt other public funds across the country to follow suit.

 

But if the retirement system doesn't act, pushing to achieve an unrealistically high return could threaten the viability of the $299.5 billion fund itself, its top investment officer and consultants say.

 

“Being aggressive, having a reasonable amount of volatility and (being) wrong could lead to an unrecoverable loss,” Andrew Junkin, president of Wilshire Consulting, the system's general investment consultant, told the board at a November meeting. CalPERS' current portfolio is pegged to a 7.5% return and a 13% volatility rate.

 

The chief investment officer of the California Public Employees' Retirement System and its investment consultants now say that assumed annualized rate of return is unlikely to be achieved over the next decade, given updated capital market assumptions that show a slow-growing economy and continued low interest rates.

 

Still, cities, towns and school districts that are part of the Sacramento-based system say they can't afford increased contributions they would be forced to pay to provide pension benefits if the return rate is lowered.

Of course, the math would seem to imply that a lower return assumption is warranted given low global interest rates and equity markets that are drastically overvalued by almost any historical measure.  Moreover, for 3 out of the past 5 calendar years, CALPERS has missed their 7.5% return threshold and their 10-year cumulative returns are 6.2%, a far cry from their 7.5% projection.

Only a year earlier, CalPERS investment staff and consultants had agreed that CalPERS was on the right track with its 7.5% figure. So confident were they that they urged the board to approve a risk mitigation plan that did lower the rate of return, but over a 20-year period, and only when returns were in excess of the 7.5% assumption.

 

Two years of subpar results — a 0.6% return for the fiscal year ended June 30 and a 2.4% return in fiscal 2015 — reduced views of what CalPERS can earn over the next decade. Mr. Junkin said at the November meeting that Wilshire was predicting an annual return of 6.21% for the next decade, down from its estimates of 7.1% a year earlier.

 

Indeed, Mr. Junkin and Mr. Eliopoulos said the system's very survival could be at stake if board members don't lower the rate of return. “Being conservative leads to higher contributions, but you still have a sustainable benefit to CalPERS members,” Mr. Junkin said.

Calpers

Calpers

 

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.

And, just to confirm the ponzi, P&I points out that for the 2015 fiscal year, CALPERS paid out roughly $5BN more in benefits than they received in contributions.

Compounding the problem is that CalPERS is 68% funded and cash-flow negative, meaning each year CalPERS is paying out more in benefits than it receives in contributions, Mr. Junkin said. CalPERS statistics show that the retirement system received $14 billion in contributions in the fiscal year ended June 30 but paid out $19 billion in benefits. To fill that $5 billion gap, the system was forced to sell investments.

 

CalPERS has an unfunded liability of $111 billion and critics have said unrealistic investment assumptions and inadequate contributions from employers and employees have led to the large gap.

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.