David Crane swings and misses on CalPERS investments
In an email to journalists and election officials, David Crane arrives at a false conclusion with his claim that CalPERS unfunded actuarial liability (UAL) will continue to grow unless the system achieves a return of at least 9.7%, not the 7.5% CalPERS currently assumes.
His principle is correct, but he arrives at an incorrect conclusion. Liabilities do grow at 7.5% per annum and, if there are no contributions towards the UAL, assets would have to grow faster than 7.5% for there not to be an increase in the UAL.
However, at CalPERS, contributions are being made to pay down the UAL. For the State Miscellaneous plan alone, the UAL payment was about $1.5 billion in the year. This was still not enough to fully offset the interest on the UAL so the UAL would still have grown even if we had achieved a 7.5% return. But the required return would have been much closer to 7.5% than the 9.7% that Mr. Crane calculated. Crane overstates the additional return needed by four times.
Below is the e-mail from Crane that CalPERS criticizes:
David Crane explains the ramifications of CalPERS’ 2.4% return for the past year
Yesterday, pension reform advocate David Crane sent this email message to journalists and elected officials explaining what CalPERS’ announced return of 2.4% (instead of the 7.5% it needed) really means:
Recently newspapers have reported that CalPERS earned 2.4% over the last twelve months and contrasted that return with its 7.5% assumed rate of return. But what those newspapers have not reported is that CalPERS needs to earn much more than 7.5% per annum for its unfunded liability not to grow.
This is because (i) under US public pension fund accounting, liabilities grow at the assumed rate of return and (ii) currently, liabilities exceed assets. That means assets have to grow faster than the assumed rate of return in order to keep up with liabilities.
As a simplified example, let’s say a public pension fund has a 77% funding ratio, which means that it has assets equal to 77% of liabilities. For greater simplicity, let’s say it has assets of $77 and liabilities of $100, and therefore an unfunded liability of $23 (100-77). Because of item (i) above, liabilities grow 7.5% per annum. That means liabilities that today equal $100 will in one year equal $107.50. For the unfunded liability not to be larger than $23 at that time, that means assets have to grow from $77 to $84.50 (107.50-84.50 = 23). That means that the pension fund needs to earn 9.7% ($77 times 1.097 = 84.50). Anything less and the unfunded liability will grow.
This is why it’s so hard for US public pension funds to catch up once they fall behind. See this relevant article from The Economist.