Stanford Report, April 5, 2010
California state pension funds going broke, Stanford study finds
New calculations by Stanford graduate students show that California's three
main public employee pension funds are in more dire financial trouble than
previously believed.
Students Howard Bornstein and Lisha Wang spoke with reporters after a news
conference where they and the other members of their research group announced
their findings about the state retirement system.
BY GWYNETH DICKEY
California public employee pension systems are worse off than anyone
previously projected, according to a new report generated by five graduate
students in Stanford's graduate Public Policy Program. The result could be
greater pressure on the state budget and a shortage of pension funds in the
future.
"This is a really dire situation," graduate student Howard Bornstein said
today at a press conference at the Stanford Institute for Economic Policy
Research (SIEPR), which is publishing the students' findings. "If we don't do
something now, we're going to have major issues in just a few years."
Bornstein and his fellow graduate students examined public records of past
performance of three pension funds – the California Public Employees' Retirement
System (CalPERS), the California State Teachers' Retirement System (CalSTRS) and
the University of California Retirement System (UCRS), which together administer
pensions for approximately 2.6 million Californians.
The students ran computer simulations to predict the unfunded liabilities of
the pension funds over the next 16 years.
Major investment needed
"The simulation shows that the state would need to invest more than $200
billion, and possibly as much as $350 billion, today to return the fund to a
minimum responsible level of funding," said Bornstein, who noted that the figure
is approximately four times the current state budget.
"It's an enormous number," said Joe Nation, a public policy lecturer at SIEPR
and the adviser for the research team. He said it's important to look at the
shortfall relative to state resources. Pension funds fluctuate with market
performance, but state employees are guaranteed a fixed pension regardless. If
the market performs poorly, the state is obligated to step in and provide the
missing pension funds. That takes money away from other public projects, such as
education and healthcare, Nation said.
"The students did an amazing job providing a better sense of unfunded
liability for those three pension funds, and I hope observers out there will
begin to understand that this is a financial train wreck that is not very far
down the tracks," Nation said.
In the report, Bornstein and his fellow graduate students suggest policies to
fix the shortfall and prevent a similar one in the future.
They propose that the managers of the pension funds project more realistic
rates of return, which would indicate higher liabilities in the future.
"The whole approach that the state currently uses is inherently flawed. They
look at averages as opposed to a fan of outcomes," said Bornstein. "If you
instead look at the range of outcomes in the future, you'd see there's over a 60
percent chance of a deficit greater than $250 billion for CalPERS alone. This is
something that really scares us."
The students suggest that the minimum level of caution should be for the
pension systems to aim for an 80 percent probability of having at least 80
percent of the funds necessary to cover the pensions. They also advocate
investing more conservatively, taking fewer risks.
"Funds in other parts of the country are in similar situations, and they are
beginning to invest in riskier assets," Nation said. "That's exactly the wrong
thing to do. If the market doesn't perform well, the taxpayer ends up
paying."
Suggested fixes
The students suggest either reducing pension benefits or moving to a hybrid
system in which retirees receive a smaller fixed pension combined with a
401(k)-style plan. This would relieve some of the burden on the state and give
employees more responsibility for their retirement. Two-thirds of Californians
would support such a plan, according to a poll by the Public Policy Institute of
California.
"The biggest challenge with this is making sure elected officials understand
the severity of the problem," Nation said. "It's a political hot potato and most
politicians shy away from the issue because you offend a lot of the
constituencies by acknowledging the problem exists."
But, he said, citizens and institutions are increasingly aware of the
situation and are speaking out.
"The University of California is engaged in this debate because they finally
understand that as pension fund benefits grow, there will be fewer dollars for
higher education," Nation said.
The report was prepared for the Office of Gov. Arnold Schwarzenegger as part
of the Graduate Practicum in Public Policy, a two-quarter sequence required for
master's degree students in the Public Policy and International Policy Studies
programs.
SIEPR conducts research on important economic policy issues facing the United
States and other countries. SIEPR's goal is to inform policymakers and to
influence their decisions with long-term policy solutions.
Gwyneth Dickey is an intern at the Stanford News Service.
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