The board of the California State Teachers’ Retirement System (CalSTRS), at its December 2 meeting, lowered several long-term actuarial assumptions including the rate of return on investments from 8% to 7.75% – and its assumed inflation assumptions by 0.25%. According to the announcement, the move acknowledges an expectation of reduced future earnings and lower inflation, and represents the culmination of “ten months of comprehensive analysis of the long-term economic assumptions affecting the CalSTRS defined benefit, following recent market declines”.
“The board wanted to have as much input and information as possible before making a decision because changing these assumptions has wide-ranging impacts on our members, their employers and the State of California,” said CalSTRS Chief Executive Officer Jack Ehnes.
CalSTRS generally evaluates its actuarial assumptions every four years, but the historic market downturn in fiscal year 2008-09 prompted an earlier review, according to the announcement. The California State Teachers’ Retirement System, with a portfolio valued at $141.3 billion, is the second largest public pension fund in the United States.
Acknowledging that it was no longer comfortable assuming its current long-term assumptions of investment returns and inflation, the board also expressed concern that recent economic events are having an undue impact on perspectives about the long-term economy. At the same time, the board recognized that it would be reevaluating all of its economic and demographic assumptions as part of the June 30, 2011 valuation of its benefits programs.
“Board members faced a difficult decision and have been careful in evaluating the recommended adjustments to the investment return assumption, especially in today’s volatile market environment,” Ehnes said. “Reviewing future investment assumptions is an important and prudent move toward finding a solution to the long-term financial challenges facing CalSTRS.”
The assumed rate of return is used to help determine CalSTRS liabilities, and the assets needed to pay future benefit costs. Revising the assumption downward increases the cost of fully funding the benefit. This increase is partially reduced by the corresponding lowering of the wage inflation assumption from 4.25% to 4%.
Lowering the assumed investments rate of return and rates of inflation for the Defined Benefit Program to the new assumptions lowers the long-term funding level of the system from 78% to 76.5%. According to the announcement, the projected shortfall in CalSTRS overall funding is based on an actuarial valuation, a snapshot of the fund’s assets and liabilities.
At its September meeting, the board adopted the actuarial valuation presented by Milliman showing CalSTRS financial health as of June 30, 2009. CalSTRS is funded at 78%, down from a funding ratio of 87% the year before. The unfunded portion of future benefits has grown to $40.5 billion from the previous year’s $22.5 billion.
CalSTRS notes that the lowered wage inflation assumption “anticipates members will have lower levels of compensation at retirement than previously assumed”, but also stated that those assumptions “are consistent with standards set by the Government Accounting Standards Board, which establishes accounting and financial reporting standards for state and local governments”. CalSTRS also noted that investment earnings, “which currently pay a majority of CalSTRS benefits, cannot alone address the projected funding shortfall”. CalSTRS notes that, since 2003, the amount of money contributed has not been sufficient to fully fund the benefits in accordance with GASB standards. The gap widened with the global market collapse in 2008. It also noted that only the state has the authority to increase contribution rates.
The CalSTRS board began discussing the recommended adjustments at its February 2010 meeting. The board requested additional information on the impact to members if the assumptions were lowered and, in June, postponed a final decision to November.
CalSTRS administers retirement, disability and survivor benefits for California's 848,000 public school educators and their families from the state's 1,400 school districts, county offices of education and community college districts.