By Ed Mendel
A decade ago, when the stock market was booming, the funding levels of CalPERS and CalSTRS were both over 100 percent, a projection that assets would be more than enough to meet pension costs in the decades ahead.
Now the funding levels of the nation’s two largest public pension funds have dropped below what some regard as the acceptable minimum, 80 percent, and for different reasons are not likely to bounce back anytime soon.
One of the triggers of San Diego’s well-publicized pension problems was an agreement that if the funding level fell to 82.5 percent, the city would have to make a big balloon payment.
Reflecting heavy losses in the historic stock market crash and other investments, a new report says the funding level of the California State Teachers Retirement System dropped to 77 percent last June — 58 percent without “smoothing” that spreads out losses.
The powerful California Public Employees Retirement System board, avoiding a $1 billion rate shock, approved a plan last month expected to boost the level in the fund covering most state workers, now about 60 percent, to just 65 percent after 30 years.
So, is there cause for alarm in the ominous-sounding new projections that assets will fall far below pension costs in the future?
Retirees getting monthly checks from the big systems, and current workers entitled to pensions in the future, should lose no sleep. Their benefits, if not ironclad, are about as legally secure as anything can be.
When funding for public pensions, which get most of their revenue from investment earnings, falls short the burden of closing the gap is on the government employer, not retirees or workers with vested pension rights.
The issue is whether growing pension costs will eat up too much of state and local government budgets, taking money from education, health, social services and other programs — maybe even leading to bankruptcies like the city of Vallejo.
Gov. Arnold Schwarzenegger and a reform group that hopes to put an initiative on the November ballot are among those who think current pension amounts are “unsustainable” and should be reduced for new hires in state and local government.
How the two big pension funds have reacted to their plunging funding levels is a sharp contrast.
Nearly all California public pension boards can set the annual pension payment made by government employers. It’s a sweeping power for the pension boards mainly made up of elected officials and employee representatives.
As state and local governments struggle to balance budgets, they can’t cut pension payments unless the pension board approves. And they must raise pension payments if told to do so by the pension boards, who have a legal “fiduciary” duty to protect retirees.
An exception is CalSTRS, which has no power over the public purse. The big system is a crucial source of income for retired teachers, who unlike many other government workers do not receive Social Security in addition to their pensions.
But CalSTRS needs legislation to set its contribution rates — currently 8 percent of pay for teachers, 8.25 percent for school districts and other employers, and 2 percent for the state.
The CalSTRS board has talked about pushing legislation allowing the board to set contribution rates, like other pension funds. But even in good times, getting legislators to give up more power over the state budget would be difficult.
All that’s left is a long-term strategy to persuade the Legislature to raise contribution rates. CalSTRS was pursuing a rate increase last year, when the funding level dropped to 87 percent by June 2008.
A report prepared for a CalSTRS board meeting next week contains the new projection that the funding level fell to 77 percent by June 2009 — 58 percent if the losses are not spread over a three-year period used to “smooth” swings in the value of assets.
A graph in the report shows that the state has tolerated very low funding levels in the past. The CalSTRS funding level was 29 percent in the early 1970s, rose to 110 percent in 2000 and will drop to 13 percent by 2040 under current assumptions.
Fully funding CalSTRS in 30 years would require investment earnings averaging more than 20 percent during the next five years or a contribution increase of 14 percent of payroll, a big jump in the current contributions totaling more than 18 percent.
What happens if nothing is done? The report said an actuary, Milliman, projects that CalSTRS investment assets will be “depleted” by 2045.
“At that time, the state, as the plan sponsor, would be obligated to fund benefits on a pay-as-you-go basis, similar to the approach by which benefits were funded in the early years of CalSTRS,” said the report.
But it’s pay now, or pay even more later. The report said that delaying contribution “increases by as many as 15 years can increase the required rate by almost 60 percent.”
Pushing debt into the future was a concern raised by the Schwarzenegger administration as CalPERS prepared to use a radical “smoothing” method with a three-year phase in to limit the state contribution increase after the market crash.
At the administration’s request, CalPERS calculated that bringing the funding level for most state workers, now about 60 percent, up to 82 percent after 30 years would require the current annual payment of $3.3 billion to jump to $4.5 billion next year.
To avoid a rate shock, the CalPERS board last month approved a new rate of $3.5 billion, a $200 million increase, expected to boost the funding level for most state workers (the “miscellaneous” classification) to 65 percent after 30 years.
The state has the option of voluntarily making a larger contribution. But the new budget proposed by the governor this month would only make the $200 million increase required by the CalPERS board.
The governor’s proposal spends $6.1 billion on retirement costs in the new fiscal year beginning in July: CalPERS $3.5 billion, CalSTRS $1.2 billion, retiree health $1.4 billion.
Schwarzenegger said in a letter to CalPERS last June that delaying a pension contribution increase would be “using our kids’ money” to gamble that investment earnings in the future will grow faster than pension obligations.
But the state has a huge budget shortfall, $20 billion over the next 17 months. The governor’s alternative if a long-shot bid to get $6.9 billion in federal money fails is a list of cuts that includes eliminating some major health and welfare programs.
Arguably, the CalPERS board acted responsibly by letting the funding level fall, avoiding even deeper state budget cuts. There have been no suggestions that the CalPERS board did not fulfill its fiduciary duty to protect retirees.
But it’s something pension board members have to keep in mind.
In San Diego, several class-action suits were filed in 2003 after the public learned of agreements in which the city raised pension benefits and the pension board cut the city’s pension payment, deliberately underfunding the system.
To read entire story, click here.