Nation’s Largest Pension System Faces Uncertain Future With Multibillion-Dollar Deficit

A sign stands in front of California Public Employees' Retirement System building in Sacramento, Calif., on July 21, 2009. Max Whittaker/Getty Images

Changing demographics and a weak economy are threatening the future of California’s state employee pension system, according to some economists.

Some are asking questions about the system’s structure and why investments have performed poorly in recent years.

“All the time and money spent by investment committees debating, sourcing and allocating to private funds, consultants, hiring new employees, and putting together endless reports to track the thousands of investments, all of it absolutely wasted,” Meb Faber, co-founder and chief investment officer of Cambria Investment Management, wrote in a November report analyzing the system.

The California Public Employees’ Retirement System, better known as CalPERS, manages about $465 billion in assets and is the nation’s largest public pension fund.

It’s responsible for managing the retirement income of more than 2 million members and administers retirement and health benefits.

With about 28 percent of what it owes to members unfunded, as of June 30, the system is facing significant headwinds, according to experts.

“Their structure is so complicated that for a long time, CalPERS couldn’t even calculate the fees it pays on its private investments,” Mr. Faber wrote. “Nowhere in this mission does it state the goal is to invest in loads of private funds and pay the inflated salaries of countless private equity and hedge fund managers, but that is exactly what CalPERS does.”

In fiscal year 2022–23, the pension fund paid $31.1 billion in benefits to about 800,000 retirees, an increase of $2 billion from the prior year, according to the agency’s recent annual report.

Cost of Living, Aging Workforce, Declining Birth Rates to Blame: Officials

Officials point to cost-of-living increases and a growing number of retirees as the reason costs are rising.

An aging workforce puts financial stress on the system, as the ratio of employees paying into the fund decreases when retirements spike.

This has resulted in fewer members contributing revenue to the fund, with the ratio dropping by 40 percent since 2001.

The number of Californians aged 65 and older has grown to more than 15 percent of the population in 2022 from 9 percent in 1970, according to Census Bureau statistics, with estimates reaching as high as 21 percent by 2030.

Declining birth rates, combined with longer lifespans, leave fewer employees to cover the pensions of prior generations, resulting in expanding unfunded liabilities, according to experts.

The California Public Employees' Retirement System building in Sacramento, Calif., on July 21, 2009. Max Whittaker/Getty Images

Executives managing the fund recognized the financial issues in the recent report, titled “Investing in Today to Meet the Needs of Our Members Tomorrow.”

Investment returns need to exceed 7 percent annually to cover expenditures, according to the agency.

However, the fund routinely fails to produce such a level—with the agency reporting 5.8 percent gains for the most recent fiscal year following a 6.1 percent loss in the previous year.

Questions also surround the pension fund’s objectives to support environmental agendas, such as climate issues. Some argue that the efforts should be more substantive, while others suggest that decisions such as partially divesting from fossil fuels are negatively affecting investment returns.

Some critics noted that the returns reported by the agency failed to meet industry standards and questioned the fund’s investment strategies.

“CalPERS has had a long-term underperformance problem compared to key financial benchmarks,” Wayne Winegarden, senior fellow in business and economics at the Pacific Research Institute—a Pasadena, California, public policy group—wrote in an August analysis of the fund’s strategies over the past 20 years.

The 5.8 percent gains reported for the most recent fiscal year represent a fraction of the 17.2 percent increase in the S&P 500—a stock market index measuring the top 500 companies in the United States.

Overdiversification, Inefficient Strategies Plaguing System: Experts

With nearly 3,000 employees managing the pension fund system, according to the agency, some have said that investments could be managed more effectively.

Currently, the portfolio consists of investments across 13 sectors, with more than 28 percent weighted in information technology, about 14 percent in health care, and more than 12 percent in finance-related assets.

Top holdings include Microsoft, Apple, Tesla, and Amazon, with nearly 1,200 stock positions totaling more than $116 billion, according to agency filings.

The logos of Big Tech companies Amazon, Apple, Facebook, and Google, in file photos. Reuters

Critics say overdiversification and inefficient strategies and management are plaguing the fund.

“Pensioners would have been better served had CalPERS simply passively invested pensioners assets into broad-based index funds,” Mr. Winegarden wrote, referring to so-called simple investment instruments that spread risk across broad sectors of the market. “It would have been a lot less costly for pensioners too.”

Critics also highlight the fund’s $4.5 billion in venture capital investments this year—equating to approximately 15 percent of all investments made in the sector by any investors, according to financial filings. This goes against a nationwide trend of institutional investors’ divesting from similar assets because of concerns of risk following the collapse of several banks with significant venture capital investments earlier this year.

Rising interest rates and falling real estate prices have also created unpredictability for investors such as the pension fund, according to the agency.

“The impact of high inflation and high interest rates creates both uncertainty and opportunities for the fund,” CalPERS CEO Marcie Frost said in the agency’s recent report. “Nevertheless, it’s essential to remember that as a long-term investor we prepare for these market fluctuations over the course of several decades.”

Unfunded Liabilities Growing

Officials also noted the potential for unfunded liabilities to increase.

Although shortages aren’t new to the agency, this year’s—totaling about $245 billion, according to the Reason Foundation, a nonprofit public policy think tank—is about a 10 percent increase from last year.

The shortfall could be resolved by increasing contributions from both the state—as the employer—and individual employees, according to the agency.

Although the financial situation remains a concern, some say the issue is manageable and point out that California isn’t alone in carrying significant pension debt.

Hawaii, Kentucky, Illinois, Texas, and most other states all have multibillion-dollar pension deficits, with amounts nationwide totaling $1.3 trillion, according to the Reason Foundation. Only Washington and New York have fully funded pension programs with surplus holdings.

“CalPERS does not have as much money as it should have, but it is not close to going broke or needing an extraordinary bailout,” Marc Joffe, policy analyst for the Cato Institute, a think tank based in Washington, told The Epoch Times on Dec. 8. “Systems in some other states have worse funding levels.”