“If you’re not at the table, you’re probably on the menu.” — Dave Low, Executive Director, California School Employees Association
“Pay now or pay more later.” — CalPERS board member Richard Gillihan, appointed by Governor Jerry Brown
The CalPERS board is considering a recommendation to lower its investment return assumption to 6.1%. That would mean higher pension costs now but much lower pension costs in the future. Therein lies the inter-generational battle represented by the issue of public pension fund investment return assumptions.
The financial consequences of the decision are big for the current generation but nothing compared to those for the next generation. Let’s say that a 6.1% investment return assumption would cause pension costs to increase by $4 billion this year. That’s a lot of money but if CalPERS doesn’t make the change and its actual return over the next 20 years is 6.1%, the next generation would get hit with $14 billion — ie, 3.5 times as much — in pension deficits. That’s $14 billion the next generation wouldn’t be able to use for its own police and fire departments, colleges and universities, social services, environmental protection and more.
This is not a new issue. Almost a decade ago Warren Buffett laid out math illustrating the absurdity of lofty investment return assumptions. Had CalPERS’s board followed his advice, unfunded liabilities today would be a fraction of their size. But CalPERS’s board continued on the same path with the result that the cost of meeting unfunded pension liabilities will already take $300 billion from government services in California.
Lowering the investment return assumption can’t help with existing unfunded liabilities but it can stop the digging of an even bigger hole.
The current generation — especially the current generation of politicians and government employees who benefit from keeping current contributions artificially low — will be well-represented at the board meeting. The next generation will not, which means they are likely on the menu. The un-represented include not only future families, students, bus riders, environmentalists and taxpayers but also the next generation of public employees who will find fewer jobs and smaller wage increases if the board continues using an implausible assumption.
Based on past board behavior one can’t be optimistic. Observers should expect long-winded discussions designed to obfuscate the simple truth, which is this: Proper pre-funding of pension promises is no different than proper pre-funding of a child’s college education. If an implausible rate of return is assumed, not enough money will be set aside and the child will not be able to fund college. If CalPERS continues to assume an implausible rate in order to keep current costs artificially low, the next generation 0f governments will not be able to fund their services.
Under-funded pension promises are like greenhouse gas emissions. Both involve selfish behavior by earlier generations at the expense of later generations, get worse the longer they’re not addressed, and, as Thomas Piketty puts it, “devour the future.” Governor Brown, his appointee Richard Gillihan and CalPERS’s investment staff are showing leadership in pressing for a reasonable investment return assumption. The next generation must hope they prevail.