California Pension Move Could Cost Both State and Localities

By: - April 2, 2012 12:00 am

The California Public Employee Retirement System (CalPERS), the nation’s largest public pension fund, yesterday moved closer to adopting a more conservative forecast for the performance of its investments, in a move that would make state agencies  and local governments pay more to support the system. 

A CalPERS committee voted to lower its expected rate of return from 7.75 percent to 7.5 percent. The full CalPERS board will vote on the proposal today. While CalPERS has averaged an annual return of more than 8 percent over the last 20 years, the fund’s chief actuary, Alan Milligan, considers that return unlikely in the future. In fact, he gives CalPERS only a 50 percent chance of averaging 7.5 percent. Milligan recommended last month that the rate drop to 7.25. 

The CalPERS board is reluctant to go that far, though, because the more cautious approach comes with a big trade-off, especially at a time when California and its local governments still have major budget problems. If the system expects less money in investment earnings, it needs to collect more money from all its members, state and local, to have enough to pay its obligations to retired workers. Shifting to 7.5 percent would cost California’s general fund an additional million in the fiscal year that begins July 1, while a move to 7.25 percent would cost it million. The state will contribute around .5 billion to CalPERS this year. Some representatives of local governments and public employee unions have argued against going to 7.25 percent. 

Similar debates are going on at other pension funds, in California and around the country. The California State Teachers’ Retirement System lowered its expected rate of return to 7.5 percent last month. 

The backdrop to the decision is that California, like many other states, is debating an overhaul of its pension system because of concerns that it will not have enough money to meet its commitments. California Governor Jerry Brown has a proposed a 12-point pension revision that would make benefits less generous in a number of ways, including raising the retirement age for new state workers. 

On paper, a lower expected rate of return would make the CalPERS unfunded liability look bigger. However, it also might put the system on a more sustainable path because the system’s investments would be less likely to fall short of expectations in the future. “Our actuary does say that if we do not take this step, it ultimately will mean a weaker-funded system,” says Amy Norris, a CalPERS spokesperson, “and that would ultimately result in higher contributions from our member agencies.”

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Josh Goodman

Josh Goodman helps lead research on fiscal management and place-based economic development programs as part of Pew’s state fiscal health project. Goodman has served as a primary author for Pew studies that examine how states should evaluate tax incentives and maintain budget discipline when implementing those incentives.