Clearing Up Some Pension Math

Say you invested $1000 in 2005 and earned these returns through 2015:

Compounded Annual Gain = 6.7%

Even though your portfolio suffered a material decline during the Great Recession, your compounded annual gain over that period would still be 6.7% and at the end of the period you would have $2000. Wonderful, right?

Those are the annual returns earned by CalPERS for that period, including the Great Recession. While some public pension fund officials still try to blame the Great Recession for today’s unfunded pension liabilities, they are seeking to mislead when doing so. CalPERS’s unfunded liabilities more than quadrupled over that period because of liability growth, as explained here.

For another example of the nonsense of citing the Great Recession for today’s pension deficits, consider the same period for the S&P 500:

Compounded Annual Gain = 7.1%

The S&P 500 performed even worse in the Great Recession yet nevertheless compounded at a higher (7.1%) rate. $1000 invested in the S&P 500 in 2005 would be worth $2100 in 2015, $100 more than in the CalPERS case.

Just as one must not over-rate positive return years, one must not over-rate negative return years. Both are subsumed within compounded annual growth rates. Also, negative return years are a fact of life. Over the last 50 years the S&P 500 had nine negative years, representing 18% of those years.

Elected officials owe it to citizens — especially to young people — to fully understand the math of pension obligations and to seek a solution.

Retirement costs are already crowding out public services in California. Absent reform, much greater crowd-out is on the way. There are millions of innocent victims — K-12 students taught by fewer teachers and specialists in larger classrooms; college and university students forced to pay higher tuition; the needy getting less in welfare; current and future public employees offered fewer jobs and smaller wage increases; retirees of bankrupt cities losing retirement benefits; environmental protection and parks being short-changed; cities unable to field a sufficient number of police and fire personnel; citizens being forced to pay payday-loan-level fines to cities seeking ever-greater revenue; taxpayers paying higher taxes for less in services; and more. Absent reform, pension costs will crowd out more than $1 trillion of California public services over the next 30 years. It doesn’t take a social scientist to grasp that civil society is at risk when so many people are being disappointed, especially when there is perceived unfairness because not all citizens suffer the consequences (eg, parents who can afford to send their kids to private schools). Elected officials must understand pension math and work towards a solution.

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