In September 2013, the California State Legislature began a four-month recess, once again leaving one of the state’s most significant and escalating issues unresolved – the major California State Teachers’ Retirement System’s (CalSTRS) funding shortfall. Until now, failing to address the shortfall has delayed some short-term budget strains but ironically made California’s K-12 education system far more vulnerable to severe cuts in both the near and long-term future.
Like many public pension funds, CalSTRS is fiscally distressed because its investments underperformed and it remained perpetually underfunded. Consequently, CalSTRS requires significant contribution increases to make up a $71 billion shortfall and pay for current and future benefits. In California, the state Legislature is responsible for approving the contribution levels.
The least expensive long-term solution CalSTRS proposes is for the state, school districts and/or program members to contribute more to the system, starting with an additional $4.5 billion in 2015 and totaling $240 billion over the next 30 years. Though the least expensive solution, this is nearly twice what the state, districts, and members currently contribute, presenting a clear funding challenge that school districts and state department budgets will likely bear going forward.
Even the hefty $240 billion funding estimate may be overly optimistic. First, it assumes that CalSTRS will earn a 7.5% average rate of return on its investments over the next 30 years, a target CalSTRS missed over the last decade and one that the system’s consulting actuaries predict it will likely miss over the next three decades. Furthermore, it assumes that the Legislature will act within the next year. CalSTRS has required increased contributions since 2003, but the Legislature has consistently avoided implementing a funding solution. Given the body’s continued inaction and seeming apathy toward the problem, pursuing a solution within the next year appears increasingly unlikely.
Waiting comes at a price. The longer the Legislature delays action, the more expensive the solution becomes. At current contribution levels and assumptions, the unfunded pension debt will grow by an average of $50 million each day for the next 30 years. At this pace, the plan will run out of assets in 2043, making the out-of-pocket annual cost of providing these legally guaranteed benefits enormous.
Rectifying CalSTRS’s funding shortfall will not be an easy endeavor. Diverting $4.5 billion from schools is the equivalent of eliminating statewide spending on K-12 books and supplies – twice. It is also more than the state spends on courts and on roads, and nearly as much as the state spends on the University of California and California State University systems combined. Having waited this long, fixing CalSTRS now will be difficult and painful. But should the Legislature wait much longer, fixing CalSTRS will mean devastating our schools and services in the process.
In this report, we first provide a general background on the CalSTRS plan and what caused its massive funding shortfall. We then outline the financials associated with restoring the plan to full funding and illustrate the costs of further delay. Our findings include the following:
- The system requires $240 billion, not $135 billion. Commentators have repeatedly pegged CalSTRS’s funding requirement at $135 billion ($4.5 billion x 30 years). In actuality, to fully fund the plan over the next 30 years, CalSTRS contributions need to increase by 15.6% of payroll, or $4.5 billion in 2015 initially. As payroll grows, so too will the annual payments, working out to $240 billion in additional contributions between 2015 and 2044, 80% more than the total contributions under current funding levels.
- Poor investment performance and benefit increases drove the funding shortfall. From 2000-01 to 2011-12, CalSTRS’s investments averaged a 3.8% annual rate of return, half of the current expected rate of 7.5%. Still, had the Legislature not increased benefits in 2000, even if CalSTRS’s investments had still underperformed, its funding ratio would be 88.4% today, making it one of the nation’s best-funded public pension plans.
- Annual investment returns would have to exceed 10%. Since 2003, CalSTRS has required larger contributions. Investment returns would have to average over 10% for the next 30 years for the plan to reach full funding without larger contributions – a highly unlikely scenario. If the plan earns only a 5.1% average annual rate of return, the required $240 billion jumps to $580 billion.
- Contribution delays will increase long-term costs. Each year the Legislature delays contribution increases, the more expensive funding the plan becomes. If left unaddressed, the unfunded pension obligation will grow by an average of $50 million each day and reach $617 billion by 2043 or possibly sooner if investments continue to underperform.