NCPA - National Center for Policy Analysis


April 27, 2010

The time bomb that is public-pension obligations keeps ticking louder and louder.  Eventually someone will have to notice, says the Wall Street Journal. 

This month, Stanford's Institute for Economic Policy Research released a study suggesting a more than $500 billion unfunded liability for California's three biggest pension funds -- the California Public Employees' Retirement System (CalPERS);  the California State Teachers' Retirement System (CalSTRS); and the University of California Retirement System (UCRS).  The shortfall is about six times the size of this year's California state budget and seven times more than the outstanding voter-approved general obligations bonds.

The pension funds responsible for the time bombs denounced the report and accused the study of being fundamentally flawed because it  uses a controversial method that is out of step with governmental accounting standards.  Those standards bear some scrutiny, says the Journal: 

  • The Stanford study uses what's called a "risk-free" 4.14 percent discount rate, which is tied to 10-year Treasury bonds.
  • The Government Accounting Standards Board requires corporate pensions to use a risk-free rate, but it allows public pension funds to discount pension liabilities at their expected rate of return, which the pension funds determine.
  • CalSTRS assumes a rate of return of 8 percent, CalPERS 7.75 percent and the UC fund 7.5 percent.
  • But the CEO of the global investment management firm BlackRock Inc., Laurence Fink, says CalPERS would be lucky to earn 6 percent on its portfolio; a 5 percent return is more realistic, says the Journal. 

Under California law, public pensions are a vested, contractual right.  What this means is that taxpayers are on the hook if the economy falters or the pension portfolios don't perform as well as expected.  The Governor's office projects that, absent reform, this figure will balloon to over $15 billion in the next 10 years. 

What to do?  The Stanford study suggests that at the least the state needs to contribute to pensions at a steadier rate and not shortchange the funds when markets are booming.  It also recommends shifting investments to more fixed-income assets to reduce risks. 

Source: Editorial, "Pension Bomb Ticks Louder," Wall Street Journal, April 27, 2010. 

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