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CalPERS latest financial report shows another dismal year

by CORY EUCALITTO | January 7, 2013

Reports have estimated California's unfunded public pension liability somewhere between $400 and $500 billion dollars. The California Public Employees' Retirement System's (CalPERS) latest Comprehensive Annual Financial Report for fiscal year 2012 shows the extent to which the state's pension problem continues to grow. CalPERS, the country's largest pension system, experienced devastating investment returns, skipped required contributions, all in the face of a rising benefit load.

The fund achieved an annual investment return of just 0.1 percent. By contrast, the system's assumed rate of return, which it uses to calculate annual contributions, is 7.5 percent. Over ten years, the total investment return was 6.1 percent - a more respectable achievement, but again not one reaching the rate necessary to meet actuarial assumptions. CalPERS CEO Anne Stausboll's introductory letter touts the decision to reduce the assumed rate of return to 7.5 percent from 7.75 percent, but a quick look at the ten-year return, or especially the five-year return of -0.1 percent, shows that actuarial assumptions are still out of touch with reality.

One inconvenience standing in the way of lower assumptions is they would require increased annual contributions, taking an even larger chunk out of already crunched state and local budgets. In CalPERS' case, though, employers are already having trouble meeting actuarially determined Annual Required Contributions (ARC).

While the state fully met its required contribution for the Public Employees' Retirement Fund (PERF), that figure has grown by over $1 billion in just five years. Further, employers met just 14.4 percent of the Judges' Retirement Fund's (JRF) ARC. This trend holds true for the system's non-pension health benefit fund as well. There, only 63.2 percent of required contributions were met.

According to research into ten year's worth of financial reports, between FY 2003 and FY 2012, the state underfunded required contributions for PERF, JRF, and JRF II by over $5 billion. It may be acceptable to blame poor investment returns on the European financial crisis, but this negligence is only the result of lawmakers' unwillingness to meet the promises made to employees, and instead shift the future burden onto taxpayers.

To make matters worse, the report shows growing benefit payments despite poor investment returns and missed required contributions. The PERF, for example, paid out $15.4 billion in retirement benefits to a total to 543,722 participants in the fiscal year. This was up from $14.2 billion to 528,343 participants one year before. The increase was driven both by a larger number of members reaching eligibility and increased individual benefit amounts driven by cost of living adjustments.

Perhaps nothing illustrates the immediate repercussions of chronic mismanagement than what it means for 3,064 participating cities, counties, school districts, and other employers. For example, one direct result of the 0.1 percent investment return is that state and local school districts will see their required contributions grow by as much as 2 percent by FY 2014. Public agencies will see this same increase by FY 2015. Contributions are then expected to grow by another 0.2-0.7 percent the following year, to the extent that the fund meets its 7.5 percent investment return assumption! Coming off a year of 0.1 percent returns, this sounds like cruel comedy. The punch line is that every dollar spent making up for CalPERS' missteps is a dollar not spent in the classroom or picking up the trash.

Of course, one can pull as many bad omens as desired out of a single year's financial report. What truly matters to retirees and taxpayers alike is the overall health of the system. To this question, one must look not at official financial reporting shrouded in the mysticism of Governmental Accounting Standards Board rules, but to fair market valuation of public pension funds. As economist Andrew Biggs has shown, the state's total unfunded liability was nearly $400 billion all the way back in 2010. One can hardly imagine the impact that CalPERS' latest financial reporting will have on this already tremendous burden.

Given the magnitude of the crisis and its ever-growing nature, the only truly sensible solution is to immediately cap existing defined benefit pension programs. Instead, new and existing employees should be shifted into defined contribution retirement plans. Defined contribution systems have a strong track record of providing retirement security in both the private sector and in public higher education. They would put an end once and for all to the proliferation of taxpayer risk put on the line by current defined benefit schemes.

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