If you’ve had a chance to look at your 401(k) or IRA rollover quarterly statement for June 30, then you’ve probably got a smile on your face. The stock market has done quite well over the past year; better than most would have expected.
The California Public Employees’ Retirement System (CalPERS) on July 12 released its investment performance for the past 12 months. CalPERS is the largest public pension system in the nation and the retirement administrator for the state and most of its counties and cities.
The news was good for them, too. Publicly traded stocks traded over the various markets returned 36.3 percent. Private equity, early-stage companies in which institutional investors make an ownership play, provided a yield of 43.8 percent.
The bond market, however, was not so kind, as interest rates continue to stay relatively low.
The fixed income portion of its portfolio stayed flat, with a yield of negative 0.1 percent. Should rates rise in the next 12 months, then the total return on fixed-income investments will be in negative territory. That’s why there’s a heavier reliance on equity performance, with their diversified portfolio, to achieve an overall combined yield of 21.3 percent. This exceeds the plan’s seven percent annual assumed rate of return.
What can we glean from this information?
Everyone who has a diversified portfolio in their 401(k), a defined contribution retirement vehicle, should have had similar results. The market gives what the market gives. But earnings of more than seven percent provide funds to reduce existing unfunded actuarial accrued liabilities.
Defined benefit pension plans should have enough funds on hand to pay beneficiaries. But the funding ratio has been well below 100 percent. With the additional investment returns, this ratio went from some 71 percent to approximately 82 percent.
Why Is CalPERS Underfunded?
The last time CalPERS saw great returns of this nature was during what was known as the “dotcom” boom. The CalPERS Board made a tragic mistake at the end of the 1990s. It should have sold stocks, locked in the profits, and used the proceeds to purchase eight percent bonds. Instead, it stealthily pushed the legislature to increase the formula for calculating retirement benefits by 50 percent, retroactive to the date of hire, with SB 400. This caused the 100 percent funded retirement plan to become two-thirds funded literally overnight.
Not selling its “dotcom” stocks at an opportune time found their values dropping dramatically, wiping out all the previous years’ gains. Consequently, CalPERS has not come close to seeing an 80 percent funding level for some two decades.
Will the CalPERS Board repeat its former misguided assumption that last year’s returns will be this year’s returns and, therefore, next year’s returns? Or will they have learned that boom follows bust?
In its July 12 announcement, there was an encouraging reminder:
“It is important to note that this high return has triggered the Funding Risk Mitigation Policy, which uses some of these plus-performance returns to reduce expected risk in the portfolio, while stabilizing volatility in employer contribution rates. The policy reduces the discount rate to 6.8 percent.”
This is good news. Going forward, instead of trying to earn seven percent each year, now the goal is to achieve 6.8 percent in returns. Although this is a smart move, the earnings assumption should be lower, as a significant portion of the portfolio is in fixed income and not earning high yields, while the stock market can’t go up at double-digit returns indefinitely.
But it’s a step in the right direction.
The downside is that employer contributions may increase in the future if annual actual returns fall below 6.8 percent for a short period of years. If this occurs, then the lower 6.8 percent target was still too high. Such is the math of defined benefit pension plans.
The fly in the ointment is the state legislature. I was the only legislator trained as a certified public accountant and certified financial planner up there during the past six years. Most of my colleagues were not financial experts. We must hope that they don’t pass bills that once again put the funding status of pension systems in jeopardy.
Although the actuaries for the plan have become smarter, the legislators have not.
For example, there is a bill flying through the legislature, AB 826, that wants to increase the amount of compensation earnable for the employees of certain counties. This is another public employee union money grab. It is being voted on literally by party lines, with most Republicans in opposition. But unions run Sacramento. The supermajority will be afraid to oppose such a bill for fear of losing union campaign contributions.
Unless Gov. Gavin Newsom vetoes AB 826, he will have the same remorse that former Gov. Davis had for signing SB 400 back in 1999. And Sacramento will have not learned anything from the “dotcom” bust.
Should Newsom sign AB 826 before Sept. 14, you will have one more reason to approve his recall with your vote. His only justification for doing so is to pay back those who are funding his counter campaign war chest with millions of dollars.
Sacramento’s political mischief is the real reason government pension plans become underfunded and how your pocketbook has been impacted and will be in the future.
John Moorlach is a former Orange County Supervisor who most recently served as a state senator. He previously spent 12 years as Orange County’s Treasurer-Tax Collector, and led the county out of bankruptcy.
Views expressed in this article are the opinions of the author and do not necessarily reflect the views of The Epoch Times.