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The California Public Employees’ Retirement System aka Calpers voted today to change the premiums they charge municipalities. [1] The issue is how Calpers “smoothes” the premiums they set. For example, the Calpers fund shrank from about $260 billion to $160 billion in the credit crash. Without smoothing, this would have caused Calpers to increase the premiums by ~ 60% in one year.

Instead of increasing the premiums abruptly, Calpers uses a 15 year time horizon to get back to their target fund balance. Today the board voted to change the time horizon from 15 years down to 5 years. This is significant. It means that any shortfalls will have to be made up 3 times as fast. Calpers is forecasting their assessments might have to increase by up to 50% over the next 5 years, due to this factor alone. California municipalities will not be thrilled about this, as the premiums were set to substantially increase without this change in smoothing.

Calpers has some significant issues confronting them:

1) Assumed 7.5% annual return over the infinite horizon. Calpers reduced this from 7.75% last year. Contrast this to Jeremy Grantham’s latest 7 year forecast that came out today. [2] It calls for Stocks to return -1.1% and bonds to return -0.9% REAL. If you assume 2.0% inflation, this translates to +.9%/+1.1% nominal. Let’s call it 1.0% per year for a 60/40 asset allocation. Contrast that to Calpers assumed 7.5% per year. This means they are likely to fall 6.5% further behind each and every year on average.

2) Stockton/San Bernardino bankruptcies. Stockton did win the latest round which kept Calpers with a higher standing in bankruptcy. I read the BK judges full opinion and think Calpers has a significant chance of losing at the actual bankruptcy trial. The judge had several comments along the lines that Calpers contracts were no different than any other contracts. He said one of the main purposes of BK law is to break contracts. It is IMPOSSIBLE to be certain how the judge will ultimately rule, but if you made me guess, I think Calpers will end up NOT being held superior to the bond holders. I am 51% confident that Calpers will have to give something. Let’s assume that Stockton is able to permanently reduce their payments to Calpers, and then what happens to the promises Calpers has made to employees? Will Calpers be able to arbitrarily reduce the pensions? Pension lawyers are NOT sure how this will all work out.

3) Most of the Calpers pensions have Cost of Living Increases built in. So even if the overall US wide solution is to increase inflation, it will NOT necessarily help Calpers out. Their liabilities will just increase alongside inflation.

BOTTOM LINE is that Calpers/CA pensions are in a perilous state IMO. Long term, I would not want to be Calpers pension recipient and/or a California muni bond holder. There is a reasonable chance that both of them will not get what they were promised.



[1] Calpers changes smoothing from 15 years to 5 years

[2] Jeremy Grantham 7 year forecasts
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