California state government’s bill for public employee pensions is set to rise by $676 million. CalPERS on Tuesday advanced a scheduled increase in employer contribution rates, bringing the state’s total bill for the 2019-2020 budget year to about $7 billion.
From what I can tell, the increase is driven by:
1. $340 million increase due to paying down the current unfunded liability. The article states that California has $287 billion in unfunded liabilities that it is trying to pay down over 30 years. Governor Newsom wants to add an additional $3 billion to that amount.
2. $229 million will have to come from various public agencies as the rate of return is being reduced from 7.25% to 7.0%.
3. $95 million is due to payroll increases.
Those three come up to $664 million of the $676 million.
The article ends with:
The fund returned 8.6 percent on its investments, higher than the target of 7.25 percent for the year. For the year ending June 30, 2019, the fund is not likely to meet its 7 percent target, Chief Investment Officer Ben Meng has said. The fund had returned 1.5 percent for the fiscal year as of the end of February, following the economic downturn at the end of 2018. The final rate won’t be known until the end of the budget year.
I suppose that California is hoping that President Trump is able to negotiate a trade agreement with China and that the stock market responds positively to that news before the June 30 fiscal year end date.
Forbes has an opinion article warning that California's budget isn't as good as it looks, largely due to pensions:
The truth is that there is no revenue surplus had by California state government. In fact, the state’s long-run obligations far exceed projected revenue collections to the tune of $1 trillion in unfunded pension liabilities alone.
Note the difference between $1 trillion and $287 billion mentioned in the Sacramento Bee.
The Forbes article figure is based on the California Policy Center. It takes an even more conservative approach than the FY 2019 figure of 7.0%. To hit a $1 trillion unfunded liability one has to go from a 7.0% down to 3.723%.
An alternative approach used by the Stanford Institute for Economic Policy Research (SIEPR) is to discount the liabilities by a rate closer to the risk-free rate. In a recent report, Stanford researchers used a discount rate of 3.723%. Using Stanford’s methodology, we estimate a UAAL [Unfunded Actuarially Accrued Liabilities] of $1.02 trillion.
I need to better understand why they'd want to use a 3.723% rate. From the paper, it has to do with the probability of benefits being paid. Yet, the paper also admits that other experts believe that future returns is perfectly fine to use.
Bloomberg has this general statement:
Riskier assets like private equity, real estate and hedge funds haven’t provided a magic bullet for state and local government pensions seeking to cover trillions in retirement benefits for aging workers. While public pensions have boosted their average allocation to high-risk equities and so-called alternatives to almost 80 percent, the median fund fell short of the 7- to 8 percent returns they count on each year to pay the ballooning costs of benefits.
At some point, the next bear market will hit. And currently, it looks like (at least in California) that real estate has flatlined. States and local governments might regret this shift to riskier assets sooner than they anticipated.
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