Red Flags: New Study Offers Grim Warning for California Pension Funds
For Immediate Release
July 12, 2016
California Policy Center
Contact: Will Swaim
Stock market overvaluation will lead to ‘major correction,’ trigger benefits cuts and tax hikes
SACRAMENTO, Calif. – There are more red flags for public-sector pension funds that rely on stock investments for most of their income, a new California Policy Center study finds.
“Three key market indicators show that publicly traded U.S. stocks are overvalued by about 50 percent, suggesting that pension funds are headed for a tough correction,” says CPC President Ed Ring, author of “How a Major Market Correction Will Affect Pension Systems, and How to Cope.”
Ring says the likely downturn will have grave implications for all Californians – not just those who depend upon the pension funds for retirement income. Lower returns on their investments will force pension funds to cut payments to government retirees or require California governments to act dramatically to cover the revenue shortfall.
Using a long-range cash flow model that simulates pension fund performance, Ring calculated the impact on California’s state and local government employee pension funds based on a market slide of 50% in 2017, followed by annual returns of 5% per year. In this case, with no changes to retirement benefits, the required annual contribution from governments would rise to 80% of payroll, costing an additional $50 billion per year. In another case, with post-crash returns projected at only 4% per year, the model estimated annual payments to rise to a staggering 113% of payroll, costing an additional $86 billion per year. Currently, California’s pension funds collect from state and local agencies an amount equivalent to about 33% of their payroll.
The study also provides several specific estimates of how much pension benefits would have to be cut (retirement age, annual multiplier, and COLA) after a severe market correction in order to keep the annual contributions from state and local agencies level at 33% of payroll.
The CPC study includes a link to download Ring’s spreadsheet so that anyone can test a variety of pension-fund assumptions.
Ring’s prediction of an impending correction cites three key stock market ratios:
- Price/earnings, now at one of the market’s historic highs
- Price/sales, now at a 50-year high
- Stocks/GDP, now near its 60-year high
Ring predicts he’ll have many critics.
“It is easy enough to step back and claim that the rules have changed, that these unusually high stock-market multiples can be sustained for additional decades, and that productivity improvements will enable the U.S. economy to support both massive debt and an aging population,” Ring writes. “Those who argue this position are betting that the U.S. economy will remain a stable refuge for wealth fleeing far more tumultuous economies elsewhere in the world. Staking the future of pension fund systems on this argument is a dangerous gamble.”
Ring’s study appears even as officials at California Public Employees Retirement System, the nation’s largest retirement system, prepare Californians for a poor earnings report next week.
Analyst Ed Ring is available for media interviews. Direct press inquiries to:
Vice President, California Policy Center
ABOUT THE AUTHOR
Ed Ring is president of the California Policy Center. He directs the organization’s research projects and is also the editor of the email newsletters Prosperity Digest and UnionWatch Digest. His work has been cited in the Los Angeles Times, Sacramento Bee, Wall Street Journal, Forbes, and other national and regional publications.
ABOUT THE CALIFORNIA POLICY CENTER
The California Policy Center is a non-partisan public policy think tank providing information that elevates the public dialogue on vital issues facing Californians, with the goal of helping to foster constructive progress towards more equitable and sustainable management of California’s public institutions. Learn more at CaliforniaPolicyCenter.org.