Examining the CalSTRS Shareholder Bailout

“CalSTRS has a $70-plus-billion unfunded liability – even with assumed investment earnings that Brown deems ‘highly unlikely’ – and says it needs about $5 billion more a year to regain solvency.”
–  Dan Walters column, “Brown budget reflects state’s massive debt,” May 25, 2014, Sacramento Bee

Those “investment earnings” that Walters quotes Brown as finding “highly unlikely,” refer to the long-term annual return on investment projection of 7.5% used by CalPERS (ref. FYE 6-30-2013 CalSTRS Annual Report, page 29).

So what happens if investment earnings generated by CalSTRS are destined to, as even California’s union-friendly Governor Brown attests, achieve more “likely,” lower returns? In November 2013, using data from CalSTRS FYE 6-30-2012 Annual Report, the California Policy Center released a study “Are Annual Contributions Into CalSTRS Adequate?,” that examined this question.

The first objective of this study was to calculate how much CalSTRS was actually paying down on their unfunded liability. Here’s what it found:

“For the fiscal year ended 6-30-2012 the California State Teachers Retirement System, CalSTRS, collected $5.8 billion. Of this $5.8 billion, $4.7 billion was the normal contribution and the remaining $1.1 billion was a ‘catch-up’ payment to reduce the unfunded liability, which as of 6-30-2012 was officially estimated to be $71.0 billion.”

Based on these numbers, which are all pulled directly from CalSTRS official disclosures, it should come as no surprise that Gov. Brown’s CalSTRS bailout plan requires annual contributions into CalSTRS to double. When you are paying down mortgage of $71 billion – the imperfect analogy that nonetheless applies quite accurately in this context – and in a given year you only pay $1.1 billion (one seventieth), you will never pay off your mortgage. Rather, you will incur negative amortization, owing more every year.

Where will this money come from?

To put this challenge in perspective, it is relevant to note just what CalSTRS retirees are getting. According to 2012 data provided by CalSTRS, as summarized in a March 2014 California Policy Center study “How Much Do CalSTRS Retirees Really Make?,” the average CalSTRS employee after a 30 year career currently retires with a pension of $51,500 per year; their average retirement age is 62. How many private sector employees can work 180 days a year for 30 years and retire with a guaranteed annuity this big – including annual cost-of-living adjustments? The conventional wisdom of retirement planners is to save approximately 25 times the amount you intend to eventually withdraw each year to live on. That’s $1.3 million. How many people can work 180 days a year for 30 years and save $1.3 million?

The idea that CalSTRS participants can save this much money via their 8.25% payroll withholding is ludicrous. And the idea that contributing 8.25% to CalSTRS vs. 6.4% to Social Security justifies a pension benefit this much higher than what participants can expect from Social Security is equally unfounded. Here is the conclusion of a February 2014 California Policy Center study “Comparing CalSTRS Pensions to Social Security Retirement Benefits.”

At age 62, the average CalSTRS retiree collects 56% of their final salary in the form of a pension, whereas, depending on their income, the average Social Security recipient collects between 29% and 36% of their final salary in the form of a retirement benefit. At age 65, the oldest age necessary to collect the full CalSTRS benefit, a CalSTRS retiree with 35 years experience will collect a retirement benefit equal to 84% of their final salary. At age 65 a Social Security recipient will collect a retirement benefit between 30% and 35% of their final salary.

The CalSTRS bailout – and it is a bailout – will cost California’s taxpayers an additional $5.0 billion per year, and only if, as Governor Brown says, the “highly unlikely” average returns of 7.5% per year are realized. But as documented in the aforementioned study “Are Annual Contributions Into CalSTRS Adequate?,” using a 20 year payback period, here’s what lower rates of return mean for California’s taxpayers:

  • At 7.5% per year, unfunded contribution = $7.0 billion per year (increase of $5.9 billion over what was actually paid).
  • At 6.2% per year, unfunded contribution = $9.6 billion per year.
  • At 4.8%, unfunded contribution = $12.2 billion per year.

The 20 year amortization period, recommended by Moody’s investor services, used in the study, resulted in an estimate $900 million over the latest figures from Governor Brown. This minor discrepancy validates these calculations more than anything else – they probably used a 30 year payback period. Fine. Let’s continue.

  • At 7.5% per year, the normal contribution necessary to CalPERS, i.e., not the “catch up” payment on the underfunding of prior years, but just the payment necessary to cover future pensions earned in each most recent year, is $4.7 billion per year.
  • At 6.2% per year, the normal contribution = $5.8 billion per year.
  • At 4.8%, the normal contribution = $7.2 billion per year.

To summarize:  In the FYE 6-30-2012 CalPERS, assuming a long-term return of 7.5% per year, received contributions (normal and unfunded) of $5.8 billion; they should have collected total contributions of $11.7 billion ($10.7 billion using Brown’s numbers). But if their rate of return going forward drops to 6.2% per year, they would have had to collect $15.4 billion. Got that? If the highly unlikely 7.5% average annual return isn’t realized, and only 6.2% is realized instead, taxpayers will pitch in nearly $10 billion more per year, just to bail out CalSTRS.

The money is not there.

And why is the 7.5% return “highly unlikely?”

(1) Pension funds are starting to pay more in benefits than they collect via contributions, for the first time ever. As a result, pension funds, who own over 20% of all U.S. equities, are becoming net sellers in the market instead of net buyers, pushing prices down.

(2) The U.S. population is aging, with citizens over age 65 projected to represent 22% of the population by 2020, compared with just 11% in 1980. All of them will be slowly selling off their retirement assets instead of buying and saving assets for retirement – twice as many people as a generation ago – also pushing prices down.

(3) A major factor in the market rise of the past 40 years was the accumulation of debt and progressively lower interest rates, which flooded the economy with cash and caused rapid stock price appreciation as companies profited from debt-fueled consumer spending – those days are over.

(4) Pension funds are now too big to consistently beat the market, assuming they ever could.

There is a larger question, however. Why is it that government unions, and their progressive partners, are so anti-corporate, when it is corporate profits that fuel the high returns of their pension funds? Why is it they urge us to blame pension challenges on banks, when it is the banks that lowered interest rates to literally zero (accounting for inflation), in order to create the asset bubble that keeps their pensions marginally solvent? Why is it they blame corporations for caring more about shareholders than workers, when their pensions are dependent on the pension funds reaping massive shareholder benefits from this supposedly misplaced priority?

Ultimately, the solution to the pension crisis facing CalSTRS that is most consistent with progressive principles would be for teachers from now on to collect Social Security instead of pensions, and for existing participants in CalSTRS to collect a pension benefit that is reduced by precisely the amount CalSTRS is underfunded – i.e., a 30% cut to benefits, across the board, to everyone. That solution would epitomize “fairness,” a concept of which they speak so eloquently, and so often.

*   *   *

Ed Ring is the executive director of the California Policy Center.

6 replies
  1. Avatar
    NOPE says:

    You can’t cut current retirees pensions 30% and call it ‘fair’. If you notified them 10 years before they retired, so they could stay on longer (or make some other arrangements) that MIGHT be fair. In addition, there are numerous errors in this ‘article’.

    I do agree with you that it will be difficult to get the stock market gains of the past due to retirees becoming ‘net sellers’ of stock, however 7.5% is not completely unattainable. Using VERY SAFE methods, I knock down 28.5% a year – even in the bad years. That said, I’m not moving 100’s of billions of dollars – just hundreds of thousands of dollars. Would like to change that – care to make a donation?

  2. Ed Ring
    Ed Ring says:

    NOPE – there is no solution that is totally fair. To fail to examine any solution that impacts CalSTRS participants, and rather places the entire responsibility onto taxpayers is certainly not fair. The solution suggested embraces the concept that if ALL CalSTRS participants share in whatever sacrifice needs to be made by them, instead of by taxpayers, then the amount any individual may have to sacrifice will be minimized.

    As for your comment that 7.5% is easily attainable, we’ll just have to agree to disagree. If you are getting 28.5% per year you are beating the market; pension funds that control a significant percentage of the market cannot consistently beat the market. And if you show me any investment that can deliver 7.5% (4.5% after adjusting for inflation) per year, on average, without risk, I will sell everything I own and make that investment. The point? If you guys think 7.5% is such a low risk rate of return, then stop asking taxpayers to bail out your pension funds when these rates of return aren’t realized – or when your actuaries fail to properly estimate longevity, etc.

    It is fundamentally unfair to ask taxpayers, whose investments are subject to market risk, to pay more in taxes in order to remove all market risk from the investments made on behalf of government workers. Such self-serving behavior undermines the legitimacy of government.

  3. Avatar
    S & P 500 says:

    Even Buffett admits that it is becoming harder for him to beat the market, partly because his fund is too big. Another reason of course is that most trading is done by computer programs, which incorporate more knowledge of historical trends than any person or group of fund managers possess–and they can trade a lot faster, too. And 7.5% gains is not attainable apparently, since CalSTRS pays a billion dollars a year in fees to invest 15% of its pension money in private equity, which is extremely risky and very beneficial for people like Steve Cohen who again escaped prosecution. Well maybe PE isn’t such a bad idea since Cohen possesses one thing that computers don’t have–insider information.

  4. Avatar
    NOPE says:

    I SAID: “however 7.5% is not completely unattainable”

    ED SAID “As for your comment that 7.5% is easily attainable”

    Funny how that went from not completely unattainable to easily attainable.

    I could list other dramatizations from above, but you get the point.

    ED SAID “It is fundamentally unfair to ask taxpayers, whose investments are subject to market risk, to pay more in taxes in order to remove all market risk from the investments made on behalf of government workers. Such self-serving behavior undermines the legitimacy of government.”

    What is ‘fundamentally unfair’ is forcing government employees into a pension system that is required to funded be BY LAW, and then not funding it – while at the same time restricting them from participating in social security. What is further ‘fundamentally unfair’ is to penalize what ever SS they have earned in the past because they are qualified for a pension. You do realize that you lose SS because you get a pension, right? (I’m losing about 55% of my SS) You do realize that when SS was set up, and states/counties/cities opted out of it that the federal government made VERY CLEAR laws that stated these pension funds must be fully funded, right? You do realize that these pensions have not been funded according to statue, right? You do realize that the government, by not paying into SS, has reduced costs to the taxpayers by ~6.5%, right? You know all this I’m sure, but prefer to put half truth after half truth out there for the ignorant to consume. You might want to use some fresh paper to type up you’re next ‘article’ on, the old batch is looking kind of aged…might even say yellow.

    Again back to you’re “It is fundamentally unfair to ask taxpayers”

    All the years – decades really, that CalPERs costs were lower than SS costs would have been, did you write articles praising the pension system/process? Did you enjoy the reduced tax rates that were a result of the lower investment mandate that CalPERs was vs SS. Did you utilize the infrastructure(s) built as a result of the savings that CalPERs delivered via those lower rates? Of course you did. Now that the pendulum has swung (for however long) the other way, you whine like a fat lady denied the last Cheeto™. If necessary, I will buy you a bag of Cheetos, and some ranch dip – anything to keep you from whining.

    Your friendly critic.

  5. Avatar
    Ginny Sand says:

    I, for one, would like to know when and why SS recipients (and those who get pensions too, for that matter) started relying solely on SS payments for their retirement. Seems to me we were all pretty happy to coast along, ignoring all the warnings from those who understand these things that our spending (esp. on ever-more government programs) was not sustainable, and that the retirement of the baby boomers was going to cause states to head toward bankruptcy, and yet there seems to be no accountability for irresponsible voting, ever-more spending and incurring ever-more debt. I loved it when Bill Clinton refused a Chile-style individual retirement program, because he said the people couldn’t be depended on to handle their own retirement planning responsibly…so we voted for corrupt or incompetent politicians (and union investment “experts”) who throw it away for us. Sigh…

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