Special report - Caiforia pension crisis
Recent stock market losses may spike local pension costs, but not immediately
The recent stock market crash caused by the COVID-19 pandemic threatens to sharply increase pension costs for local cities, school districts and other government agencies.
Those higher pension costs will worsen an already ongoing financial crisis for local governments, which have been grappling with sharp drops in tax revenue because so many parts of the economy have been forced to shut down.
But local governments won’t face increases in their annual pension payments until summer 2021 at the earliest, because pension systems are always a year behind in calculating the annual payments of individual agencies.
And most pension systems are facing less severe losses than they suffered in the stock market crash of 2008 and 2009, because they have lowered long-term performance projections and revamped their portfolios to be less risky.
The crash still threatens to be a significant financial blow to local governments next summer, a time when they seem likely to still be struggling with fallout from the pandemic.
Economic downturns that include stock market crashes are particularly crippling to the finances of government agencies.
That’s because the agencies simultaneously face shrinking tax revenues and spiking pension costs, which go up because the investments of an agency’s pension system lose value when stocks tumble.
Pension systems invest contributions from workers, combined with taxpayer money, into the stock market with the goal of using the proceeds down the road to cover the guaranteed pension payments of government workers when they retire.
Stock market gains, crashes
It’s generally a sound strategy, because investments in the stock market have historically grown at a much higher rate than any other kind of investment. So stock market gains can decrease how much taxpayers must contribute to worker pensions.
But when the market crashes, the pension system’s long-term projections of investment returns take a major hit. That can mean multi-million dollar increases to the annual pension payments of government agencies at a time when they can ill afford such spikes.
“We’ve created a vicious cycle,” said Haney Hong, chief executive of the San Diego County Taxpayers Association. “When things go bad, they go really bad.”
Many local government agencies were already facing increases in their pension payments for other reasons, most commonly to make up for underpayments in the past. So the expected increases next summer could be especially painful.
The portfolio of the California Public Employees’ Retirement System, a state agency known as CalPERS that handles pensions for most state employees and workers in every local city except San Diego, has lost about one-fifth of its value during the recent crash.
The system’s portfolio was valued at $404 billion in late February but had dropped in value to $335 billion one month later.
The portfolio of the California State Teachers’ Retirement System, which handles pensions for all local public school teachers, has suffered similar losses.
And two local pension systems, one covering workers for the county government and one covering city of San Diego workers, also have lost significant value since the pandemic began crashing worldwide markets.
A spokeswoman for the city’s pension system, the San Diego City Employees Retirement System, declined to comment this week. She said telecommuting made responding to media questions a challenge.
No reason to panic
Each of the other pension systems said this week that the recent crash is no reason to panic, noting that the impact of stock losses from any particular year are softened by spreading that impact over five years.
“It’s too early to tell what impact current market conditions will have,” said Rebecca Wilson, chief of staff for the San Diego County Employees Retirement Association.
Wilson also stressed in an email on Friday that the association’s $12 billion trust fund is “prudently invested, well-diversified and positioned to take advantage of market dislocations.”
The teachers’ retirement system says on its website that its portfolio is broadly diversified to withstand periods of turbulence.
Michael Simonson, deputy superintendent and chief business officer for the San Diego County Office of Education, said the stock market crash won’t have an immediate financial impact on pension payments for local school districts.
That’s because they’ve already been forced since 2014 to make escalated payments under policies aimed at accelerating reduction of the pension debt of the teacher’s retirement system. But an increase in the pension’s debt from market losses will eventually impact school district payments.
Simonson said school districts are still expected to face immediate financial consequences from the pandemic, which has reduced the state revenue that covers teacher salaries.
Local cities other than San Diego said they expect to see spikes in their pension payments next summer because of how the recent crash has affected the portfolio of CalPERS, which handles pensions for workers in every local city except San Diego.
Blair King, city manager of Coronado, said the large investment losses posted by the system last month make a spike in payments seem inevitable.
“We are expecting to see increases,” he said.
On its website, CalPERS says the system is “a long-term investor” that “prudently and patiently” works through all market cycles.
“Our team is focused on working together through the extreme volatility of the markets,” the website says. “We’ve also been planning for an economic downturn for some time. As a result, we are better prepared now than during the financial crisis of 2008.”
One step the system has taken is lowering its long term expected rate of return on investments from 7.5 percent to 7 percent.
The city of San Diego’s retirement system went even further last year, lowering its expected rate of return to 6.5 percent, which is the lowest in the state.
Outside of California, San Diego has the most conservative projected investment returns when compared to nine similar cities: Phoenix, Denver, Seattle, Boston, Detroit, Philadelphia, Milwaukee, Nashville and Austin.
Michael Zucchet, leader of the city’s largest labor union, said this week that such moves mean the recent market crash will have a relatively small impact on the city’s annual pension payment next summer.
Zucchet also notes that the city’s pension system has become less aggressive in recent years to reduce risk. The system’s portfolio is about 50 percent stocks, with the rest invested in safer and less volatile assets.
He said it’s unlikely the recent stock market losses will have nearly the impact of the crash in 2008 and 2009, which decreased the value of the system’s portfolio by 25 percent and increased the city’s pension debt more than $750 million.