CalPERS May Lower Investment Target, Raising Rates

(March 13, 2011) — The $230.1 billion California Public Employees’ Retirement System (CalPERS) may make a small accounting change that would reduce its investment target.

CalPERS staff has suggested that the board lower its estimate about the amount of money the fund will make in the future, reducing its discount rate assumption from 7.75% to 7.5%. The decrease in the investment earnings forecast could put greater pressure on the state and municipalities, forcing them to increase the amount they pay into the pension fund, probably by $200 million or more. If approved, the contribution increases would reportedly be effective July 1 for the state and July 1, 2012, for municipal agencies.

“There appears to be a consensus that returns are expected to be lower than historical returns over the next 10 years,” Alan Milligan, CalPERS’ chief actuary, said in a report. “Given that the median investment return net of administrative expenses is 7.80%, we recommend that the discount rate assumption be lowered to 7.50% per year to have a margin for adverse deviation similar to that currently used. Given that the state of the economy has put severe pressure on employers’ budgets, we recognize that it may be appropriate to reconsider the level of margin for adverse deviation,” the report noted.

As of February, CalPERS, the nation’s largest public pension, estimated a shortfall of about $75 billion between its accrued liabilities and the market value of its assets.

Last year, a report released by the Stanford Institute for Economic Policy Research (SIEPR) showed that the shortfall or unfunded liability of the three state retirement systems was not $55 billion as reported, but instead about $500 billion. The calculations from the SIEPR study, conducted by Stanford University graduate students, revealed that California’s three main public employee pension funds — CalPERS along with the California State Teachers’ Retirement System (CalSTRS) and University of California Retirement System (UCRS) — are in more serious financial difficulties than previously believed, resulting in more pressure on the state’s budget and a shortage of pension funds in the future. According to the report, titled “Going For Broke: Reforming California’s Public Employee Pension Systems,” the state of California’s real unfunded pension debt had so far been understated due to the accounting rules used. The Stanford report confirmed a recent report with similar, alarming findings from Northwestern University and the University of Chicago.

In response, CalPERS Chief Investment Officer Joe Dear wrote an article published in The San Francisco Chronicle, opposing the validity of the findings. “The study is fundamentally flawed because it is based on a what-if scenario that does not reflect how most public pension funds invest their assets,“ he wrote.

According to Dear, the “purely hypothetical” study uses a controversial method of calculating government pension liabilities, which he said doesn’t match with governmental accounting standards. “The Stanford study used an artificially low investment return assumption that’s about half of our historical average,” he asserted.