CalPERS has spoken. Its ominous message is reverberating through government buildings and employee cubicles all over California.
The CalPERS governing board agreed Wednesday to reduce its official investment forecast by a half a percentage point over the next three years. That seemingly innocuous decision will mean substantially higher pension contribution rates for the state, local governments, school districts and at least some public employees.
It’s the first time in four years CalPERS has lowered its forecast. The move, closely watched in the pension industry, reflects an acknowledgment that investment returns are softening. “This is very monumental for the organization,” said board member Richard Costigan moments before the vote.
The state says its CalPERS bill will increase by $2 billion a year, including a $1 billion-a-year hit to the general fund. Representatives of California’s school districts said they’ll have to shell out another $500 million a year. There was no estimate of the impact on municipalities, but officials warned the decision could further strain budgets that are still struggling to recover from the recession.
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“It is possible that we could see some bankruptcies,” said Dane Hutchings of the League of California Cities in an interview Wednesday.
The change will cost local governments in the Sacramento area millions of dollars.
Phil Wright, finance director for West Sacramento, said the city’s revenue has improved in recent years, but “it all goes to PERS.” Rising pension costs have prevented West Sacramento from rehiring workers who were laid off during the recession, he said.
At the city of Sacramento, previous rate hikes approved by CalPERS have cost $32 million a year – the equivalent of a 10 percent pay raise for every worker, said finance director Leyne Milstein. The latest decision will set the city back another $6 million a year, she said.
Dennis Meyers of the California School Boards Association said the total impact on school districts will come to $500 million a year. “That’s money that’s not being able to be used to reduce achievement gaps or buy textbooks or technology,” he said.
But Meyers, like most others who addressed the CalPERS finance committee on Tuesday, said school districts were ready to pay more to improve the fund’s finances. Despite its $303 billion in assets, the pension system is only 68 percent funded. Its investment returns have weakened in recent years, and it’s spending about $5 billion a year more on retirement benefits than it’s taking in.
“You have to do what you have to do,” Meyers told the CalPERS finance and administration committee Tuesday. The committee voted to move ahead, and that decision was ratified Wednesday by the full board.
The decision means government employees hired after January 2013, who are covered by the statewide pension reform law, will have to contribute more to the system. Other workers could be affected, too, as the strain on government budgets leaves less money available for raises when contracts are renegotiated.
Even their representatives acknowledged the importance of making CalPERS stronger. “That little extra they may have to contribute will benefit them in the long run when they retire,” said CalPERS board member Michael Bilbrey, who represents current and retired workers.
Gov. Jerry Brown, who in years past has accused CalPERS of sidestepping its funding problems, applauded the move. “This will make for a more sustainable system,” he said Wednesday.
As the largest U.S. public pension fund, nearly every move made by the California Public Employees’ Retirement System carries weight. This is no exception. Although other pension have reduced their investment forecasts in recent years, “obviously CalPERS is the biggest group in the bunch,” said Keith Brainard of the National Association of State Retirement Administrators. “When they make a change like this, it tends to get noticed.”
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By an 11-0 vote, with one abstention, CalPERS agreed to lower its forecast of annual investment returns to 7 percent, from the current 7.5 percent. The decline will be phased in over three years, although the full financial impact on agencies will take eight years.
CalPERS will have one of the most conservative forecasts among state pension plans in the country. Brainard said only 16 pension systems, out of 127 he follows, have forecasts of 7 percent or lower. CalSTRS, the California teachers’ pension system, maintains a forecast of 7.5 percent, which Brainard says is about average.
Although the Dow Jones average is flirting with the 20,000 mark, a softening worldwide economic climate is driving the reduced investment forecasts. CalPERS earned just 0.61 percent on its investments in the last fiscal year, and has averaged 4.6 percent over the past 10 years, according to Chief Investment Officer Ted Eliopoulos.
As the investment climate weakens, CalPERS is turning more conservative. It disclosed earlier this week that it will pare back some of its stock holdings in favor of more stable investments like real estate and certain types of bonds.
That will hinder CalPERS’ ability to earn its way out of its funding hole. But officials said the cautious approach is sensible as markets become more volatile.
“Juicing up the risk is not the answer,” said board member Priya Mathur.
The debate was heavily influenced by one grim prediction in particular: Wilshire Associates, a key CalPERS consultant, said last month the fund’s investment returns are expected to average 6.2 percent over the next decade.
Why, then, isn’t CalPERS reducing its forecast even lower than 7 percent, as some critics urged?
For one thing, CalPERS officials said Wednesday’s decision isn’t the last word; they will continue to scrutinize their strategies. Besides, Wilshire believes returns should start improving a decade from now, to somewhere well north of 7 percent.
Finally, CalPERS officials said they couldn’t slam government agencies with a massive pension rate hike all at once. “We are not doing this to bankrupt anybody,” said board member and state Controller Betty Yee.
Costs will start rising for the state next July, with the beginning of the new fiscal year. Municipalities and school districts will start paying more in July 2018.
By one estimate, CalPERS has missed out on $3 billion in financial returns by refusing to buy tobacco stocks. But the pension giant decided in 2016 to stick with the ban despite a recommendation from its staff that the ban be relaxed.