A Teachable Pension Math Moment

Unfortunately, compounding works in two directions.

Yesterday the California Public Employees’ Retirement System reported excellent earnings for its 2016–17 fiscal year, earning 11.2 percent. Yet CalPERS’s Funded Ratio (the ratio of assets set aside to meet pension liabilities owed by governments) improved only three percentage points, from 65 percent to 68 percent.

In other words, an extraordinary investment return 60 percent greater than the return CalPERS expects to earn and >80 percent more than the return Warren Buffett expects his defined benefit plan to earn moved the Funded Ratio only 5 percent.

That asymmetry happens because pension liabilities accrete at the discount rate, as explained here. Think of it as a football field on which goal posts keep moving further away. Even huge gains in yardage can’t move players materially closer to the end zone. This is why classrooms and other public services will be squeezed by rising pension costs for decades to come.

That situation was — and still is — caused by self-serving pension fund board members and elected officials engaged in a huge — and undisclosed — transfer of wealth from students and citizens to government employees, as explained here and here.

Next year CalPERS will artificially report an improved Funded Ratio as the result of a recent financial maneuver led by Governor Jerry Brown, as explained here. A Pandora’s Box has been opened by his scheme. Elected officials could divert tens of billions of additional dollars sitting in special funds filled by gas taxes and other fees to cover up pension deficits. Governor Brown characterized his scheme as a “loan” but since the lender is under the control of the borrower, that’s like a parent claiming a borrowing from a child’s trust fund is at arm’s length. Stay tuned.