Posted from On California, David Crane’s Substack.
Earlier this week, a journalist asked me how a stock market decline this year would affect pension spending by California’s cities, schools and the state. He wondered if it “would produce a big or small hit.” The answer is that any decline this year would produce neither.
The California Public Employees’ Retirement System (CalPERS) manages assets set aside by the state and some other California governments to meet future pension payments. According to CalPERS’s latest annual report, 42 percent of pension assets under its management were invested in the stock market. What matters to CalPERS is long term growth of stock prices, which they have achieved as illustrated by this chart of the Dow Jones Industrial Average over the last twenty years:
Drops in stock prices — which occurred many times during the period covered by the chart — do not cause pension costs to rise unless pension funds are forced to sell their holdings during a decline. That doesn’t happen at CalPERS because the professionals there know not to put their funds in the position of having to sell stocks at the wrong time. That’s one reason they limit their investment in stocks to less than half of the fund and maintain large holdings of liquid instruments. On its total portfolio, CalPERS has earned an excellent 6.7 percent annualized return over the last 20 years.
Rising pension spending by governments is caused by rising pension liabilities. Pension liabilities owed by California’s state government, which is the largest client for whom CalPERS manages pension assets, grew at an eight percent annual rate over 20 years as reported by its Annual Comprehensive Financial Reports, much more than the rate of return earned on pension assets. That’s why the state’s spending on pension costs quadrupled over that period to now nearly $14 billion per year.* Similar growth has occurred in pension liabilities owed by schools for which pension assets are managed by the State Teachers’ Retirement System (CalSTRS), who are also capable investors who know to avoid having to sell stock at the wrong time. Still, pension spending quadrupled at LAUSD to $1.4 billion per year over an even shorter period.
Pension liabilities will continue to grow for the reason explained here as will pension spending. It didn’t have to be that way but the State Legislature chose to maintain the status quo in 2006 when they refused my plea to lower the rate at which pension liabilities were discounted and to fully fund upfront pension contributions from employees and employers using a reasonable rate.
*In addition to annual pension spending, the Governor and the State Legislature have provided $20 billion of supplemental contributions to CalPERS and CalSTRS.
