A lot hinges on whether CalPERS makes that 7.75% rate of return they promise. It's like a mortgage in that a small change in the % return on CalPERS investments makes an enormous difference in how much is owed. If CalPERS can't make 7.75% (it's made 5.5% for the last 10 years), then retirement liabilities will keep mounting as CalPERS continually fails to make its targets. Tax money will have to make up whatever the gap is between the projected earnings and the actual earnings, tax money that would otherwise go to schools, roads, parks, aid to the elderly and poor, etc., etc.
What is the likelihood of making that 7.75%? Less than 1 in 5, based on the average stock market returns from 1900 to 1999 (excluding the two recent big bubbles and their collapse). Dr. Joe Nation (former Democratic legislator from San Rafael) in a Stanford Economic Institute for Economic Policy Research report recently calculated the probabilities of the 3 largest retirement funds making their targets and what happens if they don't. Looking at stock market returns over the 100 years 1900-1999 he found the average return on investments is 6.2%. Meaning CalPERS has a 50% chance of making that. The higher the return required, the lower the probability of making it. 7.75% has an 18% chance.
At that 6.2% rate, this means state retirement funds are currently underfunded by 3 times the current estimate based on a 7.75% return. A powerful testament to the multiplying power of compound interest. This translates into triple the pension liability, and the annual payments to make up that gap tripling from the current $4.8 Billion to $14.6 Billion. That is larger than Brown's proposed 2012 budget for the UC, CSU, and all the Community Colleges in CA ($9.8B), bigger than the entire prison budget ($10.7B), nearly 3 times the CA budget for "Natural Resources" and "Environmental Protection" ($5B).
The assumed return on investments of 7.75% was set by the CalPERS governing board. Of the 13 current board members, 11 are also beneficiaries of the CalPERS retirement plans giving them a vested interest in keeping the projected actuarial assumptions high so that benefits can appear to be well funded. No professional or technical proficiencies are required to be a board member.
(To be continued)
Dr. Nation's report is available here:
Governor Brown's 2012 Budget is here: