A Balanced Investment Strategy
On Thursday, February 2, 2012, the Teachers’ Retirement Board voted to lower the investment return assumption a quarter of a percent to 7.5 percent. The move, based on the recommendation of outside actuarial firm Milliman, Inc., marks the second time in 14 months the board has lowered the assumed rate of return. So why is this important?
Under stable economic conditions, every four years the board evaluates the current investment return assumption to ensure estimated earnings are in line with future expectations. In December 2010, the board decided that a recent change in asset allocation and troubled economic conditions resulting from the market downturn warranted an off-schedule reevaluation. At that time, the board voted to reduce the investment assumption from 8 percent to 7.75 percent. The most recent vote falls in line with the four-year cycle and does several things.
First, it further recognizes the consequences of the 2008-2009 economic crisis and the realities of projected CalSTRS investment performance for the foreseeable future. Last calendar year, the CalSTRS portfolio earned a 2.3 percent return, down from 12.7 percent in 2010. Clearly, CalSTRS continues to experience fallout from global market conditions, which remain uncertain for investors. Add to that heightened market volatility in U.S. and foreign markets coupled with an unfolding debt crisis in Europe and a weak domestic recovery. Our investment managers suggest that three years are needed before we begin to see signs of recovery. Keep in mind CalSTRS is a long-term, patient investor looking toward a 30-year horizon.
Second, it adds to the current projected unfunded liability of $56 billion, which is based on the June 30, 2010, actuarial valuation—a snapshot of the CalSTRS fund’s assets and liabilities. In April, the board will be presented the June 30, 2011, actuarial valuation. When adopted, the new valuation becomes the cornerstone for analyzing the funding status. With the lower investment forecast, funding needs may expand by another $500 million a year. Until the next valuation is adopted however, estimates of how much more is needed will not be available.
It’s important to balance future funding needs with what we are asking of current and future generations. By lowering the assumption rate, the need for more funding does occur, but if we ask more than is needed of our new and current members, we’ve unnecessarily burdened them. Lowering the assumption rate below what is a reasonable earning expectation of 7.5 percent could present an unnecessary financial burden.
Lastly, it further underscores the reality that CalSTRS cannot invest its way to financial health and how imperative a funding plan is to the long-term health of the fund. What is needed to fund the existing benefit plan is an increase in contribution rates, which can be gradual and predictable. Absent changes in contribution rates or liabilities, current calculations show the $144.8 billion fund will deplete its assets by the early 2040s. We must have a responsible funding strategy that will protect the state General Fund, as well as uphold the state’s promise to teachers. And the longer it takes the more the costs will rise. The Legislature and Governor must tackle the challenge of crafting a specific funding strategy since only they have the authority to do so.
As also presented at the most recent board meeting, the legislative conference committee on pensions asked CalSTRS to develop examples of how the Defined Benefit Program can be sustained through different strategies of increased contributions. In response, six scenarios and their projected impact on the funding status were submitted to the Legislature earlier this month. Each scenario is based on parameters suggested by legislative direction and CalSTRS stakeholders and considers legal restrictions identified by outside counsel. Although the board has reviewed the scenarios, the board has not taken a position on specific contribution rate increases.