California’s public pension debt grows

The California Public Employees’ Retirement System, the retirement system for California’s state, school, and public agency workers, suffered investment losses of almost $30 billion in 2022. For the nation’s largest public pension system, this is an additional $1 billion in losses from its results reported in July.

CalPERS announced that its investment losses were -7.5% for its fiscal year, a further downgrade from the -6.1% returns reported a few months ago. These losses were in stark contrast to last year’s outstanding investment results when CalPERS posted 21.3% gains, which were mistakenly taken by many as a sign of stabilization.

Currently, the retirement system’s annual assumed rate of return—an estimate of the plan’s investment gains—is 6.8%. Through the years, CalPERS’ failure to meet its assumed rate of return has been the main driver of the system’s unfunded liability. With the latest investment losses applied, Reason Foundation estimates CalPERS’ debt is now $164 billion. This public pension debt roughly translates to over $4,000 in debt for every Californian.

Another marker of a pension plan’s financial health is the ratio of its debt to assets, also known as its funded ratio. After this year’s financial losses, CalPERS reported that its funded ratio plummeted from 81% in 2021 to 72% as of June 30, 2022, which means the pension system now has just 72 cents of each dollar needed to provide the pension benefits that have already been promised to current workers and retirees.

California’s public sector workers’ pensions are guaranteed by the state—meaning that state and local taxpayers are ultimately on the hook for CalPERS’ debt. When pensions are underfunded, like CalPERS is, the state must compensate for the debt through increased contributions. The 2022 fiscal year’s financial losses will likely cause state and local government contribution rates to rise in the next few years as governments, i.e., taxpayers, make up for the difference between the assumed rate of return of 6.8% and this year’s -7.5% loss.

The nonpartisan Legislative Analyst’s Office has determined that required public pension “contributions may increase 5%-12% of payroll over the next several years.” When a more significant chunk of state and local budgets is shifted to cover the rising costs of these pension benefits, other government services must be cut, or governments must pursue tax increases to maintain their current spending levels.

Recognizing that long-term investment forecasts are warning of lower annual returns in the coming decade, CalPERS has wisely lowered its assumed rate of return over the last several years. It has also created an asset liability management process that sets the ground for better balancing the cost of pension payments with expected future investment returns.

However, this year’s dismal financial returns, ongoing worries about a possible recession, the economic slowdown hitting California’s technology sector especially hard, and a state budget deficit that the Legislative Analyst’s Office says will reach $24 billion in 2023-24 are sending strong signals that further action is needed.

CalPERS should be even more proactive in accounting for these economic trends by further lowering its investment return expectations. Based on market expectations of asset growth for the upcoming decades, CalPERS should lower its expected rate of return to under 6.25%.

In addition, the pension plan’s leadership should encourage more government agencies and employers to take advantage of the California Employers’ Pension Prefunding Trust. Prefunding allows employers to generate investment income to pay the required contributions and reduces budget dependency on investment income. Moreover, it helps government employers during challenging financial times by offsetting their pension costs. This strategy would help pay down pension debt faster and stabilize some local government budgets.

During this economic uncertainty, many CalPERS stakeholders likely recognize that the problems that have kept so many public pension systems underfunded for the last few decades still exist. As a result, public pension plans—and thus taxpayers—are as vulnerable to financial shocks as they were in the past. California should prioritize solutions that minimize these risks in the future, making efforts to pay down its pension debt and making CalPERS more resilient and prepared to deal with the ups and downs of an uncertain economic future.

A version of this column first appeared in the Orange County Register.