The sharp decline in financial markets will likely result in a huge setback to government-employee pension funds, which never fully recovered from the last recession. Though the accounting of these systems is more complex than ordinary municipal budgets, and the implications of market drops can take time to become apparent, a picture is emerging of the costs that some of the biggest funds—like the California Public Employees’ Retirement System (CalPERS)—face. Meantime, the risks that some of our worst-funded state and city pension systems must now confront, including New Jersey’s and Chicago’s, are also becoming evident. Last week, the president of the Illinois State Senate even asked for a multibillion-dollar bailout of the state’s pension system. The failure of many pension funds to fix their funding during the last decade of market expansion will weigh heavily on taxpayers if the economy and financial markets don’t turn around rapidly.
With about $350 billion in assets—down from about $400 billion at the market’s height, earlier this year—CalPERS is the nation’s largest public-employee pension fund. It took a battering in the last recession, when its funding shrank from 87 percent of the money needed to meet future obligations in 2007 to just 68 percent a few years later. After an 11-year market expansion, though, CalPERS is barely more than 70 percent funded, as of last June. Taxpayers have paid the price. The state and its local governments funnel $15.6 billion into the fund, up from $6.4 billion in 2007.
CalPERS CEO Marcie Frost assures local officials that the system is prepared to weather this downturn, having reduced its exposure to volatile stocks. Nonetheless, the CalPERS rate of return for the first nine months of the current fiscal year, which ended on March 31, was negative 4 percent, compared with a projected annual gain of 7 percent, which is necessary to keep CalPERS from taking on more debt and forcing even higher payments from local governments. Officials estimated that even if the fund scratches its way back to a zero-percent return for the fiscal year that ends June 30, its funding status would slip to about 66 percent. Under the worst-case scenario—a 10 percent investment loss—the nation’s largest public-employee retirement system would have just 60 percent of the money on hand that it needs to meet future obligations.
Both scenarios would require more money from taxpayers. For public-safety workers who are part of CalPERS, local governments are already paying pension costs equal to 50 percent of every worker’s salary. Over five years, CalPERS says, that amount could increase to nearly 70 percent of salary cost. For every $1 in salary paid to a cop or firefighter, a jurisdiction would need to spend almost 70 cents more just on pension costs. California schools are paying the equivalent of 28 percent of salaries to fund pensions for employees who are part of CalPERS. If assets decline by 10 percent, governments would have to contribute 37 cents for every dollar of salary paid to school employees who are part of CalPERS—a one-third increase in pension costs over four years. No wonder, then, that Frost acknowledges “the affordability of [pension] plans has become ever more difficult” for the 3,000 local-government entities in the state that provide workers with pensions through CalPERS. Last week, school officials around the state asked Governor Gavin Newsom to delay scheduled pension increases.
The New York City Retirement System, composed of five pension plans with some $150 billion in assets, has also seen its burden to taxpayers soar in recent decades. Twenty years ago, the city was spending some $1.5 billion a year on pensions. Costs rose to $10 billion this year. Before the Covid-19 crisis, the city had projected that the steep increases might finally be over, thanks to more than a decade of robust investment returns; the market’s decline has upended those estimates.
“The cratering of the financial markets has undoubtedly affected the value of assets under the management of the New York City Retirement System (NYCERS)—the city’s five pension plans,” the New York City Independent Budget Office recently reported. The budget watchdog’s new analysis estimates that if the city’s pension fund records a zero-percent return for this year, the cost to taxpayers would be $107 million a year in higher pension payments, added every year to the city’s current pension costs, for the next 15 years. The numbers get even grimmer, however, if the losses mount up. The worst-case scenario—a 20 percent decline in assets, which would mirror the losses in 2008—would require the city to spend more than $400 million annually for the next 15 years in increasingly expensive pension payments. In just the next five years, that would add more than $2 billion cumulatively to the city’s retirement-funding requirements.
Some government pension systems are so poorly funded that they face what’s known as a liquidity crisis—when a system has so little cash on hand that it must sell assets at a loss just to pay current benefits. In a report last September, ratings agency Standard & Poor’s identified eight seriously underfunded state and local pension systems that could soon face such crises—including the New Jersey state teachers’ fund, which has just 25 percent of the money it needs on hand to finance its future obligations, and the Chicago police retirement system, with only one-fifth of the assets it needs.
As a mature fund, the New Jersey pension system is paying out about $4.5 billion a year in retirement benefits and other kinds of payments to 104,000 beneficiaries. Yet contributions by active teachers and state government amount about $2.8 billion annually, leaving a $1.7 billion deficit. When the market is good, investment returns help make up the difference. For the fiscal year ended June 30, 2018, for instance, a nearly 10 percent market gain generated $2 billion, which the fund largely used to pay retirees. This year, however, market gains have largely evaporated for everyone.
In its last financial report, the New Jersey teachers’ pension fund had just $530 million in cash. Like most underfunded systems, it placed most of its assets in the market, eager for high returns. Now, its investments have almost certainly declined, and it will likely have to sell these shares at a low price just to raise cash. This kind of liquidity problem had a major effect on many pension systems after the 2008 market crash; CalPERS sold some 2.3 million shares of Apple to raise $370 million in cash that year. Five years later, those shares were worth $1.5 billion.
That kind of math illustrates why it becomes so hard for underfunded pensions to fix themselves, even when the market rallies. The New Jersey teachers’ fund has only about $20 billion invested in the market, so even when the state’s investment managers generate a nearly double-digit market return—as they did in fiscal 2018—the gains are barely enough to pay pensions. If it were fully funded, by contrast, the fund would earn enough in a good year to cover pensions and save billions of dollars more for a rainy day.
For some underfunded pensions, the only way to avoid a liquidity crisis is to raise the burden on taxpayers. That’s what happened in Chicago, where the police pension fund pays out about $775 million a year in benefits. The fund takes in about $700 million, leaving a cash shortfall when investments don’t pan out. The gap used to be much greater, but a $500 million annual property-tax increase in Chicago has closed the gap. Since 2016, the amount of money the city has been required to contribute to the police fund alone increased by $306 million, to $588 million. Even so, the fund, with just $3 billion in assets before the market drop, hasn’t been able to improve its fortunes.
These numbers should be sobering to political leaders like New Jersey Governor Phil Murphy and Illinois Governor J. B. Pritzker, who have refused to cut benefits to get pensions solvent. In Illinois, the depth of the problem is starting to dawn on state leaders. State Senator Don Harmon last week asked President Trump for $40 billion more in assistance for the state and its cities, including $10 billion to bolster its pension system. Even so, Murphy and Pritzker argue that government could mend these financial woes through additional taxpayer contributions. Before the crisis, Pritzker was touting a progressive income tax that he hoped would raise more than $3 billion annually for state and local pensions (the state’s own employee-pension system is just 35 percent funded). Murphy has proposed a millionaires’ tax to help fix pensions. But the amounts that state and local governments must raise and pay every year in both places just to stop money from rushing out of their pension systems are enormous. Even before the Covid-19 crisis, they were falling short. It’s hard to imagine that they’ll be able to afford the new bills.
Frost of CalPERS observed on a recent conference call with state and local officials that a worker’s pension is “really only as safe as an employer’s ability to pay for it.” For “employer” she might have substituted “taxpayer”—that’s who will be on the hook for the losses that government pensions are seeing.