Forcing public pension plans to make political investing decisions could hurt taxpayers and retirees

As international tensions threaten U.S. and global energy supplies, the California State Senate is considering legislation that would compel public pension funds to divest from fossil fuel companies, potentially starving these firms of capital. The State Senate bill is the latest in a series of initiatives designed to replace traditional portfolio management with a set of shifting environmental, social and governance (ESG) investment mandates that could harm public employees, taxpayers, and the nation’s economy.

The proposed law, Senate Bill 1173, applies to the California Public Employees’ Retirement System (CalPERS) and the California State Teachers’ Retirement System (CalSTRS), which collectively manage close to $800 billion of taxpayer funds intended to provide pensions for state and local government employees, as well as teachers and professors across California. Both pension funds have far less money than they need to cover promised retirement benefits over the coming decades and are largely relying on strong investment returns to close their funding gaps.

Limiting the discretion of pension board members and investment managers to maximize risk-adjusted returns could ultimately lead to tax increases or lower-than-expected benefits for retirees if these pension systems don’t have the money to provide benefits already promised to workers. While public employee pensions enjoy strong legal protections in California, they are not guaranteed to keep up with inflation, and insufficient funding restricts the systems’ ability to provide cost-of-living adjustments (COLAs) to retirees.

Historically, California lawmakers have understood that public pension systems have a fiduciary responsibility to taxpayers, employees, and retirees. Article XVI, Section 17b of the California State Constitution includes the following:

The members of the retirement board of a public pension or retirement system shall discharge their duties with respect to the system solely in the interest of, and for the exclusive purposes of providing benefits to, participants and their beneficiaries, minimizing employer contributions thereto, and defraying reasonable expenses of administering the system.

Employer contributions as mentioned in this section refer to pension fund payments made by state and local governments, as well as local education agencies, mostly with taxpayer funds. The lead authors of SB 1173, State Sens. Lena Gonzalez (D-Long Beach) and Scott Weiner (D-San Francisco), seem to understand that the state constitution imposes a fiduciary responsibility on the state’s pension boards, but try to exclude fossil fuel investments from this mandate, stating in the bill:

The purpose of this section is to require the Public Employees’ Retirement System and the State Teachers’ Retirement System, consistent with, and not in violation of, their fiduciary responsibilities, to divest their holdings of fossil fuel company investments as one part of the state’s broader efforts to decarbonize the California economy and to transition to clean, pollution-free energy resources.

Given this potential conflict, the senators have included provisions in SB 1173 indemnifying CalPERS and CalSTRS board members, employees, and contractors from any legal liability if pension fund stakeholders decide to sue them for failing to meet their fiduciary responsibilities by liquidating fossil fuel investments.

CalPERS and CalSTRS are tasked with providing the pension benefits they’ve promised to workers, not promoting the state’s energy or climate change goals. With Russia invading Ukraine and international sanctions ratcheting up, it is possible that Russia, the world’s third-largest energy producer, may eventually be ejected from global energy markets for an extended period.

California’s gas prices, currently nearly $5 per gallon, highlight the need a robust domestic energy market. Although some may see high gasoline prices as a good way to combat climate change by reducing driving, Californians on modest incomes may not be able to use public transit or buy a pricey new electric Tesla. Many Californians have little choice but to pay more at the pump to get to work and essential locations, thus reducing their spending on other items. Ultimately, efforts to prevent capital from making its way to companies that provide oil and gas could hurt the pocketbooks of California’s families.

To be clear, CalPERS and CalSTRS do not need to go out of their way to invest in oil and gas companies, they should simply invest in whatever will best ensure they’ll have the assets to pay for the pension benefits promised to workers. And state lawmakers shouldn’t restrict those efforts or force their environmental or social goals onto pension fund managers.

Entrepreneurs are developing many tools to transition us away from fossil fuels, if that’s what Californians want. The best options involve private capital and innovation reducing the cost and increasing the availability of renewable energy sources, including wind, solar, and nuclear. However, forcing public pension funds to potentially undermine the U.S. domestic market for oil and natural gas before the economy is ready to fully replace these alternatives would be an unforced error that could also hurt taxpayers and pensioners.

A version of this column was first published at the California Policy Center.