The two big state pension funds have been on very different paths since both had large surpluses in 2000. But they will have identical funding levels if CalSTRS, like CalPERS last month, adopts a recommended lower investment earnings forecast this week.

Though their pension generosity and investment portfolios are different, both of their funding levels will have dropped from about 69 percent of the projected assets needed to pay future pensions, before the earnings forecast were lowered, to 64 percent afterward.

Identical funding levels are even more suprising because the annual rates school districts pay to CalSTRS, a public pension oddity with no power to raise employer rates, have been frozen for most of the time since 2000 when it was 120 percent funded.

Legislation for a “funding solution” in 2014 and pension reform in 2013 gave CalSTRS limited power to raise state and new teacher rates, following small current rate increases for the state and teachers. School districts were hit hard with new rates that more than double by 2020.

CalPERS dropped employer rates to near zero when it was 135 percent funded in 2000. Then rate increases were limited by an unusual actuarial method (reformed in 2013) that “smoothed” investment gains and losses over 15 years and refinanced pension debt annually.

CalPERS also had major losses from ill-advised real estate investments, made an untimely shift to global stocks outperformed by U.S. stocks in recent years, and had a five-year investment performance that Wilshire consultants ranked dead last among big pension funds.

Yet despite their different paths, the 69 percent funding levels last year of the California Public Employees Retirement System and the California State Teachers Retirement System were not far from national averages.

The aggregate funding level for the 100 largest U.S. public pensions was 70 percent last year, Milliman actuaries reported, using their own earnings forecasts for the investment portfolios rather than those of the pension funds, which critics say are too optimistic.

The aggregate traditional funding level for a sample of 160 state and local pensions in the Public Plans Database was 74 percent in 2015, the Center for Retirement Research at Boston College reported last year, and 72 percent under new government accounting rules.

Why the similarity among pension funding levels? Experts say they are all in an investment “low return environment” caused in large part by a government policy that keeps key interest rates low to spark economic growth.

“Recent economic conditions have seen continuing declines in long-term government bond interest rates that serve as the foundation of capital market returns,” said a report by actuaries that recommends CalSTRS lower its earnings forecast from 7.5 percent to 7.25 percent.

“This has resulted in a general lowering of the expected returns (at least over the medium term) from the various asset classes and translated into a lowering of the investment return assumption by many public pension plans across the nation.”

CalPERS consultants predicted last year that a “low interest rate and low return environment” would give its investment portfolio a 6.2 percent return during the next decade before averaging more than 7.5 percent over the next three decades.

The CalPERS board responded last month by adopting a more conservative investment portfolio and lowering the earnings forecast used to offset or “discount” future pension obligations from 7.5 percent to 7 percent.

To fill the resulting funding gap, a major employer rate increase will be phased in over eight years, the fourth increase since 2012.


A chart created by CalPERS staff last year to “frame the big picture” funding challenge shows a long drop in interest rates, after a peak in the early 1980s, and an increased shift from predictable fixed-income bonds to stocks and other risky investments to get higher yields.

Ted Eliopoulos, CalPERS chief investment officer, told the board last September the funding challenge was “precipitated” by an unusually long decline of interest rates around the globe for more than three decades.

He said the low rates “resulted in many if not most U.S. pension and institutional investors, including CalPERS, having an asset allocation that is dominated by equity and growth assets, which poses the largest risk in our portfolio.”

CalPERS had a cushion going into the last financial crisis and stock market crash. The funding level of 101 percent in 2007 dropped to 61 percent in 2009 after the investment fund plunged from about $260 billion to $160 billion, a loss of $100 billion.

With an investment fund valued at $308 billion last week and a funding level of 64 percent, little improved after nearly a decade, CalPERS has a thin cushion if there is another major economic downturn.

A funding level that drops below 40 percent or even 50 percent could be crippling, CalPERS board members have been told by experts. Raising employer rates and the earnings forecast high enough to project a funding level of 100 percent may become impractical.

The chart shows that in the early 1960s all CalPERS investments were in fixed-income assets like bonds, avoiding the risk of big losses but yielding limited earnings to pay for pensions.

In what can seem ironic in the current “pension crisis,” voters approved two legislative ballot measures allowing pension funds to shift from bonds to stocks and other risky investments in an attempt to get greater yields and reduce taxpayer costs.

Proposition 1 in 1966 allowed up to 25 percent of pension fund investments to be in large-company stock that paid dividends and met other safety tests, beginning the move away from bonds shown on the chart.

A proposal in 1982 to allow up to 60 percent of pension fund investments in stock, Proposition 6, was rejected by 61 percent of voters. A less restrictive proposal allowing any “prudent” investment, Proposition 21, was approved by 53 percent of voters in 1984.

The shift from bonds allowed optimistic projections of investment earnings to justify generous pension increases critics say are “unsustainable,” pushed massive debt to future generations, and made government an owner of large parts of the private-sector economy.

Pension funds have helped reshape the economy by pushing for corporate governance reform, lobbying for the Dodd Frank Wall Street regulation after the financial crisis, and investing in high-yielding private equity leveraged buyouts that critics say resulted in layoffs and outsourcing jobs.


Even if California pension funds had remained limited to predictable bonds, they would likely be struggling in the current investment environment.

Warnings that record low global interest rates are harming pension funds and insurance companies were issued by the Organization for Economic Cooperation and Development in Paris two years ago and the International Monetary Fund last year.

“The solvency of many life insurance companies and pension funds is threatened by a prolonged period of low interest rates,” the IMF said in its Global Financial Stability Report.

A Pensions & Investments editorial (“Damage of Low Rates” Jan. 26, 2015) urging an interest rate increase briefly mentioned CalPERS but was mainly concerned about the impact on the remaining private-sector pension plans.

The low interest-rate policies “put defined benefit plans (pensions) on an accelerated path toward extinction, damaging the idea of a prudently funded and financially secure safety net of retirement income,” said the editorial.

Well-managed Netherlands public pension funds, required to be 105 percent funded to avoid pushing debt to future generations, cut the pensions of some retirees by an average of 2 percent in 2013.

After warning of a pension cut, a big Dutch civil service fund announced earlier this month that “the rise in interest rates and better returns on its investments” pushed the funding level above the required minimum and avoided the need for cuts.

Federal Reserve Chairwoman Janet Yellen said this month interest rates may continue to rise over the next two years, which for pension advocates would be a welcome and long overdue change.

To stimulate the economy, the infuential overnight federal funds rate was held at zero to 0.25 percent from 2008 until a quarter percent increase in December 2015, followed by a second quarter percent increase last month to a range of 0.50 to 0.75 percent.

Yellen’s speech at Stanford University, with cautions about unforeseen economic changes, said federal officials expect to increase the target a few times a year until “by the end of 2019, it is close to our estimate of its longer-run neutral rate of 3 percent.”

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Originally posted at Cal Pensions.