The Solvency of Public Pensions

By James Schaefer

This is a contrarian view.  It might be seem like “The Twilight Zone” for someone to suggest that a state employee pension fund could be regarded as a model for fiscal prudence relative to Social Security.  Herewith, however, is an observation.

CalPERS is California’s massive state employee pension fund.  At around $230 billion, it is the nation’s largest public pension fund.  And it invests in the market to generate the majority of the earnings needed to pay retiree benefits.

Its market returns have historically been about 8.1%.  The market currently provides almost 64% of the money needed to pay its members’ benefits; 70% is considered sound by actuaries, and at times in the past, market returns have provided well over 100% of the money needed to pay CalPERS pension benefits.  California’s general fund is required by law to backstop any CalPERS benefit payment shortfall, which means that, in a bad market, taxpayers could be on the hook for perhaps 30% to 35% of pension funding requirements.

California’s public sector union and management employees, and its public sector retirees, are vested in their own accounts.  And those accounts are protected by fiduciary responsibility.  In 2010, Mr Schwarzenegger tried to borrow $2 billion from CalPERS, to help address California’s budget shortfall.  Calpers management said “no”.

Contrast this with Social Security:

  • 100% of the revenue comes from the taxpayer, 0% from the market
  • There are no vested accounts, and the courts have ruled that taxpayers have no legal claim to their Social Security benefits
  • Interest on the Social Security trust fund is currently 4.62%, and it is paid by taxpayers.  Earnings in the CalPERS pension fund is over 8% historically, and CalPERS currently uses 7.75% to calculate fund growth.  These earnings come from market investments, not taxpayers.  That is to say, CalPERS earnings come out of the profits of publicly-held businesses
  • 100% of the Social Security trust fund — all $2.5 trillion of the surplus — has been borrowed by the federal government.  CalPERS wouldn’t let the state borrow even a fraction of 1%
  • The Treasury can only pay back the Social Security trust fund through $2.5 trillion in future taxes or future borrowing, which means that America’s taxpayers will pay $5 trillion to provide $2.5 trillion in Social Security benefits represented by that trust fund surplus
  • On the same income base, and with a similar contribution rate, CalPERS monthly benefit payments are higher than Social Security monthly payments.  Both are paid out over the same retirement lifetime, and both are COLA-corrected.  The higher CalPERS payment stream is not because the taxpayer is getting dunned — the difference is the market return

Having the taxpayer backstop possible market shortfalls in a hypothetical, market-based Social Security system would be fractional compared to the current system, where the taxpayer covers 100% of the Social Security benefit stream — and more than 100%, if one considers the double payment that will be needed to redeem the $2.5 trillion in Treasuries in the Social Security trust fund.

Social Security should be changed to emulate CalPERS in several respects: invest in the market; provide vested accounts; and protect those accounts under fiduciary responsibility, to prevent the fund’s use for other government programs.

The market is safe for public sector pension funds, and for private sector 401(k) and IRA accounts.  It should be safe for Social Security.






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