Just How Much Money Might CalPERS Have to Collect in an Economic Downturn?

When evaluating the financial challenges facing California’s state and local public employee pension funds, a compelling question to consider is when, exactly when, will these funds financially collapse? That is, of course, an impossible question to answer. CalPERS, for example, manages hundreds of billions in assets, which means that long before it literally runs out of cash to pay benefits, tough adjustments will be made that will restore it to financial health.

What is alarming in the case of CalPERS and other public sector pension funds, however, is the relentless and steep rate increases they’re demanding from their participating employers. Equally alarming is the legal and political power CalPERS wields to force payment of these rate increases even after municipal bankruptcies where other long-term debt obligations are diminished if not completely washed away. Until California’s local governments have the legal means to reform pension benefits, rising pension contributions represent an immutable, potentially unmanageable financial burden on them.


The City of South Pasadena offers a typical case study on the impact growing pension costs have on public services and local taxes. Using CalPERS own records and official projections, the City of South Pasadena paid $2.8 million to CalPERS in their fiscal year ended 6/30/2017. That was equal to 25% of the base salary payments made in that year. By 2020, the City of Pasadena is projected to pay $4.3 million to CalPERS, equal to 35% of base pay. And by 2025, the City of Pasadena is projected to pay $5.9 million to CalPERS, equal to 41% of base pay.

Can the City of South Pasadena afford to pay an additional three $3.0 million per year to CalPERS, on top of the nearly $3.0 million per year they’re already paying? They probably can, but at the expense of either higher local taxes or reduced public services, or a combination of both. But the story doesn’t end there. The primary reason required payments to CalPERS are doubling over the next few years is because CalPERS was wrong in their estimates of how much their pension fund could earn. They could still be wrong.

Annual pension contributions are calculated based on two factors: (1) How much future pension benefits were earned in the current year, and how much money must be set aside in this same year to earn interest and eventually be used to pay those benefits in the future? This is called the “normal contribution.” (2) What is the present value of ALL outstanding future pension payments, earned in all prior years by all participants in the plan, active and retired, and by how much does that value, that liability, exceed the amount of money currently invested in the pension fund? That amount is the unfunded pension liability, and the amount set aside each year to eventually reduce that unfunded liability to zero is called the “unfunded contribution.”

Both of these annual pension contributions depend on a key assumption: What rate-of-return can the pension fund earn each year, on average, over the next several decades? And it turns out the amount that has to be paid each year to keep a pension fund fully funded is extremely sensitive to this assumption. The reason, for example, that CalPERS is doubling the amount their participating employers have to pay each year is largely because they are gradually lowering their assumed rate of return from 7.5% per year to 7.0% per year. But what if that isn’t enough?


It isn’t unreasonable to worry that going forward, the average rate of return CalPERS earns on their investments could fall below 7.0% per year. For about a decade, nearly every asset class available to investors has enjoyed rates of appreciation in excess of historical averages. Yet despite being at what may be the late stages of a prolonged bull market in equities, bonds, and real estate, the City of South Pasadena’s pension investments managed by CalPERS were only 73% funded. As of 6/30/2017 (the most recent data CalPERS currently offers by agency), the City of South Pasadena faced an unfunded pension liability of $35 million. Using CalPERS own numbers, if they were to earn 6% per year on their investments in the coming years, instead of their new – and just lowered – annual return of 7%, that unfunded liability would rise to $58 million.

As it is, by 2025 the City of South Pasadena is already going to be making an unfunded contribution that is nearly twice their normal contribution. Another reason for this is because CalPERS is now requiring their participating agencies to pay off their unfunded pension liabilities in 20 years of even payments. Previously, attempting to minimize those payments, agencies had been using 30 year payoff terms with low payments in the early years. Back in 2017, based on a 6% rate-of-return projection, and in order to pay off a $58 million unfunded pension liability on these more aggressive repayment terms, the City of South Pasadena would have to come up with an unfunded pension contribution of $5.0 million per year, along with a normal contribution of around another $2.4 million per year.

But why should it end there? Nobody knows what the future holds. These rate-of-return projections by definition have to be “risk free,” since otherwise – and as has happened – taxpayers have to foot the bill to make these catch up payments. How many of you can rely on a “risk free” rate-of-return,” year after year, for decades, in your 401K accounts of six percent, or even five percent? At a 5% rate-of-return, the City of South Pasadena would have to pay an unfunded contribution of $6.2 million, along with a normal contribution of $2.8 million.

These scenarios are not outlandish. Most everyone hopes America and the world are just entering a wondrous “long boom” of peace and prosperity, ushered in by ongoing global stability and technological innovations. But the momentum of history is not predictable. Imagine if there was an era of deflation. It has happened before and it can happen again. The following chart shows how that might play out in the City of South Pasadena. Notice how at a 4% rate-of-return projection, in 2017 the City of South Pasadena would have had to pay CalPERS $9.8 million; at 3%, $11.4 million.

City of South Pasadena  –  FYE 6/30/2017
Estimated Pension Payments and Pension Debt at Various Rate-of-Return Projections

And what about the rest of California? How would a downturn affect all of California’s public employee pension systems, the agencies they serve, and the taxpayers who fund them? In a CPC analysis published earlier this year, “How to Assess Impact of a Market Correction on Pension Payments,” the following excerpt provides an estimate:

“If there is a 15% drop in pension fund assets, and the new projected earnings percentage is lowered from 7.0% to 6.0%, the normal contribution will increase by $2.6 billion per year, and the unfunded contribution will increase by $19.9 billion. Total annual pension contributions will increase from the currently estimated $31.0 billion to $68.5 billion.”

That’s a lot of billions. And as already noted, a 15% drop in the value of invested assets and a reduction in the estimated average annual rate-of-return from 7.0% to 6.0% is by no means a worst case scenario.

To-date, meaningful pension reform has been thwarted by powerful special interests, most notably pension funds and public sector unions, but also many financial sector firms who profit from the status quo. But a case to be decided next year by the California Supreme Court, Cal Fire Local 2881 v. CalPERS, may provide local agencies with the legal right to make more sweeping changes to pension benefits. The outcome of that ruling, combined with growing public pressure on local elected officials, may offer relief. For this reason, it may well be that raising taxes and cutting services in order to fund pensions may be a false choice.


CalPERS Annual Valuation Reports – main search page
CalPERS Annual Valuation Report – South Pasadena, Miscellaneous Employees
CalPERS Annual Valuation Report – South Pasadena, Safety Employees
CalPERS Annual Valuation Report – South Pasadena, Miscellaneous Employees (PEPRA)
CalPERS Annual Valuation Report – South Pasadena, Safety Employees, Fire (PEPRA)
CalPERS Annual Valuation Report – South Pasadena, Safety Employees, Police (PEPRA)

Moody’s Cross Sector Rating Methodology – Adjustments to US State and Local Government Reported Pension Data (version in effect 2018)

California Pension Tracker (Stanford Institute for Economic Policy Research – California Pension Tracker

Transparent California – main search page
Transparent California – salaries for South Pasadena
Transparent California – pensions for South Pasadena

The State Controller’s Government Compensation in California – main search page
The State Controller’s Government Compensation in California – South Pasadena payroll
The State Controller’s Government Compensation in California – raw data downloads

California Policy Center – Resources for Pension Reformers (dozens of links)
California Policy Center – Will the California Supreme Court Reform the “California Rule?” (latest update)

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Aggregate U.S. Pension Data Shows Grim Outlook

Editor’s Note:  This analysis by economics blogger Mike Shedlock clearly shows why government employee pensions are taking an awful risk by continuing to forecast annual investment returns of 7.0% or more per year. In his first chart Shedlock points out how between 2008 and 2014 the aggregate value of state and local government worker pension system assets only increased 12.7% – a return of 1.9% per year. If one extends the horizon back to 2003 – i.e., if one backs up to include the stock market run-up from 2003 through 2008 – that annual return improves, to a still paltry 4.3%. The headwinds facing global investment portfolios include an aging population, which means there will be a higher percentage of retirees selling their assets which drives down prices and returns, as well as interest rates, everywhere, now at historic lows, which means that debt stimulated economic growth is more problematic than ever. What do the pension systems intend to do, if they can’t hit their 7.0% per year annual returns over the next several years? The answer to-date is to raise every tax and fee in sight to feed the pension systems, which along with incremental benefit adjustments is claimed to be sufficient. But only if 7.0% returns are forthcoming. What if they are not forthcoming? What then?

One of my constant themes over the past few years is the underfunding of state and local pension plans. Illinois is particularly bad, but let’s look at some aggregate data.

The National Association of State Retirement Administrators (NASRA) provides this grim-looking annual picture in their most recent annual update:

State and Local Defined Benefit Plan Assets at Year-End
2003-2014 ($ = Trillions)

Between the end of 2007 and end of 2014, pension plan assets rose from $3.29 trillion to $3.71 trillion. That’s a total rise of 12.76%.

Plan assumptions are generally between 7.5% to 8.25% per year!

S&P 500 2007-12-31 to 2014-12-31

In the same timeframe, the S&P 500 rose from 1489.36 to 2058.90.

That’s a total gain of 590.54 points. Percentage wise that’s a total gain of 40.22%. It’s also an average gain of approximately 5.75% per year.


  • In spite of the miraculous rally from the low, total returns for anyone who held an index throughout has been rather ordinary.
  • The first chart is not a reflection of stocks vs. bonds because bonds did exceptionally well during the same period.

Drawdowns Kill!

To be fair, the first chart only shows assets, not liabilities, but we do know that pensions in general are still enormously underfunded, with Chicago and Illinois leading the way.

Negative Flow

Reader Don pinged me with this comment the other day: “Nearly all public pension funds have a negative cash flow, meaning they pay out in benefits each year more than they receive in contributions. For all public pension funds, the negative cash flow is approximately 3% of assets, which means an average fund needs to produce an annual return of 3% to maintain a stable asset value.

That’s fine if assets have kept up with future payout liabilities and plans are close to fully funded.

However, it is 100% safe to suggest that neither condition is true.

So here we are, after a massive 200% rally from the March 2009 low, and pension plans are still in miserable shape.

And plan assumptions are still an enormous 8% per year. Let me state emphatically, that’s not going to happen.

Stocks and junk bonds are enormously overvalued here.

GMO Investments Forecast


“The chart represents real return forecasts for several asset classes and not for any GMO fund or strategy. These forecasts are forward‐looking statements based upon the reasonable beliefs of GMO and are not a guarantee of future performance. Forward‐looking statements speak only as of the date they are made, and GMO assumes no duty to and does not undertake to update forward‐looking statements. Forward‐looking statements are subject to numerous assumptions, risks, and uncertainties, which change over time. Actual results may differ materially from those anticipated in forwardlooking statements. U.S. inflation is assumed to mean revert to long‐term inflation of 2.2% over 15 years.”

Over the next 7 years GMO believes US stocks will lose money (on average), every year. Those are in real terms, but returns are at best break even, assuming 2% inflation.

Bonds are certainly no safe haven either. I strongly believe GMO has this correct.

Assume GMO Wildly Off

Even if one assumes those GMO estimated returns are wildly off to the tune of four percentage points per year, pension plans needing 8% per year will be further in the hole with 4% per year annualized returns.

Illinois Non-Answer

Illinois house speaker Michael Madigan and Chicago governor Rahm Emanuel believe tax hikes are the answer.

Both are sorely mistaken. Here are a few viewpoints to consider.

The only way out of this mess is a pension restructuring coupled with municipal defaults.

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Mike Shedlock is the editor of the top-rated global economics blog Mish’s Global Economic Trend Analysis, offering insightful commentary every day of the week. He is also a contributing “professor” on Minyanville, a community site focused on economic and financial education, and a senior fellow with the Illinois Policy Institute.

Unions & Pension Funds

U.S. House Resolution 6484, the “Public Employee Pension Transparency Act,” will finally require public employee pension funds to adhere to the same regulations that govern private pension funds. The reason for this is clear enough – by not reporting sufficient information about the financial status of these massive funds, there is greater potential for them to become underfunded. This is because reducing the benefits promised under these funds, or increasing the annual contributions required by these funds, are both politically unpopular. There is an inevitable temptation to cook the books. Here are some of the key reforms in H.R. 6484:

“The plan sponsor of a State or local government employee pension benefit plan shall file a report for each plan year beginning on or after January 1, 2011, setting forth the following information:

(a) A schedule of funding status, which shall include a statement as to the current liability of the plan, the amount of plan assets available to meet that liability, the amount of the net unfunded liability (if any), and the funding percentage of the plan.

(b) A schedule of contributions by the plan sponsor for the plan year, indicating which are or are not taken into account under paragraph (a).

(c) Alternative projections which shall be specified in regulations of the Secretary for each of the next 20 plan years following the plan year relating to the amount of annual contributions, the fair market value of plan assets, current liability, the funding percentage, and such other matters as the Secretary may specify in such regulations, together with a statement of the assumptions and methods used in connection with such projections, including assumptions related to funding policy, plan changes, future workforce projections, future investment returns, and such other matters…

(d) A statement of the actuarial assumptions used for the plan year, including the rate of return on investment of plan assets and assumptions as to such other matters as the Secretary may prescribe by regulation.”

There has been a great deal of debate as to whether or not the financial solvency of public employee pension funds is seriously threatened. One of the key variables affecting this debate is the future rate of return these funds are using in their long-term projections. For example, a pension fund that is solvent – i.e., requires no increase to the annual contributions into the fund and projects no unfunded liability – when the fund managers use a long-term rate of return of 4.75% (this is still CalPERS official after-inflation return projection), will find themselves with an unfunded liability equivalent to 50% of their asset value if they lower that rate of return to 2.5%. It is reasonable, with literally trillions in assets under management by public employee pension funds, and taxpayers supposedly liable to make up any shortfalls, to expect rigorous disclosures of their financial status, and justifications for the return projections they assume. H.R. 6484 is long overdue.

Opposition to H.R. 6484 has been fierce, however. Leading the charge are the public employee unions who have negotiated the pension benefits that are now turning out to be unaffordable. An excellent report posted on December 20th, 2010 by Mike Flynn on entitled “Public Pension Cost Cover-Up? The Union Effort to Kill Transparency,” provides numerous examples of how public sector unions across the United States are condemning H.R. 6484. Lining up against H.R. 6484 are a who’s who of public employee unions, including the SEIU and AFSCME, along with public employee pension funds represented by the National Association of State Retirement Administrators (NASRA) and the National Conference on Public Employee Retirement Systems (NCPERS). Flynn’s notes on the composition of the NCPERS Board of Directors make for interesting reading:

  • Pat McEllicott, President, former president of the Tacoma Professional Fire Fighters Union, IAFF Local 31
  • Mel Aaronson, First Vice President of NCPERS, is the treasurer of the United Federation of Teachers (UFT), Local 2, American Federation of Teachers (AFT).
  • Daniel Fortuna, Second Vice President of NCPERS, is a 30-year member of the Chicago Fire Fighters Union, IAFF Local 2
  • Tina Fazendine, NCPERS Secretary, was the Insurance and Retirement Services manager for the City of Tulsa, Human Resources Department.
  • Richard Wachsman, NCPERS Treasurer, was with the Dallas fire department for 41 years and held offices on the board of the IAFF Local 58.
  • Elmer J. Khal, Past President of NCPERS, is a past president of IAFF Local 93.

No conflict of interests here, right? After all, only five of these six directors have been union members and only four of the six have been officers in unions. A visit to NCPERS website provides an illuminating glimpse into a massively funded propaganda machine, relentlessly promoting an agenda that includes two grotesque canards, (1) public employees do not receive total compensation that exceeds private sector employees (ref. “Pay Comparability Study Debunks Theories on Public Employee Pay and Benefits,” and (2) public employee pension funds are not in financial crisis (ref. their letters to Business Week and the New York Post).

These sorts of biased perspectives are pouring out of dozens of public employee union funded, public employee pension associations across the U.S. Their agenda, apparently, is to keep their members, voters, taxpayers, media pundits and policymakers in denial as long as they possibly can. But the reality of unsustainable deficits, maxed-out debt, and obvious disparities in compensation and benefits between public and private employees can only be obscured a while longer through extreme exertions. The party is ending.

Whether or not there are a few places left in America where public employees are underpaid – and public employee pension funds are overfunded – is certainly open to some debate. But in California it is getting harder and harder to argue either of these points with any credibility. The only thing standing in the way of defaults and bankruptcies is a commitment to get accurate information and make equitable financial adjustments based on good data. H.R. 6484 is one vital step in that direction.