For years, the California State Teachers’ Retirement System suffered from considerable underfunding. In 2014, the state finally came up with a plan to fully fund the pension obligations made to teachers by the mid-2040s. Within the context of a financially irresponsible pattern of underfunding, this was a responsible development.
Naturally, this comes at a cost, as the state, school districts, teachers and taxpayers play catch-up in addressing CalSTRS’ $96.7 billion unfunded liability.
According to a recent update from the state’s nonpartisan Legislative Analysts’ Office, from fiscal year 2016-17 to 2020-21, annual contributions to CalSTRS from school districts, the state and teachers will rise from $9.7 billion to $14.3 billion.
For context, in 2013-14, districts were contributing just under $2.1 billion and the state $1.36 billion to CalSTRS. For the current, 2016-17 fiscal year, school districts and the state are expected to contribute $4 billion and $2.5 billion, respectively. By 2021-21, districts will contribute $7 billion and the state $3.6 billion.
Other than the practical reality that both the state and school districts will see greater portions of their budgets going toward CalSTRS obligations, the funding plan has been aggravated by numerous developments. In 2014-15, CalSTRS’ unfunded liability was estimated to be $76 billion. By 2015-16, it was $97 billion.
This $21 billion increase to the unfunded liability was driven by a litany of factors.
Pension funding relies on the contributions of the state, school districts and teachers. Those contributions are then invested, with investment returns responsible for most of the funding. As pension funding must be planned out over the long term, the assumed long-term rate of return on investments is critical. The higher the assumed rate of return, the better funded pension plans are assumed to be, and thus fewer contributions from taxpayers and employees are needed. Conversely, the lower the assumed rate, the more contributions are needed to fund the obligations.
Earlier this year, CalSTRS’ voted to immediately reduce its long-term assumptions from 7.5 percent to 7.25 percent, with a further reduction to 7 percent in 2018. This decision, along with other assumptions like assumed wage growth, drove up CalSTRS’ unfunded liability by $7 billion. In the real world, CalSTRS’ failure to meet its investment return targets in 2015-16 also caused the unfunded liability to grow $2.4 billion. Other factors, like faster-than-expected salary growth and updated demographic assumptions also contributed to the $21 billion increase to CalSTRS’ unfunded liability.
Stepping back, the practical impact of this means there will be less money at the district-level for students, as districts will see growing portions of their budgets go toward CalSTRS as well as CalPERS.
All of these increases are being done with the goal of fully funding pension promises made to CalSTRS’ beneficiaries by the mid-2040s. District officials, taxpayers and teachers alike should be wary, as there is reason to believe even assuming a long-term investment return rate of 7 percent is overly optimistic and could contribute to underfunding as a result.
Taken together with the plausibility of a recession in the coming years, absent any further pension reforms, and the possibility that even the more responsible assumptions of today might be too optimistic, school districts and taxpayers are in an unfortunate situation of having to play catch-up on pension funding, thereby spending more and getting less for it.
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