Stanford University recently released an analysis of the three big public pension funds in California saying they are woefully underfunded, with a potential shortfall of over $500 billion, much larger than their publicly stated shortfall of $55.4 billion. They based this on assuming a 4.14% return, on what risk-free U.S. Treasuries yield, rather than the 7.5-8.0% the funds themselves estimate they can make long-term.
The stock market yielded a 5.3% annual return in the 20th century. Funds assuming they can make upwards of 8% year after year, while completely legal and permissible, seems a bit fanciful. Interestingly, the accounting rules about this for private pensions are much stricter. They can’t make assumptions like that.
The analysis was commissioned by Gov. Schwarzenegger who is focusing on the cost of public pensions. Here’s the reason why.
By law, public pensions must be funded at 100% even if the fund is losing money. The pensions currently have the legal authority to mandate that the state and any municipalities make up the difference in pension shortfalls.
That money, of course, ends up coming from taxpayers, some of whom might be a bit grumpy about paying for someone else’s pension when they just lost their job or house. It’s easy to see how this can be (and probably already is) an explosive political issue. Other programs will have to be cut to finance the public pensions.