In the coming years the light amount of chatter will turn into a roar in discussion about the future solvency of public pension systems. The majority of state run public pension systems throughout the U.S. are facing a difficult predicament. Assumed returns have not lived up to expectations, a greater share of pensioners are pulling from the pool of funds, and the base of contributors (employees) is not growing at a sufficient rate to help offset pension retiree outflows. One of the larger state pension systems, CalPers, faces this exact problem. Earlier this month the CalPers board took action to help thwart this impending problem, but will it be enough to ward off a future train wreck?
CalPers, like other pension systems, find itself in a bind based on a number of issues. A main issue is the fact that the average return on investment has under-performed over the last 10 years versus what assumed returns have been. Roughly, the 10-year average has been slightly over 6%, while the assumed rate per year was 7.5%. While in one year this might not be that big of a miss, the fact that we’re looking at a period of a decade brings into the reality of compounding returns. For every year performance isn’t up to expectations a deeper and deeper hole is dug. Since that hole has been dug and we are standing in it, future actions must change.
The future for CalPers means a reduction in assumed returns. A phased approach will bring the assumed rate down to 6.5%. Since returns are assumed to be lower in the future, the dollars needed to make up for the lesser returns must come from other sources. The primary source will be what is known as employer contributions. For every dollar made by public employees, a larger share will need to be contributed by the employer to CalPers. In addition, employees contribution amounts will also increase. This will help counter the fact that less returns on the money being invested are assumed in the future.
At this point, some credit must be given to CalPers in their action to address the pensions issues before they become something that is beyond manageable. Yet, given the reality we face, the chatter will ultimately lead to the fact that a greater amount of money going to pensions means fewer dollars going to providing the services and goods the organizations are created provide. Whether it is fire, police, school, health, or any form of government administration, less money will be available because of the increasing needs of state pension systems. Once this becomes more apparent, it is likely to be a point of contention.
In the larger picture, CalPers is not a stellar and not a bottom rung state pension system when compared to the rest of the state pensions. Will it become insolvent? Probably not, unless we see a major financial market fall out reminiscent of last decade’s collapse. In such a case, conditions could call for excessive contribution increases, which would call into questions the ability of local agencies to function properly. Assuming such a situation does not arise, what will occur is a gradual increase in the form of a wealth transfer from today’s services, goods and employees to the massive wave of Baby Boomers that have or will shortly retire and draw from a pension system.
Whether we realize it or not, the pension problem is not only a public institution problem. It is a problem that impacts everyone, from the roads we drive on, to the schools our children attend, to the emergency services we count on in times of need. The system is an interconnected web, which reminds us of the inconvenient truth that there is no free lunch. When part of a structure is weak, another part of the structure must bear an additional burden. The public pension burden is here and will become heavier each year into the foreseeable future.