September 30, 2010

pension: facts

i've decided to put out some facts about California's current budget crisis in relation to pension reform as this seem to be a hot topic around the office watercooler.  GAS (Governor Arnold Schwarzenegger) is pushing for pension reform by refusing to approve the budget if pension reforms are not included.

The attack on secure retirement is, I believe, politically based and nothing to do with economics.  Some facts:  (note: I belong to CalPERS so I am only including facts that are associated with CalPERS. Some facts may also be pertinent to the other pension plans)
  1. The state contribution for about two-thirds of the workforce is the same, as a percentage of payroll, as the average during the 1980s.
  2. The average retiree receives $2,100 per month which can increase by no more than 2% per year, regardless of inflation.
  3. For every $8 received by a retiree in a pension, $6 comes from investment returns; $1 from employee contributions; $1 from the employer or taxpayer.
  4. The employee contribution varies between 5% and 8% of salary. The employer or State contribution varies from nothing to 21%, depending on investment returns. Over a 20 year period, the employee and employer contributions are about equal.
  5. Due to the downturn in the economy, the State contribution is currently 16.9%, or about $3.3 billion per year.
  6. PERS estimates that in future years, the State’s contribution could increase to 24% or $4.7 billion, before gradually reducing. The increase will be less than that if investments yield a higher return than projected, which has frequently been the case in the past.  Current project of return I believe is around 7.5%.
  7. GAS asked CalPERS to bill the State an additional 1.5 billion more than necessary in order to bolster his argument that pension plan is too expensive.  CalPERS rejected GAS's proposal.
when we talk about budget crisis in California, it is related to the General Fund.  CalPERS requested state contribution to increase by 600 million (3.9 billion total) this fiscal year but only 87 million of which comes from the General Fund.  The rest comes from Special Funds such as transportation.  This is also an estimate which projects salary increses.  State employees have not had raises for the past 3 years as well as on the receiving end of GAS's 15% unpaid furlough leaves so the actually amount is projected to be around 475 million.

of course, one or two rotten apples can spoil the whole and incidents like city of Bell and Vernon greatly damage the image of public employees and their pensions.


  1. The numbers, by themselves, sound fine and dandy, until you look at the bigger picture.

    You are looking at 1 generation of current workers supporting the needs of 2-3 generations of retirees who are living longer lives. Hence, the money you contribute is a ponzi supporting 3-4 other retirees; it does not sit there waiting for you to retire.

    In addition, 7.5%(even 4%) investment returns on billion-dollar portfolios in 0% interest environment in a deleveraging global economy is laughable and downright silly.

    The whole idea of pensions work only if the population is growing rapidly, as the new generation of workers can comfortably cover the retirees. Now, the demographic pyramid is upside down. Look no further than Japan and Europe on pension crises.

    Because of all of the above, you have unfunded pension liabilities across the board. You should check CalPERS unfunded liabilities; they are desperately trying to cover them after losing ~30% in asset value in 2008.

    BTW - you are not alone in your reasoning; unions in Europe are striking on a daily basis for the same reasons.

    An article on unfunded pension liabilities.

    And an FYI - if you are expecting to retire on nice CalPERS pensions, good luck. SS has stopped COLA increases, which indicates that the revenues has fallen far below outlays. Also, the politics has changed - NJ is seriously considering canceling pensions all together due to their budget deficit(of course, the courts will be an entirely different result, but nevertheless, the possibility is out there now).

    Translation: it is most likely that CalPERS and SS will run out of money before our generation retires, due to demographics, deleveraging, and debt servicing.

    If you are looking for a scapegoat, look across the generational lines. Our generation will be fighting with AARP politically for the next few decades on this issue alone.

    We live in interesting times........

  2. Kaiwen, my 7.5% is conservative even in this deleveraging global economy. Calpers posted 11.8% investment gain in 2009 and their 20-year investment return remains steady at 7.75 percent – the assumed rate of return necessary to pay future member pension benefits.

  3. That's assuming it makes any sense. :)

    Check this calculation out from wiki.
    The 124 billion dollars of income in the 9 year period 1999-2007 has been reduced in half by the combined losses of 67 billion in 2008 and 2009. This totals to 57 billion dollars of investment income during this 11 year period, or about 5.1 billion a year on an investment portfolio of 261 billion in October 2007 and down to 186 billion in October 2008. This is a 2.5% return on investment over the 11 year period.

    As I mentioned earlier, 08-09 took a big chunk of the principal. Hence, that 11.9% gain in 09 per CalPERS is not even enough to return the fund back to pre-07 levels.

    If you do the math, you will realize there has been an underfunded component of almost 5% of assets (not counting the 08-09 ~30% drop). Yet, pension liabilities are rising at a 7.75% clip (as u mentioned).

    So, I'm sure you can now see why the whole system is bound to collapse at some point, due to demographics and deleveraging. There is no way CalPERS can hit 7.5%, unless it can somehow take a lot more risks.

    Also, CalPERS is stuck since a significant amount is in alternative investments, which are illiquid, and declining in value versus 07-08 pre-crash levels.

    My point: don't believe what CalPERS says - just like Wall Street, they are only telling you what you want to hear. Crunch the numbers and you'll see the truth. After all, they need to justify their job performances as well. :)