Blog entry Jack Ehnes

The Principal Cause of the CalSTRS Funding Shortfall

As CalSTRS begins to emerge from the worst economic downturn since the Great Depression, renewed focus on the sustainability of the defined benefit pension has surfaced, with some calling for the elimination of a plan that has provided a secure retirement to California’s educators for the last 100 years.

Some questionable articles and studies conclude that soaring liabilities, overly optimistic investment assumptions and overly generous benefit enhancements are the true cause of the funding shortfall and charge CalSTRS with downplaying or ignoring these factors intentionally. Nothing could be further from the truth.

Efforts to shore up CalSTRS’ approximately $71 billion unfunded liability should not be sidetracked by the misinformation and ill-formed conclusions that often characterize such negative efforts. If we are to make any headway in what we forecast as difficult dialogue ahead, we’ll need to inform ourselves with technical finance subjects like asset performance and actuarial pension math to better understand what is needed to restore the plan to an actuarially sound funded status.

Investment Returns Not Enough to Restore Funding

CalSTRS and its independent actuary, Milliman, realize that significant misconceptions about the cause of the decline in CalSTRS’ funded status, from having a surplus to being significantly underfunded, may not be easily understood. In April 2013, Milliman presented an analysis of the change in CalSTRS’ funded status from 2000 to 2012. The conclusion was that two-thirds of the decline during that period was due to investment-related asset performance.

Despite many years in which benchmarks were exceeded, asset performance fell short of the actuarially targeted return. CalSTRS has long said returns on its investments alone will not be enough to fully restore the fund’s health. Only a thoughtful, long-term solution crafted by the Legislature and the Governor can do that.

Although CalSTRS has met its assumed investment return of 7.5 percent for the last 20 years, the market cannot restore the fund’s long-term health. In order for that to occur, CalSTRS estimates that it would need at or above a 10 percent investment return each year for the next 30 years to achieve full funding by about 2043 – a near impossibility. Simply put, reliance on the market is not a viable alternative.

Good Math, Faulty Conclusions

Some recent articles on CalSTRS’ unfunded liability appear to show an understanding of pension math. Comparing actual investment performance to the assumed investment return of 7.5 percent is correct when looking at retirement system funding. To the extent that actual investment performance falls short of the expected return, all else being equal unfunded liabilities tend to increase.

However, these articles go on to draw faulty conclusions that inaccurately attribute a growth in the cost of future benefit payments, rather than asset decline as the primary cause of the increase in unfunded liabilities. For example, from 2008 to 2012 there was a $48 billion increase in CalSTRS’ unfunded liabilities. During this time, assets decreased by $11 billion, which led some to conclude that the difference was due to liability growth. In actuality, the correct comparison of the impact of the asset return is the actual return compared to the expected return.

When making this comparison, returns less than the assumption are what caused an increase in the unfunded liabilities that exceeded $48 billion. The liabilities actually increased less over that period than projected by CalSTRS actuaries. This is why CalSTRS says the unfunded liability “stems largely” from the 2008-09 market decline.

Benefit Enhancements not the Primary Cause of the Shortfall

In 1998 CalSTRS was 104 percent funded. It was the first time in the fund’s history that assets were more than sufficient to meet current and future obligations. Shortly after, several benefit enhancements designed to attract and retain teachers at a critical juncture when schools were mandated to have no more than 20 students to a classroom, were enacted. Moreover, the Legislature had the foresight to end some of the benefit enhancements within 10 years.

It’s fair to say that CalSTRS liabilities along with its assets increased as anticipated by CalSTRS actuaries. What subsequently occurred was a considerable economic downturn in 2001, followed by a second, more substantial one, later in the decade. These downturns had almost twice the impact of the benefit enhancements.

Thus, these events less than 10 years apart, coupled with contributions made by members, employers and the state that are set in statute and have not been adjusted in recent years to offset the resulting investment losses, have negatively affected the fund.

CalSTRS has made considerable effort to call attention to its unfunded liability, which is the outstanding debt for projected future benefits, and the risk of not addressing it. The fiscally sound approach to sustain the long-term viability of the fund is a gradual, predictable increase in contribution rates, equitable to all parties involved.

I urge those who would dismiss our evidence to take a moment and think about the effects the dot com bust and the Great Recession had on individuals, families and our nation as a whole. We all suffer in hard times, even the California State Teachers’ Retirement System.


STRS investment mismanagement

It is somewhat appalling that 2/3 of the decline in asset value occurred over a ten year period. Obviously the enlightened managers were asleep at the switch. Then I read recently that one of the esteem managers wanted to divest the fund of so- called carbon related technologies, aka oil, and invest in unproven green industries. Hopefully the latter manager us gone and there are now more enlightened managers at the switch. I had often spoken fondly of the STRS, even to my investment manager, but will hold back now. I only pray the STRS gets its investment portfolio in order on behalf of the teachers facing retirement.

unfunded liability

Employee contributions must go up. Full retirement must be postponed several years - 2 or 3 Double dipping must be prohibited

unfunded liability

It seems most likely that estimates of asset earnings were overly optimistic to begin with. 7.5% growth cannot be sustained forever. Some insurance annuities guarantee a 4% return, which makes more sense. Any earnings above that should be reserved to make up periodic shortfalls. We more than likely will continue have the seven lean years and seven fat years. It is likely at this point that current employees will have to gradually increase their contributions.

Thank you for your comment.

The CalSTRS board periodically reviews its various long-term assumptions to determine if they need adjustments up or down. Relative to the investment returns, these assumptions reflect long-term horizons that do factor in "lean and fat years." Unfortunately, nearly all economic forecasting models failed to anticipate the horrific recession in this last decade. CalSTRS has also reduced its investment assumption from 8 percent to 7.5 percent in the past four years to reflect a more conservative perspective. Comparisons to for-profit insurance companies are not entirely apples to apples comparisons. Investment portfolios for large public pension plans reflect highly diversified global investment strategies that provide a greater opportunity for higher returns (and risk) than found in most insurance company portfolios.

Comparing rates of return

To compare the rates of return that CalStrs projects with Insurance Annuities rates is a little misleading. Insurance companies need to make profits for their owners while CalStrs has only teachers to respond to. To me that's a big difference!

Strs Shortfall

I have 5 questions. (1) Where is the money coming from to pay the retirees right now? (2) How much more would be needed from the current pay of the current teachers to make the system work? (3) Are they thinking about reducing the current formula for retirees? (4) Can the already retired have their pension reduced? And one last question; (5)Who makes these decisions? I would like to lobby with my ideas if I knew to whom I should write letters.


Start here. Time is of The Essence. Carpe Diem ! Let's not tarry another second. FixIt ! Higher employee contributions if necessary. Lower retiree benefits if required. Ca. Legislature commitment to sustainability is critical. Ca. STRS cannot be allowed to collapse due to benign neglect. As a present retiree, I cannot over- emphasize the well being that is derived from the defined benefit I am receiving. I want this to go on in perpetuity for those educators coming after me. It is of enormous import to educators who spend 35-45 years of their lives assuming responsibility for all of California's children. The system may not be perfect, but it's not broken either ( not withstanding the constant educator bashing going on ) . As a group, California educators are the best in The World. They work under circumstances , lay people cannot begin to understand. For those that control the politics and purse strings, Please do whatever is necessary to revitalize the retirement system. To fail to do so, would be a travesty to California's children and an arrow to the heart of The Golden State's future.

Call to action

So let's all get started......I am willing to lobby my representatives. Anyone out doing it already?

Funding shortfall and decison making

I agree that misinformation and invalid assumptions are not helpful as we (hopefully) move on to address the solutions to this issue. However I also think that it is not productive to gloss over and not acknowledge the impact decisions about benefit enhancements has had in contributing to the dilemma we now face. It is important to understand that unprecedented volatility in world markets has caused the majority of our dilemma. I appreciate your giving us an analysis of where the shortfalls are coming from. However, this quote from your blog, “These downturns had almost twice the impact of the benefit enhancements.” Would lead me to believe that over 1/3 of the liability is due to those enhancements. How are we as members or the general public going to feel confident that decisions about pension funding and formulas are based upon well-reasoned and consistently fair principles if past and current decisions are not openly and fairly discussed? The decision to create a separate class of unit members through those enhancements was both ill-conceived and inherently unfair. And now as part of the attempts to correct things we have created another separate class of members in those newly hired educators that do not get the benefit of the same formula everyone else was hired into. That move may well have been necessary based upon changing life expectancies and demographics. However, if I were one of the newly hired, I would have a hard time swallowing the fact that my formula is significantly reduced while there are large numbers of members getting up to 400 a monthly and/or a .2 “career factor” increase to the previous (better) formula just because the legislature made a decision to address a short term problem. By the way, I am going to benefit from the career factor when I retire and I am not planning to give it back, however that does not change my opinion that it was bad policy to create unequal and arbitrary differences in member’s benefits.

CalStrs Retirement

I am very grateful that this forum has been established. Now those of us who want can have a voice with some suggestions. There is nothing we can do about the short-lived enhancements-let's move on. I am 61 and would gladly agree to a gradual increase in the retirement age formula that would affect me to a certain degree. I would prefer this to getting more taken out of my pay check in our monthly contribution. I have seen teachers/administrators retiring at 55,56,57. There is no way the system was ever set up to pay people for 30+ years of retirement. The longer life span has not been addressed by retirement age formulas. It will happen eventually and the sooner the better. It also appears that only the governor and legislators can change these things rather than the business people running it. That, unfortunately, is bad news for us.

Yields going forward

The US economy abused consumer debt growth to avoid collapse 2002-2007 and then followed on with government debt issues when that strategy inevitably failed: blue is consumer debt / wages, red is government debt / GDP.. This has resulted in a new investment regime, one of lower returns, as the system is to indebted to support higher yields. blue is total non financial debt / GDP, (left axis), red is 10 year treasury rate. With risk-free returns down at 3%, earning 7.5% is a lot, lot harder. Complicating matters is that taxes have to go up on wagearners pretty soon ensure the baby boom echo adequately funds their SSA retirement (i.e. FICA has to rise 5% over the next 20 years), and the nation's wealthy are notionally on the hook for around $2T of the $2.7T sitting in the social security trust fund that needs to be redeemed over the next two decades to fund the boomer retirement wave coming. Politicians, the corporate media, and rightwing propaganda mills will avoid the above realities, but them's the facts.

Investment Performance

This is an interesting overview, which seems aimed and eliminating the perception that benefit enhancements are the primary cause of the problem, but as you note, that leaves fund performance as the primary culprit. Unfortunately, the overview fails to mention what the returns on investment were during this period of decline and how it compares to peers. For example, the San Diego City Employees' Retirement system recently reported a 10 year return on investment of 8.4%. You mention here that your target was 8% for most of the period and is now 7.5%. That seems quite reasonable with good investment strategies. What was the performance of this fund over the period noted and how does it compare with peers?


I think you’ve made some truly interesting points. Not too many people would actually think about this the way you just did. I am really impressed that there is so much information about this subject that have been uncovered and you did it so well, with so much class. Thanks. clipping path


Thanks Jack Ehnes for share with us a informative article. Specially 'Good Math, Faulty Conclusions' this topics is very interesting for me thanks again.

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