Thursday, March 4, 2010

"Giant California pension funds may lower earnings expectations"

In our June '09 post, "Markets/Economy: "Paul Krugman's fear for lost decade" and Why the Public Employee Union Pension Plans are Toast" I touched on expected rates of return for CalPERS:

...Now the relationship to public employee pensions. In "Public pension funds’ rosy forecasts pose problems" we linked to a story that pointed out:

...Lowering the projection of earnings by even a percentage point or two would create a funding gap of tens of billions of dollars.
CalPERS, an industry leader, warned its 1,500 local government members last fall that their employer contribution rates may increase from 2 to 5 percent of payroll in July 2011 if the stock market does not recover by June 30, the end of the current fiscal year....
Just so we're clear, those local government members are the California towns and cities that entered into contracts with the public employee unions guaranteeing those benefits.
When CalPERS investment returns fail to hit their targets the cities have to raise taxes/cut services to make up the shortfall. The link continued:

...After the big drop in the stock market last fall, the CalPERS investment portfolio, once a high flier, had an average annual return of 3.32 percent for the last 10 years, well below the forecast of 7.75 percent...

...Legendary investor Warren Buffet, in his annual letter to Berkshire Hathaway shareholders in February of last year, questioned the 8 percent earnings forecast common among the pension funds of major corporations.

“How realistic is this expectation?” Buffet said. “Let’s revisit some data I mentioned two years ago: During the 20th Century, the Dow advanced from 66 to 11,497. This gain, though it appears huge, shrinks to 5.3 percent when compounded annually.”

The founder of Vanguard mutual funds, John Bogle, told a congressional hearing on retirement security last month that corporate pension funds raised their assumed earnings from 6 percent in 1981 to 8.5 percent by 2007, far above historical norms.

“And the pension plans of our state and local governments seem to be in the worst condition of all,” Bogle said, adding parenthetically: “Because of poor transparency, inadequate disclosure, and non-standardized reporting, we really don’t know the dimension of the shortfall.” ...

Here's the official CalPERS response:

Beware of the anti-pension ideologues who come out of the woodwork during market downturns. Like vultures, they prey on the highly charged and negative investment environment, looking for ways to convince you a temporary performance downturn will be typical for all time!

They know -- but don't tell you so -- that we set our rates based on a fiscal year investment return. They don't tell you that our assumed rate of return is made based on advice from a range of experts within CalPERS and within the industry and that it is regularly evaluated every two to three years in public session. They don't tell you what you would learn from a textbook on pension management: that some years investment returns are as expected; other years, they will be more than expected and yes, some years they will be less than expected.

They don't tell you that over the last 24 years, we have exceed our assumed rate of return 17 times, and eight of those years were more than double the 7 3/4 percent assumed rate of return.

(And here's an interesting fact: For five years after the Great Depression, there were multiple double digit return years.)

We will withstand the market swings, with our goal in mind: to achieve our assumed rate of return averaged over many, many decades. That's what we are designed to do. That's the math that matters.

Patricia K. Macht
Assistant Executive Officer
Office of Public Affairs

To my jaded eye that is nothing but smoke and/or mirrors....

See also "Californians Eye Carbon Revenues" (And So Do the Public Employee Unions)" for some of our previous CalPERS posts.
Here's the latest, after an average 55% run-up in the major averages, from the Sacramento Bee:

Bruised by heavy losses and wary of the economic road ahead, California's two big public pension funds are considering reducing their official forecasts of future investment results.

Such changes would have huge implications for taxpayers and public employees. A reduction in the investment projections would put more pressure on taxpayers and workers to support the two retirement systems, which already are significantly under-funded. The less the California Public Employees' Retirement System and the California State Teachers' Retirement System believe they'll earn from their investments, the more they have to depend on other sources.

For instance, CalSTRS long has assumed it would earn 8 percent a year on its investments – but is now being urged by consultants to scale back that figure. Board members are sweating the potential impact.

"If we go less than 8 percent, we're going to make it up where?" board member Kathy Brugger asked her colleagues at a meeting last month. The board plans to decide in September if it should lower the estimate.

Even if the two funds don't lower their investment forecasts, they're still looking to taxpayers to help them recover from recent investment losses.

CalPERS, which has the authority to set its contribution rates, is imposing increases of about 6 percent to 10 percent on the state as well as the local governments that use it for pensions. CalSTRS, which needs the Legislature's approval to raise rates, plans to petition lawmakers for an increase sometime next year. Employee contributions might go up as well.

In rethinking their investment forecasts, the two funds are responding to the combined $100 billion they lost in the fiscal year that ended last June. Although they've recouped some of their losses, the prospect of a tepid economic recovery is prompting pension funds across the country to lower their predictions. In CalPERS' case, some of the pressure is coming from the Schwarzenegger administration, which accused the fund of not facing up to its problems.

Nationwide, several public pension funds are cutting or are about to cut their investment forecasts, consultant Nick Collier told the CalSTRS board last month.

Collier, of Milliman Inc., said CalSTRS' current forecast of 8 percent is reasonable but "somewhat aggressive." Most of his clients assume annual returns of 7.75 percent, and several are cutting the forecast by a quarter point. While he said there's no one right answer, he suggested CalSTRS reduce its forecast.

That put board members in a bind. Several indicated they would be willing to reduce the forecast but openly fretted about the implications.

"We need to do something," said board member and state Controller John Chiang. "I also don't want to overreact."

Predicting investing results is difficult – but also vitally important. About 75 percent of CalSTRS' money comes from its investment returns, with the rest coming from school districts, the state and teachers. Although results in any given year can vary widely from what's predicted, the forecasts have an almost sacred quality to them. They represent a pension fund's fundamental long-term expectation of its financial health.

They change incrementally – maybe a half a percentage point or less – and hardly ever.

Although both California funds re-examine their assumptions every three years or so, CalSTRS hasn't altered its forecast since 1995. The CalPERS estimate has held steady at 7.75 percent since 2003.

Those forecasts were thrown seriously out of whack when the financial markets collapsed in late 2008. CalPERS lost 23 percent of its portfolio in the fiscal year that ended last June, and CalSTRS lost 25 percent.

"Negative 25 percent wasn't quite what we were thinking of," said Mark Olleman, another Milliman consultant, in remarks to the CalSTRS board....MORE

Also from the SacBee: