The Forever California Public Pension Crisis
Trailer
The California public pension funds, CalPERS and CalSTRS are and will be under permanent fiscal stress. This is due to three reasons.
The first reason is because California is rapidly aging. And, this is especially true for the pool of public pension employees. As a result, both pension funds have only 1.2 to 1.4 active employee supporting 1 pensioner. By comparison, the Social Security system has 2.7 employees. This ratio is called the Old-Age Dependency ratio. The lower this ratio the increasingly unsustainable the pension system is.
The second reason is because the California public pensions are excessively generous. As an example, an employee making $100K a year would have a pension that could replace 70% to 100% of his salary in retirement depending if he retires at 62 or 67. Meanwhile, counterparts in the private sector would replace only 21% to 31% of their salary as Social Security beneficiaries. Obviously, the greater the wage replacement rate, the greater a pension system’s fiscal burden on the contributors (employers and employees).
The third reason is because the California legislature is unable to address this crisis because it is beholden to public sectors’ unions. Back in 2013, the legislature passed a partial pension reform PEPRA. It did not address the pensions large unfunded liabilities. But it was a step in the right direction. As we speak, the legislature is moving forward with AB 1383 that would dismantle a good bit of the PEPRA pension reform.
The pension crisis is getting worse
Despite PEPRA, total contributions to CalPERS have risen from 26.7% of payroll in 2010 to 40.2% in 2026. Over the same period, total contributions to CalSTRS have risen from 20.5% in 2010 to 40.2% in 2026.
If public employees were just part of the Social Security system like their private counterparts, the total contributions as a % of payroll would be far cheaper at just 12.5%, evenly split between employer and employee. Instead, employers pay 31.7% of payroll to CalPERS and 19.1% to CalSTRS with the State contributing another 10.8% to CalSTRS. These are staggeringly expensive pension systems associated with huge financial burden on employers and the State.
Strangely enough, according to CalPERS own disclosure 67% of their members are also Social Security beneficiaries. This double dipping into both a State and a Federal pension when the public pensions were meant as substitute for Social Security is unexplainable.
The outlook is not good
Between 2010 and 2026, total contributions to CalPERS and CalSTRS rose by 13.5 and 19.7 percentage points, respectively. Given the pension plans inherent structural weaknesses and the political inability to shore them up, it is most likely total contributions will continue to rise and exceed 50% of payroll in the near future.
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Data sources:
Data sources were too many to document for every single graph and tables. Full disclosure, I extracted the majority of the data using Gemini. In my experience, Gemini is a far more precise and efficient data extractor than Claude. In numerous other projects, I have audited Gemini’s data extraction, and I have yet to find any errors. Meanwhile, with Claude all I ever saw were errors (I am not kidding). For this project, I used on occasion Chat GPT for data extraction (especially stock market data). And, it was very precise. I could readily verify that with convenient links to original sources.
For this project, Gemini extracted extensive data from CalPERS and CalSTRS annual disclosures and compiling related time series over many years. Using Gemini and Chat GPT allowed me to gather data in a number of minutes instead of many more hours.
I welcome anyone auditing my data disclosure, and if you can identify any errors supported by links to the correct data set, I would welcome that and edit my article accordingly.
The original Pension Crisis Trigger: SB 400 in 1999
The stock market experienced a heck of a Bull run during the 1990s. During this decade the S&P 500 rose by 347% from 329 at the beginning of the decade to 1,469 at the end.
In 1999, government unions exploited the 1990s superior market returns and passed Senate Bill 400, which significantly enhanced benefit formulas for state workers and granted pension contribution holidays — reductions and eliminations in employer and employee contributions — under the assumption that the unusually strong investment returns of the late 1990s would contiue indefinitely. At the time, CalPERS and CalSTRS were fully funded, and lawmakers treated these surpluses as a permanent condition, handing out benefits without thinking about how to fund them in the future.
However, at the turn of the century, the stock market experienced two crashes with the Dot.com Bubble in 2000 and the Housing Bubble starting in 2008, associated with market downturns of around — 50%. As a result, the S&P 500 at the end of 2012 was still lower than it was in 1999.
The mentioned adverse market conditions devastated public pension fund investment returns and added more than $100 billion in unfunded pension obligations to California’s books. The cities of Stockton, Vallejo, and San Bernardino filed for bankruptcy. Dozens of other municipalities were left in slow fiscal suffocation as pension contributions consumed ever-growing shares of general fund budgets, crowding out money for infrastructure, education, and other government services.
Responding to the Crisis: The PEPRA Pension Reform (2013)
The California Public Employees’ Pension Reform Act (PEPRA) took effect on January 1, 2013. PEPRA was designed to strengthen the long-term stability of California’s public pension funds by introducing several key changes, including reducing retirement formulas, increasing retirement ages, capping the annual salary used for final compensation calculations, and establishing equal sharing of employee contribution rates. The tables below detail the main changes enacted by PEPRA and their impact on CalPERS and CalSTRS members.
Note that the 50% pension cost sharing by CalPERS members is limited. Classic members who joined before 2013 are exempt (they make up 32.5% of current members). Also, new members who joined in 2013 or later who are State employees are also exempt (they make up 18.4% of current members. As a result of these exemptions, over half (50.9%) of current CalPERS members are exempt from this 50% cost sharing requirement.
New members of CalSTRS’ contributions have remained constant at 10.25% of payroll since 2016–17. Meanwhile, over the past decade total contributions including schools and State have risen from 29.2% to 40.2% of payroll. This period is associated with a rising mix of new members. So, the total contribution should have actually decreased. Instead, as stated it rose by 37.7%. Meanwhile, as mentioned employee contributions remained flat at 10.25%. Given that it appears unlikely that CalSTRS members’ contributions at 10.25% truly covers 50% of their specific pension costs which would have to total only 20.50%. Granted the unfunded liabilities have pushed employers’ and State’s contribution rates upward during this period. However, one can question why would unfunded liabilities have accelerated and pushed such contribution rates after PEPRA.
PEPRA has not performed that well so far
Even though PEPRA has saved tens of billions in pension liabilities. It is far from having resolved the Pension Crisis. This is because:
- the PEPRA 50% employee cost sharing applies only to PEPRA new members (joined after 2012) normal costs.
- It does not cover the ongoing huge unfunded pension liabilities. The latter are substantial as shown in the table below.
The years represent fiscal years ended June 30.
In 2024 (most recent data available) unfunded liabilities still amount to 26% of total liabilities for CalPERS and 30% for CalSTRS.
As shown in the table below, both pension funds (CalPERS and CalSTRS) have required massive increase in employer contributions since 2013 (PEPRA).
As shown above, employer contribution to CalPERS as a % of payroll rose from 20.5% in 2013 to 31.7% in 2026. Over the same period school district’s contribution to CalSTRS rose from 8.3% in 2013 to 19.1% in 2026. As a side note, if these public entities were only part of the Social Security system, their contributions would be way lower at 6.25% of payroll.
The mentioned public pension contributions put immense financial stress on public employers (agencies, municipalities, cities, districts, etc.). The latter have to constantly raise sales & parcel taxes and bonds to fund their operating costs and capital investments, respectively. If not for such pension contributions burden, these public employers would have to raise far less external financing.
If PEPRA had worked as intended, it should have resulted in a decrease in the growth of pension liabilities as the mix of employees and pensioners progressively shifted from Classic (before PEPRA) to PEPRA members (hired after 2012). In turn, this should have translated into a slower growth or even a decline in employer contributions. So far it has not. Granted the unfunded liabilities do represent an attenuating circumstances. On the other hand, these costs confirm that the California pension crisis is far from resolved.
Next, let’s look at funding ratios. This ratio includes a pension fund’s assets in the numerator and the present value of pension liabilities in the denominator. These pension liabilities evaluated over the next 30 years are discounted by an estimated rate of return of a pension fund diversified investment portfolio (this discount rate is typically around 7%).
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The pension funds use two valuations for their assets. The first one uses market value (prevalent in the market sector). The second one is a smoothed actuarial basis over 5 years. I am not sure this method is trustworthy given that it results in a volatility of the funding ratios that is often as high as using the more reliable market valuation method.
If the public pension funds were private, they would have to drastically cut benefits
As shown earlier after PEPRA, the funding ratios have remained within the mid-70s range. That is a fragile level of long term solvency for a pension fund. Using regulated private sector standards, both CalPERS and CalSTRS plans being under 80% would have to come up with plans to shore up their funding ratios above the 80% level. Also, they would have to use much lower long term risk free rates to discount their liabilities resulting in much higher liabilities present values and substantially lower funding ratios. Using such lower discount rates, their respective funding ratios would fall below 65%. At such point, a plan would have to cut pension benefits to restore an 80% level. Below, I explore what the pension funding ratios would be using much lower discount rates.
The pension funds currently use discount rates close to 7.0%. And, their funding ratios are around 75% as highlighted in yellow within the table above and showing up with the dashed red lines within the graph.
Estimating the present value of liabilities over the next 30 years associated with an annual growth rate of 5.0% due to COLA and demographic trends, one can see how just a small decrease in the discount rate of liabilities translates into much lower funding ratio. Using a discount rate just under 6% would already cause the funding ratio to drop below the 65% threshold.
This exercise underlines that if these pension funds were in the private sector, the benefits would have to be lowered dramatically.
However, the pension funds discount rates are all right
Regarding discount rate mandates, the private sector may be too stringent. Within the private sector, they often discount liabilities by a risk-free rate. The latter is disconnected from the long term investment return of a plan’s investments. See below the discount rates that the two pension plans have used since 2010. As shown, they have remained steadily around 6.80% to 7.00% since 2018.
Given the pension funds’ investment portfolios’ respective diversification shown below, the discount rates of 6.80% to 7.00% appear reasonable.
Additionally, the discount rates of 6.80% to 7.00% appear conservative vs the historical pension fund returns on their investment portfolios. It is only when we go back to the onset of the Financial Crisis that the pension funds average investment returns are as low as their respective discount rates. If we shorten the time series going back to 2010 or earlier, their respective average investment returns are substantially higher than the mentioned discount rates.
Caveat. The pension funds’ yearly returns are not directly comparable to the S&P 500. This is because the pension fund years represent their fiscal years ended on June 30. Nevertheless, the entire time series still gives you a directionally long term relevant comparison between the pension funds and the S&P 500.
The pension funds average investment returns are lower than the S&P 500. This is because as reviewed earlier, the pension funds investment portfolios are highly diversified. As a result, they are also far less volatile than the S&P 500 as shown on the table below. Volatility is captured by the standard deviation of yearly returns going back to 2007.
Why the public pension funds will always be under financial stress
This is for two main reasons:
1) Aging Demographics
2) Excessively generous benefits
1) Aging Demographics
In the absence of robust immigration into California, the State has aged rapidly. The Median Age has risen by over 10% since 2010. Consequently, over the same period the Fertility Rate has dropped by over 25%.
Because of California’s rapid demographic aging (faster than the US as a whole), both public funds have most adverse Age-Old Dependency ratios (number of member workers divided by number of pensioners). On the same metric, economists advance that Social Security is in big trouble. However, Social Security’s Age-Old Dependency ratio is far better than for the public funds. Indeed, both public funds are trending towards a ratio of only 1 whereby only a single worker on the payroll is supporting a pensioner. By comparison, Social Security really “low” ratio is still at 2.7 workers per pensioner. In other words, Social Security ratio is still about twice as high or strong as the public pension ratios. The public pension ratios’ extremely low levels (and trending down) will continue to impart nearly unbearable financial stress on the solvency of such funds.
2) Excessively generous benefits
The California public pension plans are associated with unsustainably high benefits. CalPERS has two main formulas (2% at 62 and 2.5% at 67). CalSTRS has only the first one (2% at 62).
As an example, let’s assume an employee’s most recent salary is $100,000. And, that he starts working full time at 27. Using the 2% at 62, his pension would replace 70% of his salary.
62–27 = 35 years of service
35 x 2% = 70% replacement of salary
If he works 5 years longer and benefits from the 2.5% at 67 (CalPERS only), it would replace 100% of salary.
67–27 = 40 years
40 x 2.5% = 100% replacement of salary
Meanwhile, for private sector’s employees, Social Security would replace only 21% of his salary if he retires at 62 and 31% if he retires at 67.
The mentioned California public pensions are deemed to compensate for the majority of employee members not receiving Social Security benefits. However, about 67% of CalPERS members receive both a CalPERS pension and Social Security. This State and Federal pension double dipping is rather baffling.
Conclusion for this demographic section
California public pensions appear unsustainable because:
- Their wage replacement rates can range from 70% to 100% (multiples higher than Social Security) is extremely high.
- The pension funds’ Old-Age Dependency ratios trending downward towards 1 employee supporting 1 pensioner (vs 2.7 for Social Security) put undue financial pressure on the pensions systems.
As is both CalPERS and CalSTRS require total contribution of over 40% of payroll vs only 12.5% for Social Security. Given California continued demographic aging, total contribution will most likely rise much further. And, new member contributions that appear fixed at 10.25% (for CalSTRS) may contribute far less than the 50% cost sharing mandated by PEPRA.
How to dismantle PEPRA: AB 1383
Assembly Bill 1383 represents a direct legislative effort to weaken many of the PEPRA terms. Sponsored by public safety unions, AB 1383 seeks to roll back or provide workarounds to PEPRA’s rigid caps for law enforcement and fire services. It also would increase pensionable salary caps for most members of CalPERS and CalSTRS. The modifications proposed by AB 1383 will markedly impact the effectiveness of PEPRA.
The fiscal impact of AB 1383 according to the Reason Foundation include:
1) An increase in employer annual contribution to CalPERS of $343 million.
2) Over 30 years. CalPERS long-term costs would rise by $12.1 billion on a present value basis.
3) An immediate contribution hike of close to 1 percentage point, resulting in an immediate increase in member contribution of 0.5 percentage point.
Thus, AB 1383 by dismantling key provisions of PEPRA amounts nearly to a return to SB 400 in 1999 that caused the onset of this Pension Crisis.
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