California’s state and local pension plans have over $265 billion in debt

California’s public pension plans are taking on more risk than other pension systems while generating relatively poor investment return results, a new Reason Foundation report finds. The California Public Employees’ Retirement System, CalPERS, and California State Teachers’ Retirement System, CalSTRS, are the nation’s two largest government-run pension funds, overseeing $558 billion and $382 billion in assets, respectively.

As it stands, California’s state and local governments have the most public pension debt in the country, with total unfunded pension liabilities of more than $265 billion, according to a new report from the Reason Foundation. That’s over $6,000 in pension debt for every state resident. CalPERS has $166 billion in debt, and CalSTRS has $39 billion in unfunded liabilities.

Since pension benefits promised to government workers are constitutionally protected, taxpayers are on the hook for that debt. In the years ahead, paying this pension debt will consume an ever-larger portion of state and local budgets.

So, to pay for retirement promises already made to government workers while also hoping to keep costs down, public pension systems are chasing new investment return strategies and targets. Worryingly, California’s over-reliance on high-risk, high-return strategies could result in overwhelming losses, a burden that taxpayers would ultimately bear.

Historically, pension plans have relied on investments like stocks and bonds, but many plans are moving away from this strategy and dedicating more assets to higher-risk investment strategies, such as real estate, hedge funds, private equity, and commodities, for which it can be challenging to obtain accurate market value information, and reporting periods lag behind those of traditional investments.

The Reason Foundation finds that in 2001, only 11% of California’s pension assets were allocated to alternative investments. However, by 2024, this share had increased to 37%, which is the 18th-highest in the nation.

CalPERS has more than doubled its shares in private equity over the last four years (from 6.3% of its total assets in 2020 to 17% in 2024), and it plans to expand further, so that private assets (private equity and private debt) make up 40% of its portfolio.

As it attempts to make up for the failure to set aside enough money to pay for promised retirement benefits, CalPERS is moving away from safer, predictable investment options in the hopes of better returns from riskier options that charge high fees, come with less transparency, and more risk and volatility that could leave taxpayers holding the bag.

With debt and costs rising, the pressure to take public pensions in this direction is strong because investment outcomes greatly impact overall funding progress and contribution requirements. The pressure is also increasing because California’s pensions have generated investment returns that fall below those of other pension systems nationwide.

Over the past 20 years, CalPERS achieved an average return of 6.8%, and CalSTRS achieved 7.6%, both of which are far below the S&P 500 average of 10.4% for the period.

Even over the last five years, during which CalPERS and CalSTRS have adopted higher-risk strategies in the hope of achieving better investment returns, California still ranked 36th out of 50 states in average investment returns for all public pension plans. California’s average investment return over the past five years was 7.51%, while Nevada ranked first with 9.67% average returns, and Washington state was second with 9.66% average returns for its pension systems during that time.

It is in taxpayers’ best interests for CalPERS, CalSTRS, and other public pension plans to achieve high investment returns, but investment strategies should include a thorough evaluation of the downside risks. Private equity charges high fees that primarily benefit fund managers, not retirees or taxpayers. They have opaque accounting practices and market valuations. They offer the potential for high investment returns, but that comes with high risk that they could fail to deliver.

Underestimating the risks associated with alternative investments could lead to even more costs. Taxpayers at the state and local level would see more money siphoned away from infrastructure, education, and public safety to make up for investment losses and to pay public pension debt. California’s pension systems should be more cautious about taking risks with taxpayers’ money and workers’ retirement benefits.

A version of this column first appeared at The Orange County Register.

The post California’s state and local pension plans have over $265 billion in debt appeared first on Reason Foundation.

Source: https://reason.org/commentary/californias-state-and-local-pension-plans-have-over-265-billion-in-debt/