Asymmetric Pension Smoothing: A Prudent Reform to Strengthen CalPERS and CalSTRS Funded Ratios

Public pension systems in California, particularly CalPERS and CalSTRS, face persistent challenges in achieving full funding despite periodic strong investment returns. With CalPERS’ funded ratio recently improving to approximately 79% following solid market performance, meaningful structural reforms are essential to sustain progress and protect taxpayers.  One such reform—adopting asymmetric smoothing for investment gains and losses—offers a mathematically sound path to accelerate funded ratio improvements while enhancing long-term fiscal stability.

Current practices at CalPERS rely on symmetric treatment. The system employs a 15-year rolling asset smoothing period for recognizing market gains and losses, combined with layered amortization of unfunded liabilities, typically over 20–30 years for experience gains and losses.  CalSTRS applies similar smoothing mechanisms, with investment gains and losses often recognized over shorter periods (such as five years for certain differences) but aligned in a balanced manner overall.  This symmetry, while intended to reduce volatility, introduces a subtle bias that delays recovery from downturns.

Consider the fundamental mathematics of investment cycles. A 50% loss in asset value requires a 100% gain simply to return to the starting point. For example, $100 million in assets falling to $50 million needs to double— a 100% increase—to recover. Symmetric smoothing spreads both the initial loss and subsequent recovery evenly over the same period, deferring the full impact of shortfalls and allowing unfunded liabilities to compound with interest. This prolongs underfunding, increases future contribution pressures on employers and taxpayers, and risks intergenerational inequity.

Asymmetric smoothing addresses this asymmetry directly: amortize investment losses over shorter periods (e.g., 10–15 years) while spreading gains over longer periods (e.g., 25–30+ years). Losses would be recognized and funded more aggressively, compelling earlier adjustments in contributions, benefits, or investment strategies to rebuild assets swiftly. Gains, conversely, would provide extended contribution relief and buffers against future volatility, preventing premature optimism that leads to benefit enhancements or reduced funding discipline during temporary windfalls.

This approach is not radical but prudent actuarial conservatism. It aligns with best practices emphasizing rapid elimination of unfunded liabilities (ideally within 15–20 years for new bases) to promote funded ratio growth.  By front-loading the “pain” of losses and back-loading the benefits of gains, asymmetric smoothing reduces the cumulative drag from market cycles. Over time, this would drive CalPERS and CalSTRS funded ratios higher more reliably, mitigating the risk of taxpayer bailouts and improving creditworthiness.

California’s Controller has a critical oversight role in auditing and exposing these dynamics. Implementing asymmetric smoothing through would complement broader reforms. Policymakers and pension trustees should direct actuaries to model this framework immediately, incorporating sensitivity analyses across historical market scenarios.

California cannot afford to smooth away hard truths. Asymmetric treatment of gains and losses represents a targeted, data-driven step toward restoring the fiscal health of our pension systems and securing the promises made to public employees without burdening future generations. The math demands it; prudent governance requires it.