On Friday, Governor Newsom took a notable step towards impacting climate change. In Executive Order N-19-19, the Governor ordered multiple state agencies to utilize specific assets and programs to mitigate the effects of climate change. Specifically, the Order directed the Department of Finance, the State Transportation Agency, the Department of General Services, and the California Air Resources Board to take specific actions to reduce carbon emissions and combat climate change in their respective areas, while accomplishing their existing obligations and goals.
Among the agencies and policies mentioned in the Order, the most significant financially is the Department of Finance, which is directed to create a framework to guide California’s $700 billion investment portfolio of pensions systems – the California Public Employees’ Retirement System (CalPERS), the California State Teachers’ Retirement System (CalSTRS), and the University of California pension system – towards companies that focus on reducing carbon emissions, “including but not limited to investments in carbon-neutral, carbon-negative, climate resilient, and clean energy technologies.”
Regardless of what one thinks of these priorities, politicizing the investment strategies of public pensions has proven to have some risks. Various divestment policies have cost CalPERS fund more than $3.5 billion dollars, according to calculations by some consultants. With the costs of divestment being so significant, CalPERS is considering a comprehensive review of all existing divestment policies in 2021 in order to ensure it can meet its projected returns. As then-Chief Executive Marcie Frost noting in 2018 while discussing a potential divestment action, “With a targeted return of 7%, we need access to all potential investments . . .” Notably, Governor Newsom’s Executive Order does not require or request the divestment in any specific product, technology, or industry. Rather, it prioritizes investment in specific assets and programs to combat climate change, which will be interesting to see if this type of political influence has any notable financial impact on pensions.
California’s public pensions already have significant unfunded liabilities. In a March 2019 analysis, the Public Policy Institute noted that unfunded liabilities for California’s public pensions are at an all-time high. Specifically, CalPERS and CalSTRS already have a combined reported gap of over $240 billion between their estimated obligations and current value of assets. In the event of a recession, California’s pension funds would certainly struggle to meet their projected returns, which would further increase this gap, and taxpayers could be forced to chip in to cover the gap. Thankfully, Governor Newsom himself is aware of the treacherous waters ahead of California. The June Budget contained an extra payment of $9 billion over the next four years to pay down unfunded pension liabilities, including $3 billion to CalPERS and $2.9 billion to CalSTRS on behalf of the state, and $3.15 billion to CalSTRS and CalPERS on behalf of schools.