California pension funds face huge shortfall

SAN FRANCISCO (Reuters) - Three big California public pension funds face an estimated collective shortfall of more than half a trillion dollars over the next 16 years that threatens the fiscal health of the state, according to report released on Monday.

California's pension liabilities are dire and changes in how the California Public Employees' Retirement System, the California State Teachers' Retirement System and the University of California Retirement System are funded and invest are urgently needed, the report by the Stanford Institute for Economic Policy Research said.

"California's public pension liabilities are substantially understated," the report said, referring to the $55.4 billion in combined unfunded liabilities at the end of July 2008 stated by the three funds.

"Given the consequences of pension underfunding, we believe every effort should be made in short order to implement policy changes to reverse the current shortfall and to prevent a similar shortfall in the future," the report said. "Specifically, improved long-term funding outcomes can be influenced through higher contributions, investment in less risky assets, and lower benefit levels."

Even before the recession and financial crisis, the three California pension systems faced a combined shortfall of $425.2 billion, which widened substantially between June 2008 and June 2009 due to a combined loss of $109.7 billion in the value of their portfolios, the report said.

Its authors used far more conservative accounting than that used by the pension funds to estimate their combined shortfall. "We're preaching fiscal realism," said coauthor Cameron Percy.

The report's estimated shortfall reflects the appetite for risk at the three pension systems, which combined have 1.9 million active and inactive members and 760,000 current retirees, and their strategies to post average annual investment returns between 7.5 percent and 8 percent, the report said.

To meet their return targets, investment staff at each system have deployed funds with a preference for equities and alternative assets, leaving overall portfolios exposed to significant volatility, the report said.

The report's authors recommended that the pension systems allocate more funds to fixed-income investments to reduce risk.

They also recommended increasing contribution to the pension systems and reducing their costs by moving away from defined benefits by incorporating 401(k)-style options in retirement plans for members, an idea California's public-sector unions oppose.

Governor Arnold Schwarzenegger has called for an overhaul of the state's pension plans. He said in a statement that the report "reinforces the immediate need to address our staggering pension debt. ... The consequences are clear: increasingly large portions of state funding for programs Californians hold dear such as schools, parks and health care will be diverted to pay for this debt. That is bad enough, but without reform, pension debt will only grow."

(Reporting by Jim Christie; Editing by Leslie Adler)