Four years ago, as the California State Teachers’ Retirement System still was recovering from the dot-com bust at the turn of the decade, its leaders learned some troubling news. The pension fund was $20 billion short on money needed to pay retirees over the next 30 years.
But rather than hike contributions from teachers and school districts, CalSTRS officials decided, in the words of Chief Executive Jack Ehnes, to “roll the dice” and bet that a flourishing bull market would make their woes disappear. “There was a 40% chance we could invest our way out of it,” Ehnes said recently.
It turned out to be a bad bet. Now the state, its schools and teachers, under law, will have to cover the losses.
CalSTRS’ $130-billion investment portfolio lost more than a quarter of its value in the recent recession. The projected shortfall at the state’s second-largest public pension fund ballooned to $43 billion by last June.
“There’s no doubt about it -- we need to come up with a new financial plan,” Ehnes said.
The 97-year-old pension plan must ask the state Legislature, the governor and taxpayers for billions of dollars. Getting that money -- even with an expected massive lobbying campaign and a bruising political battle -- is no sure thing.
CalSTRS’ board is “delusional if it expects the state to bail them out,” said Marcia Fritz, president of the California Foundation for Fiscal Responsibility. The Sacramento group wants to reduce pension benefits for newly hired government workers, another way to reduce the shortfall.
“It will be difficult to attract support” from legislators, let alone the public, Ehnes acknowledged.
After all, few private-sector workers have guaranteed lifetime pension benefits. They’re not likely to want to spend more on retired teachers, community college instructors and school administrators if it means additional slashing of budgets for schools, universities, prisons, health programs and social services. Last year, the Legislature and governor slashed $60 billion from the state budget, and they expect to cut $20 billion more this year.
CalSTRS’ troubles come at a particularly sensitive time. A political corruption scandal at a large New York state government pension fund has put the spotlight on public pensions as corporate America has been laying off workers, freezing pay and curbing 401(k) fund contributions.
The state’s biggest public pension fund, the $200-billion California Public Employees’ Retirement System, has opened an internal probe into possible influence peddling by so-called placement agents. Such go-betweens often earn huge commissions by helping private equity and real estate investment funds gain access to retirees’ money.
The state attorney general’s office and the U.S. Securities and Exchange Commission also are looking at placement-agent activities at CalPERS, including those by former board member Alfred J.R. Villalobos. He was paid almost $60 million in fees by investment fund managers who did business with the pension fund. The teachers pension has not been tainted by alleged wrongdoing.
Local government pension funds in Los Angeles, San Diego, Orange County and elsewhere have been grappling with finding ways to meet their own expensive obligations.
“It’s clearly the case that public-sector pensions across the country are coming under the microscope,” said Olivia Mitchell, executive director of the Pension Research Council at the Wharton School at the University of Pennsylvania. “The public-sector pensions have discovered what the corporate sector figured out 15 or 20 years ago: Offering defined-benefit plans looks predictable and safe, but there are many perils hidden in the details.”
Those perils -- poorly performing investments, growing pension obligations and mounting pressure on state and school-district budgets -- are becoming starkly clear at CalSTRS. Its ratio of expected assets to pension obligations at the beginning of the decade was 110%, meaning CalSTRS had more than enough money to pay all future pensions.
By last June 30, the ratio had fallen to 77%, below the 80% that experts consider to be the minimal secure level. Independent actuaries project that the funding ratio could plunge to 13% by 2039 and to zero in 2045, leaving the state government legally obliged to pay the entire pension bill for the next generation of retiring teachers.
The CalSTRS board wants to raise new money by increasing contributions made by the state, school districts and community colleges to as much as 22% of total payroll, from 8% now, over the next 30 years. It also is considering boosting working teachers’ contributions by an undetermined amount, from a current 8.25% of payroll.
And if the shortfall isn’t addressed in the next few years, the cost to the state of meeting its century-old obligation would grow proportionately greater until it reaches “a tipping point when things get too expensive,” Ehnes warned.
The annual contributions from the state, local school districts and community colleges to CalSTRS, about $3.5 billion for the upcoming fiscal year, would need to be raised by an additional $4 billion in 2011, the fund estimates.
Waiting just five years to raise the contribution level would boost that annual increase to $6 billion, and waiting 10 years would increase the amount to $8 billion, CalSTRS said.
The increases are necessary because CalSTRS’ actuaries say the fund would need a return on investments of more than 20% a year over the next five years to make up for recent recessionary losses. Over the last 30 years, CalSTRS’ portfolio has increased an average of 8.65% a year.
In an attempt to be more conservative, the board now is considering reducing its assumed annual return to as low as 7.5%. CalPERS also is considering lowering its 7.75% benchmark.
Those assumed numbers are still higher than the 6.9% annual return that investment guru Warren Buffett assumes for investments held by pension funds at units of his Berkshire Hathaway Inc.
“Who are they [CalSTRS] kidding? They should not be assuming more than 6%,” said David Crane, a former investment banker and the governor’s special advisor for jobs and the economy.
“Unreal assumptions,” he warned, “will come out of the pocket” of future generations of Californians.