California's public pension systems have come under fire recently by several studies. One of the reports, by students at the Stanford Institute for Economic Policy Research Institute, recommends that public pensions be cut by nearly half their expected rate of return. The state's taxpayers will have to swallow hard if they want to go along with that flawed advice.
Pension funds are critical to retirement security, but they are not immune from the significant investment losses that have hurt all investors. But the Stanford students don't tack away from trouble. They head straight for it -- by calling on public pensions to assume T-bill-like returns for investment portfolios. This approach will run the funds aground at the feet of the state's taxpayers.
Given a choice in 1984, California voters rejected a risk-free investment approach and removed a 25 percent constitutional limit on public pension fund equity exposure when they approved Proposition 21. Leaning on risk-free investments to finance public pensions imposes more costs to the taxpayers.
Pension financing in California will be one of the issues at the top of our next governor's inbox. At the California State Teachers' Retirement System, we think it is important that this important topic be discussed with all the facts.
The primary purpose of a pension is to help employees retire with the ability to maintain their standard of living and independence at the lowest possible cost to employees and employers. We've read a lot about the benefit formulas that could provide 90 percent of pay for those who retire at age 50. Very few public safety employees qualify for this benefit.
The CalSTRS benefits paid to public educators are modest.
If a person needs to plan on 80 to 90 percent of pay in retirement to maintain their pre-retirement standard of living, certainly this benefit level assists in achieving that objective.
The benefits paid to public school teachers are guaranteed and, therefore, there is no risk that the benefits will not be paid. CalSTRS prudent long-term investment strategy is based on an asset allocation process that evaluates the system's need for liquid funds to pay current benefits and provides a disciplined investment approach that directs funds that are not immediately needed into longer-term, less liquid and higher earning investments.
Over the long-term, equities provide a higher return than bonds despite the increased level of risk. Historically, more than 60 percent of CalSTRS benefits are paid from investment earnings. It is clear that reducing our investment in equities and increasing our exposure to bonds will increase the cost of the benefits to employers and, ultimately, the taxpayer.
Why would anyone recommend an approach that passes so much of the cost directly to the taxpayer? CalSTRS funded status represents a figure at a point in time that can change with swings in the market. Experience has shown that, over time, Wall Street losses are offset by greater recovery.
For instance, the closing value on March 31, 2010, puts CalSTRS up $18 billion in value from June 30, 2009. That equates to a nearly 18-percent return for the fiscal year. With less than 90 days to go before we cross the fiscal year finish line, the U.S. stock market has regained 60 percent in value in the past 12 months, far outpacing the return for U.S. Treasuries.
Critics of public pensions have suggested that existing defined benefit public pension plans are too expensive. Research by the National Institute on Retirement Security showed that for a given level of benefit, a defined benefit plan is about half as costly as a defined contribution plan because defined benefit plans have better diversification, can pool risk and achieve higher investment returns.
Public pensions systems, such as CalSTRS, take their responsibility to provide retirement benefits in an efficient manner seriously. Part of that is accomplished by taking advantage of the long-term nature of their overall liabilities, and investing appropriately to maximize investment returns with a prudent level of risk, which in the long run will reduce taxpayer costs.
CalSTRS with a $132.6 billion portfolio is the second-largest public pension fund in the United States. It administers retirement, disability and survivor benefits for California's 848,000 public school educators and their families from the state's 1,400 school districts, county offices of education and community college districts.
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