A divided CalSTRS board on Friday delayed action until November on a staff recommendation to lower its earnings forecast, a change that would boost the multi-billion dollar increase already wanted from the Legislature.
A majority of the board, seeing no need for prompt action, asked for more information about why markets are expected to yield lower earnings, a recommendation in writing from actuaries, and information about a pending accounting rule change.
But two of the 12 board members said the board should be “totally honest” and “wave a red flag” that the California State Teachers Retirement System needs additional money after huge investment losses in the stock market crash.
The recommendation to lower the earnings forecast from 8 percent a year to 7.5 percent over the next three decades is costly because CalSTRS, like most public pension funds, gets most of its money from investments.
With 8 percent earnings, CalSTRS already wants increased contributions amounting to 14 percent of payroll – a major increase in the current contribution of school districts 8.25 percent of pay, teachers 8 percent, and state 4.5 percent.
Dropping earnings to 7.5 percent would boost the contribution increase to 20 percent of pay, nearly doubling the current payment. The staff report gave no dollar amount. But the state teacher payroll last year was $28 billion.
Doing the math, a contribution increase wanted under the current earnings rate would be $3.9 billion. Lowering the earnings rate would boost the contribution increase to $5.6 billion.
The Legislature is struggling with an estimated $19 billion deficit in the new fiscal year beginning July 1. The CalPERS board has already decided to wait until next year before beginning to push for a contribution increase.
The staff recommendation to lower the assumed earnings was expressed in mild language, with no lecture about how the Legislature can pay now or pay a lot more later if the funding gap is allowed to widen.
“The impact of reducing the assumed investment return will not have a substantial impact on individual members, but will result in a better representation of the fiscal condition of CalSTRS benefit programs based on the current economic outlook,” the staff report concluded.
Lowering the assumed earnings rate could reduce some disability payments, supplemental annuities and other benefits. The staff report outlined the reductions in detail before saying they are not “substantial.”
In rough terms, CalSTRS has an investment portfolio worth $130 billion and annual contributions of $5.8 billion. After the market crash, the big fund assured retired teachers, who receive no Social Security, that future pension payments are secure.
Unlike nearly all public pension funds in California CalSTRS lacks the power to set its own contribution rates. But the staff report said a lower earnings rate could trigger a small contribution increase under a 1990 law, $150 million.
The nonpartisan Legislative Analyst thinks the increase under the law would be $111 million or more in the fiscal year beginning in July of next year and could grow to $425 million or more by 2016.
As CalSTRS works on a strategy to get a contribution increase from the Legislature, the larger California Public Employees Retirement System is debating whether to impose a contribution increase on the state now or wait.
A CalPERS decision about increasing the state contribution $600 million to $3.9 billion was postponed until later this month. State Treasurer Bill Lockyer said boosting the payment as the state faces a huge general fund deficit would be imprudent.
The Legislative Analyst estimates that only about $100 million of the proposed CalPERS increase would come from the deficit-ridden state general fund. The rest would come from special funds such as transportation.
A lengthy process at CalPERS, including public hearings, could result in lowering its assumed earnings rate, 7.75 percent, early next year. Last month the CalPERS staff and four consultants made 10-year earnings forecasts averaging 7.29 percent.
At the CalSTRS board meeting yesterday (June 4), consulting actuaries from Milliman said the average earnings rate assumed by large public pension funds is 7.9 percent. But many are lowering their forecasts.
Board member Carolyn Widener said an earlier Milliman report said 8 percent earnings were “reasonable.” She criticized the actuaries for not putting the 7.5 percent recommendation in their written report, instead of only in a slide presentation.
The board members have a “fiduciary” obligation to protect the interests of retirement system members. The CalSTRS general counsel, Brian Bartow, said the recommendation should be in a written record.
“I would prefer if I had my choice,” said Ian Lanoff, the CalSTRS fiduciary counsel told the board, “that you wait and see something in writing that fleshes out the recommendation, because to me it really came out of the blue and sort of surprised me.”
Board member Chris Solich, representing Treasurer Lockyer, suggested a workshop to help members understand why earnings are expected to decline. She also said the treasurer supports building a “record” for an earnings rate change.
A big reason for the declining earning forecasts is the historically low yield on bonds, making them very sensitive to interest rate increases, said Allan Emkin of Pension Consulting Alliance.
“If the interest rates go the other way and go up one percent, which I don’t think anyone would think would be that radical, you will get a 9 percent reduction in the value of your fixed income portfolio,” Emkin told the board.
Board member Peter Renke said the Governmental Accounting Standards Board may propose changes this month that could change the way pension funds calculate their unfunded liabilities.
“We are kind of having this conversation and mentioning in passing, ‘Oh by the way, GASB may be likely to offer some proposed changes that would revolutionize how we account,” Renke said.
Board member Roger Kozberg said he does not think GASB will change CalSTRS operations or investment policy. He said the board’s “primary obligation” is to give its best estimate of earnings, which can change with circumstances later.
“I am absolutely comfortable in implementing the staff’s recommendation today,” said Kozberg, “and I think to do anything less would not be totally honest.”
Board member Cynthia Bryant, representing Gov. Schwarzenegger’s finance department, said the board should act on the recommendation of staff and the experts.
“I think part of our job is to stand on the west bank of the Sacramento River,” she said of the location of the new CalSTRS building, “and wave a red flag at the policymakers across the river and say, ‘Here is the real situation of our fund.'”
Reporter Ed Mendel covered the Capitol in Sacramento for nearly three decades, most recently for the San Diego Union-Tribune. More stories are at http://calpensions.com