Salinas, CA : CalPERS Fund Coming Up Very, Very Short

I wrote recently on my blog about an alarming shortfall in the pension fund for state workers.  The California Public Employees' Retirement System (CalPERS) now has just 63% enough cash to fund future pension liabilities after losing $69 billion in the 2008 downturn, about a quarter of its funds.  I was happy to read the headline in the Wall Street Journal "CalPERS Lowers Target Rate" which implied the fund had realized it was coming up way short on its investment strategy and needed to make a turn in another direction.  But upon reading the story, I found that they had lowered their expected rate of return from 7.75% to 7.5%.  I don't think that's nearly enough.  The fund has earned an average rate of return of 5.1% over the past ten years, although it did make a 7.5% return over 20 years, which included the dot-com bubble.  By lowering its rate of return, the state of California, schools and county agencies will have to kick in a bit more to cover an expected shortfall, however, I think expecting a return of 7.5% might be too aggressive.  The move does require the state to kick an additional $300 million annually, but the fund only earned a 1.1% rate of return last year and putting aggressive targets forward won't help the 1.6 million Californians who currently rely on CalPERS benefits if these targets aren't met.  And it certainly won't help the next generation of retirees.  The Board which oversees CalPERS rejected the advice of its actuary to lower the expected rate of return to 7.25%.  My guess is that they felt making a reduction of 500 basis points in the expected rate of return would be too unpopular with union employees (union representatives comprise six members of a board of 13) and the state of California.  It's going to be politically unpopular to do any type of reduction.  But employees must face reality.  The stock market is extremely volatile and there's no guarantee that historical rates of return will hold up.  Even those at CalPERS don't seem extremely bullish. "At least this is a move in the right direction, but we are still kicking the can down the road," CalPERS board member Dan Dunmoyer told Bloomberg Businessweek.  The actuary who proposed a greater reduction told the CalPERS Board that the fund had a 50% chance it could generate a 7.5% rate of return over the next decade.  I don't like those odds when calculating what someone may have in their supposed golden years.  There's more than $100 million/year at stake.  California will spend $3.5 billion in the current fiscal year ending June 30 on pension benefits, and lowering the rate of return to 7.5% will raise costs by $167 million in this year alone.  Lowering it to 7.25% like the actuary recommended, however, would have raised costs by $425 million, 2.5x the amount not double as you would expect by lowering the expected rate of return by twice as many percentage points.  It's not a linear equation.  If the rate of return drops a couple of percentage points, the shortfall would add more than $1 billion per year to the deficit.  With the new change in assumptions, the fund now estimates it will have 70-75% of funds needed to cover promised benefits.  But Stanford University came out with a report that estimated the fund will generate an estimated 6.2% annual return which would mean it only has 58% of the funds it needs to make good on its promises.  It's anyone guess what will happen with the stock market.  Let's hope retires don't end up with IOUs from our state government in lieu of their pensions and long-term care benefits.  I remember well the year I got an IOU from the state of California instead of my tax refund.  I was not a happy camper.  I would have been really unhappy if this were my income for the month and I needed to pay rent and other bills.