California's big public pension funds are already short tens of billions of dollars. An organization of accountants is about to make the picture look even worse.
A proposed change to pension accounting standards could give more ammunition to conservatives seeking to reduce pension benefits for public sector workers. Gov. Jerry Brown is expected to issue a wide-ranging proposal to overhaul pensions sometime soon.
As Brown and the Legislature prepare to wrestle over pension costs, an organization that sets the industry standards for how government finances are reported, the Governmental Accounting Standards Board, is proposing new rules for calculating pension fund liabilities – the amount of money such funds owe retirees.
The proposal wouldn't have much effect on CalPERS, the nation's largest public pension fund. But it would have an enormous impact on the second largest public fund, CalSTRS.
The California State Teachers' Retirement System already faces a funding gap of $56 billion – the difference between the money it expects to have on hand over the next 30 years and what it will need to pay out in benefits during the same period.
The accountants' proposal would triple the gap – on paper – to around $150 billion, said Ed Derman, deputy chief executive officer at CalSTRS.
"It complicates things," Derman said. "People are going to see this other number … and they're going to say, 'Oh my gosh, it's a much bigger problem.' "
Derman said CalSTRS' financial problem won't actually worsen. It will just look worse to accountants – and maybe elected officials. That could complicate CalSTRS' efforts to plug its funding gap.
Public pensions and their cost to taxpayers have emerged as a hot-button political issue since the market crash of 2008 greatly reduced pension fund assets. CalPERS responded by raising state contributions, which it has the legal right to do. CalSTRS, however, is legally required to get approval from the Legislature for higher taxpayer contributions to teacher pensions.
With the state budget already in dire shape, the teachers' pension fund has hesitated to broach the issue aggressively, although it has been quietly lobbying lawmakers for about two years.
Today, CalSTRS gets about $6 billion a year combined from the state, school districts and teachers.
It believes it needs about $4.1 billion more each year or it will run out of money in a little more than 30 years. If that were to happen, the state would be responsible for paying benefits to retirees.
"We have to be responsible, to educate the governor and the Legislature," Derman said.
Even pension funds that will be relatively untouched by the accountants' proposal are taking notice of the political consequences.
"There's going to be a perception problem – what is the cost of the pension system?" said Alan Milligan, chief actuary at the California Public Employees' Retirement System.
The GASB rules also could cause big headaches for the 1,700 school districts that belong to CalSTRS. For the first time, they would have to report a portion of CalSTRS' funding gap on their own statements – making their finances look worse than they do now.
Because of that, "the pressure will be much more severe on getting a solution," said Marcia Fritz, a pension reform advocate who leads the California Foundation for Fiscal Responsibility.
GASB isn't a regulator. It's an industry group and has no police authority. But it has enormous sway over government agencies, including public pension funds. Milligan said agencies that ignore GASB rules have to issue so-called "qualified" financial statements, which create red flags for bond buyers.
Conservatives say the current public pension system in California is unsustainable and needs a complete makeover. Unions have made some concessions but have vowed to resist major structural changes.
In some ways, the debate comes down to an accounting question: How should pension funds measure their long-term liabilities?
Right now, funds base their calculation on a forecast of how their investments will do. CalSTRS, for instance, says it will earn an average 7.75 percent a year on stocks, bonds and other investments.
But because public pensions are guaranteed by taxpayers, conservatives and some academics contend pension funds should use a rate comparable to a super-safe investment like Treasury bills – something on the order of 4 percent.
Using a lower investment return rate would cause pension funds' financial shortfalls to mushroom. In one controversial study, a group at Stanford University last year calculated that the funding gap at CalPERS, CalSTRS and the University of California would exceed a combined $500 billion.
The GASB proposal, set to take effect next June, is an attempt to compromise between the two schools of thought.
Pension funds that have a funding solution in place – like CalPERS – won't have to change their calculation.
Pension funds still awaiting a solution – like CalSTRS – would have to adopt a lower rate. Their funding gap would expand, even though they say their true financial situation hasn't changed.
"We have to get people to understand," Derman said. "It wouldn't really affect what we actually do."