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Public Sector Finances Likely to Worsen

Rick Roeder, FSA       November 2010

Reality is starting to set in for many of America’s largest public pension funds. One of the key elements in determining how much a plan sponsor should put into its pension trust fund is the assumed rate of investment return.  Higher assumed investment returns translate into lower current required contributions and vice versa. For mature funds, investment returns are assumed to account for 60-70% of all inflows into a fund.

Let’s summarize what is going on at four of America’s largest funded pension systems.

The largest, $221 billion behemoth, CalPERS, is in the midst of a evaluation process that will culminate in February 2011. Roeder Financial predicts that CalPERS current rate of 7.75% will be lowered to 7.5% after all the analysis and politicking is done. And politicking will happen even if done on a subtle and indirect basis. The politicking will take the form of:

  • This is a very important decision. We need more time to study this.
  • This will have dire consequences for both the state, current employees and the 2,000+ contract agencies that invest monies with CalPERS
  • The markets have done reasonably well since March 2009 so why reduce the rate now?

It is a reasonable guess that the total current actuarial liabilities for all entities in CalPERS are somewhere in the general area of $240 billion.  A modest reduction of 0.25% in assumed return will result in a liability increase of roughly $6 billion.  The actuarial price tag for benefits earned in the current year (“normal cost” in actuarial jargon) will also increase.   Since the state of California is broke, the actions potentially taken by  CalPERS and CalSTRS will do nothing but make the state even “broker.”

CalPERS “little sister,” CalSTRS, “only” has $139 billion in assets. Still, little sister is #2 in America in pension assets! In June, both the CalSTRS’  in-house actuary, Rick Reed, and their outside consultants recommended a decrease in the assumed rate from 8% to 7.5%.  CalSTRS’ current funded ratio is 78% and would drop to 74% with the lower assumption.  Currently, the school districts pay 8.25% of payroll into the fund each year while the teachers contribute 8%. The system would need to receive almost double these rates to eliminate the projected long-term actuarial shortfall if the actuary’s recommendation was implemented.  Reed’s recommendation was trailed to a November 5 meeting for further study.  However, no decision was made at the November meeting due to some absences on the Retirement Board.  Action on the recommendation has again been deferred to their December 2 meeting.  Stay tuned!


The state of New York is the 3rd largest public fund, weighing in at $125 billion.  In September, the state reduced its assumed return from 8% to 7.5%.

Last month, Illinois State Employees’ Retirement System announced that it was reducing its assumed rate of return from 8.5% to 7.75%.  This was daunting news for the underfunded plan.  Given the State of Illinois’ past funding practices for the state’s five pension systems, or perhaps, more accurately stated, “ non-funding practices”, it is difficult to say how this will translate into actual dollars going into the trust fund.  The aggregate funded ratios for the state plans have hovered at a dismal 50%.  However, regardless of funding practice, the bond rating community will take note of the amount of unfunded liabilities.  So even if there is not an immediate impact on the plan sponsor’s funding policy, there may be an impact on the perceived quality of future bond issues.  Lower investment ratings will often translate into higher financing costs.

Roeder Financial annually completes a funding survey for California’s 40 independent retirement systems (see the Ramble at  This trend of lowering assumptions is not limited to America’s largest  public systems.  Since our last survey was issued in May, we know of at least 4 surveyed systems which lowered their assumed return.

The rampaging bull market from 1983-2000 was unparalleled in American history in both breadth and depth.   Unfortunately, this provided a double whammy from which the public sector has yet to recover.  Not only were future assumed investment returns increased to the 8%-8.5% range but the investment gains were used as the basis for increases in pensions to unprecedented levels.  Such pension levels are very difficult to undo for existing employees, even for future service, under most state laws due to the “contact impairment” doctrine that generally applies to most public employees.

The National Bureau of Economic Research estimates a trillion dollars of unfunded liability for public plans.  With the recent and coming reductions in assumed investment returns, such shortfall will increase.  Perhaps, on a more optimistic note, this also points to increased fiscal responsibility among the stewards of our public retirement plans.

Half-century ago, the Shirelles’ smash hit, “Dedicated to the One I Love”, had one poignant lyric that we hope will apply to public pension governance:  “The darkest hour is just before the dawn.”

HAPPY HOLIDAYS from Roeder Financial

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