The California Public Employees Retirement System (CalPERS) recently announced investment losses for its last fiscal year, which will increase the state’s retirement debt. CalPERS now has about $611 billion in retirement debt and is 72% funded, meaning it has only 72 cents of every dollar in retirement benefits already promised to workers. As a result, California state and local governments can expect to face continued fiscal pressure from public employee retirement benefit costs over the next few years.
CalPERS posted a -6.1% return for its fiscal year ending June 30, 2022. Although it lost billions, the -6% loss compares favorably to the movement of major stock indices. For example, the S&P 500 Index posted a total return, including dividends, of -10.6% in the 12 months ending June 30. Since CalPERS invests in other asset classes that have outperformed stocks, it hasn’t felt the full impact of the stock market decline. .
But at least some of the outperformance may be illusory. The two best performing asset classes in CalPERS – private equity and real assets – are reported with a one-quarter lag. Thus, the results published by CalPERS do not reflect the changes in valuation from April to June, when the values of many types of risky assets were down. While CalPERS’ investment policies led to outperformance in the most recent fiscal year, they resulted in severe underperformance in the prior fiscal year. year. In its 2021 fiscal year, CalPERS posted returns of 21.3% – generally great news, but well below the S&P 500 return of 40.8% for the same period and lower than all other major mutual funds. US pensions with the same year-end date.
Going forward, there are concerns that CalPERS management will focus more on maximizing risk-adjusted returns for retirees, as its investment team potentially becomes preoccupied with environmental, social and governance (ESG) issues. The CalPERS Board of Directors received presentations on sustainable investing, the organization’s “diversity, equity, and inclusion framework” and the “racial impacts of capital markets operations.” Although we wish this was not the case, there can be tensions between optimizing investments and prioritizing social objectives in investment strategies.
To CalPERS’ credit, it used some of its strong investment performance last year to reduce its discount rate and assumed rate of return from 7% to 6.8%, which is more conservative than the most other major public employee pension funds. This change slightly mitigates the impact of the -6% results for 2022.
Ultimately, the impact of this year’s negative returns and unfunded public pension liabilities affects contributions required by the state government and any local government that participates in CalPERS, including most southern cities. from California.
Employer contribution rates, ultimately paid by taxpayers, are determined with a lag of approximately 14 months from the end of the fiscal year. So this summer, government employers will receive good news about lower contribution requirements stemming from the 2021 results. But those benefits will be almost entirely reversed when governments receive their updated actuarial reports from CalPERS next summer.
Longer term, there could be good news for these government employers and taxpayers as the benefits of Brown-era pension reforms begin to be felt. These reforms reduce the amount governments must contribute on behalf of public employees hired after January 1, 2013. public pensions will start to fall. for many employers. Actuaries at consultancy GovInvest expect these savings to begin to materialize for most government employers after the 2028-29 financial year, when employer contributions as a percentage of payroll will begin to decline.
California governments can expect to face continued fiscal pressure from public employee retirement benefits over the next few years. But thanks to more conservative investment assumptions and earlier reforms, the impacts won’t be as severe as those facing the governments of Illinois, New Jersey and some other states. And, longer term, there may be light at the end of the tunnel as long as national and local tax bases hold up, market conditions improve, and CalPERS invests wisely.
Marc Joffe is a senior policy analyst at the Reason Foundation.