Author(s): Stuart Buck
California has promised its public employees lavish pensions and retiree health benefits without setting aside nearly enough money to pay for those benefits. As a result, California already admits to a $75.5 billion shortfall in paying for these promises to public employees—$40.5 billion for the teachers’ retirement plan (California State Teachers’ Retirement System, or CalSTRS) and $35 billion for the California Public Employee Retirement System (CalPERS).
This shortfall has grown so large because elected officials preferred the hidden cost of higher retirement benefits to the visible cost of higher wages. For instance, a recent report from the Reason Foundation noted that thanks to a 1999 pension bill radically increasing benefits, “there are 9,111 state and local government retirees in California, such as police officers, firefighters and prison guards, who receive pensions of at least $100,000 a year (through CalPERS), and an additional 3,065 retired teachers and school administrators who receive pensions of over $100,000 a year (through CalSTRS).” As a California pension recipient told Forbes last year, “It’s just taxpayers’ money, so nobody cares.”
Unfortunately, the situation is actually far more dire than is currently admitted. The actuarial valuations mentioned above took place as of June 30, 2008 and both pension systems have had substantial losses in their investments since that date. As of the most recent information available, CalPERS’ assets had dropped to a reported $200 billion, and the teachers’ retirement system’s assets had dropped to$134 billion; these losses would add another $44 billion in unfunded liabilities.
But it gets even worse. When the California pension systems set aside money for future pension payments, they rosily assume that their investments are going to earn a steady 7.75 percent or 8 percent return year after year. But that assumption is clearly too optimistic—especially after a decade of zero stock market growth—and does not match the bond-like nature of pension obligations. Financial economists generally agree that pension obligations should not be measured with such optimistic assumptions.
In this paper, I re-estimate California’s pension obligations using a discount rate approximating what private pensions are allowed to use. With this more realistic assumption, California’s unfunded pension liabilities—i.e., the gap between existing plan assets and the present value of benefits accrued by participants—actually reach $282.2 billion, a figure that rises to $326.6 billion when current market values are taken into account. On top of that, the California Controller estimates that retiree health benefits are currently underfunded by $51.8 billion. The total of these actuarial obligations thus reaches $378.8 billion.
This is a staggering figure. For comparison, as of July 1, 2009, the California state government had approximately $67 billion in outstanding state bonds.3 Thus, shortfalls in state pensions and retiree health benefits are more than five times the existing state debt. All of this is money that California taxpayers may eventually have to cough up to pay for someone else’s retirement. Other crucial state services—from bridge repairs to teachers serving in the classroom—may be shortchanged because state retirees are receiving so great a portion of the state budget.
California politicians can either continue hiding their heads in the sand, or else face up to these looming obligations by ceasing to promise overly lavish benefits and by increasing the required contributions from salaried employees. In addition, California may consider changing the structure of its pension system so that it depends more on employee savings, rather than promising a guaranteed financial payment regardless of how much a given employee saved.