California cities and the state could see their annual pension bills rise as much as 12% because high inflation will lead to cost-of-living adjustments for retirees and pay increases for current public employees.
Required contributions may increase 1% to 8% of payroll over the next five years for civil service employees and 2% to 12% for public safety workers, depending on how long high inflation lasts and how quickly the Federal Reserve returns to an inflation target of around 2%, according to the California Public Employees’ Retirement System’s annual review of funding levels and risk.
“Recent and current increases in the Consumer Price Index are expected to have a material impact on the pension liabilities in future actuarial valuation reports,” the system said in the review released Friday.
The forecast for California, the most-populous state, underscores the breadth of pension pain around the US as rising interest rates hammer returns and concern grows over a recession that would crimp governments’ ability to meet payments. New York State Comptroller Tom DiNapoli warned in September of a similar crunch.
Unlike private sector pensions, public retirement funds provide cost-of-living adjustments. Some funds, including Calpers, link increases to the Consumer Price Index. Meanwhile, as inflation rises, public employees bargain for higher wages to keep pace. These pay increases are used to calculate future pension benefits.
Budget Gaps
US public pensions suffered their biggest losses in more than a decade last fiscal year. Nationwide, they have an average assumed rate of return of about 7%. Calpers, with about $420 billion assets, assumes a 6.8% long-term rate. When returns lag, taxpayers have to make up the difference.
Calpers lost 6.1% for the 12-month period ending June 30, its worst performance since 2009, as stocks and bonds fell in tandem. The pension’s funding ratio declined to an estimated 72% from 81.2%.
Projections of increased pension obligations is unwelcome news, said Johnnie Piña, legislative affairs lobbyist for the League of California Cities. The pension reduced its investment target to 6.8% from 7%, requiring governments to increase contributions.
“Cities have been forced to make tough budget decisions, and any additional costs will make it that much more difficult for cities to maintain core services to residents,” he said.
New York’s DiNapoli said pension bills for the state and local governments outside New York City would increase as investment returns slip and inflation leads to higher cost-of-living adjustments or COLA’s. Next fiscal year, average contribution rates will rise to 13.1% from 11.6% of payroll for civil employees and to 27.8% from 27% for police officers and firefighters.
Meanwhile, New York City is estimating annual pension contribution will rise by about $6 billion over the next three fiscal years, contributing to widening budget gaps. The city’s pension funds lost 8.65% in the fiscal year ending June 30.
CPI-Linked
Unprecedented federal stimulus in the wake of the Covid-19 pandemic, supply chain disruptions, a tight labor market and high gas prices resulting from Russia’s invasion of Ukraine has led to the highest inflation since the 1970s. In response, the Federal Reserve has raised interest rates aggressively to slow the economy.
In September, the core consumer price index, which excludes food and energy, increased 6.6% from a year ago, the highest level since 1982. October’s US inflation reading is due Thursday.
Calpers retirees are entitled to cost of living adjustments, and will receive higher benefits while inflation persists. However, pensions, including Calpers, limit the adjustment. Calpers limits COLAs to a maximum of 2% compounded annually for most state retirees and school retirees. However, public agencies can contract for a 3%, 4%, or 5% adjustment, according to the pension.
Just over a third of major state and local public pension provide CPI-linked COLA’s to current retirees, according to the Center for Retirement Research. Limits to COLA’s can mute the impact of rising inflation, the Center said in an August report.
While COLA’s are calculated annually, pay increases tend to lag higher inflation measurements because of the time it takes to negotiate labor agreements.
Under Calpers’ “slow recovery” scenario, — where it would take five years to get inflation to Calpers’ long-term target of 2.3% — employer contribution rates for police officer and firefighter pensions could increase 12% starting in the fiscal year ending June 30, 2028.
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