CalPERS Refuses To Bite Bullet

Will Continue Deferring Costs To Next Generation

According to the New York Times, CalPERS will not consider cutting its investment return assumption below 7 percent, a rate well above long term historical returns for similar portfolios and its consultant’s forecast. The negative consequences for future generations are huge. Here’s how:

Let’s say you establish a fund to pay for your new baby’s college tuition. You expect tuition to cost $100,000 in 20 years and the college fund to earn 7 percent per year. How much do you need to contribute this year? The answer: $26,000. But what happens if that $26,000 actually earns 6 percent? The fund will have only $83,000 by year 20, leaving your child $17,000 short. Had you assumed 6 percent instead of 7 percent, you would’ve contributed $31,000 upfront and left no deficit for your child.

In other words, had you contributed $5,000 more today your child wouldn’t face a $17,000 deficit 20 years from today.

Now do the same math for CalPERS, which currently requires annual contributions of $14 billion based upon a 7.5 percent assumption. CalPERS proposes to reduce that rate to 7 percent. Using the same 20 year example, that would boost required contributions to ~$15 billion. But what happens if that $15 billion earns 6 percent instead of 7 percent? The fund would end up $10 billion short. Had CalPERS assumed 6 percent at the outset, it would’ve required $18 billion upfront and left no deficit.

In other words, if the current generation contributes $3 billion more today, the next generation won’t face a $10 billion deficit in 20 years. That’s the math for just a single year’s failure to contribute sufficient funds to meet pension promises. Also, the NYT reports the board plans to phase in the reduction, meaning even greater deficits.

The board, which is dominated by government employees, has an incentive to assume unreasonable rates of returns. As explained here, while both employees and citizens share in contributions, only citizens pay for deficits. Unreasonable investment return assumptions lower costs for employees at the expense of much higher costs for citizens.

Future generations should not be forced to pay off promises to public employees who provided services to past generations. CalPERS’s past unreasonable assumptions have already created pension deficits that will already crowd out $300 billion of government services over the next 30 years, and that doesn’t count the additional crowd-out from CalSTRS’s deficit or the deficits associated with retiree healthcare. Any way you look at the math the consequences are cruel to young people and their descendants. They are also dangerous, because diversions from government budgets to pay off pension debts prevent generations from fielding enough police and fire personnel, not to mention teachers and environmental engineers.

CalPERS should’ve adopted a reasonable rate of return long ago. It’s long past time for it to do the right thing.

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