November 18, 2010

By Ed Mendel

The nonpartisan Legislative Analyst’s Office, not known for rosey scenarios, forecasts a moderate increase in annual state payments to CalPERS during the next five years, mainly due to cost-cutting pension agreements negotiated with labor unions.

State payments to the California Public Employees Retirement System are expected to increase from $3.6 billion this year to $3.9 billion in fiscal 2015-16, according to a state budget “fiscal outlook” from Legislative Analyst Mac Taylor.

But the annual report issued last week notes that rates could go higher if, as expected, CalPERS lowers the investment earnings assumed in the decades ahead, requiring more state contributions to cover pension obligations.

After an asset workshop last week, CalPERS seems likely to adopt a new asset mix next month that would lower the current earnings target, 7.75 percent a year, to at least 7.5 percent.

Still, the analyst’s report is a neutral look at the impact of public employee union “givebacks” that ease the strain on the deficit-ridden state budget. The budget gap over the next year and a half has ballooned to an estimated $25 billion.

A half dozen unions, following the Highway Patrol’s lead, agreed to new contracts earlier this year that raised employee pension contributions to 10 to 11 percent of pay, up from 5 to 8 percent. The state employer contribution for most workers is 20 percent of pay.

The big move came last month when negotiators for the largest state worker union, prodded by Gov. Arnold Schwarzenegger’s vow not to sign a state budget without pension reform, agreed to a new state contract.

The 95,000-member Service Employees International Union Local 1000, representing nine bargaining units, announced earlier this month that the contract was “overwhelmingly” ratified by members, receiving 76 percent of the vote.

“We’ve done our part to get the state through this unprecedented budget crisis,“ Yvonne Walker, SEIU Local 1000 president, said in a news release.

“This is the worst recession in more than eight decades, and our members stepped up and made temporary sacrifices to help California and keep CalPERS strong,” Walker said. “But through this agreement, we are ensuring our long-term security.”

Unions representing 60,000 state workers, nearly a third of the state workforce, did not agree to new contracts, holding out in hope of a better deal from the incoming administration of Gov.-elect Jerry Brown.

Typically skeptical, the Legislative Analyst’s outlook (p. 38) expects several worker cuts in the new state budget signed last month, 100 days into the new fiscal year, to save $1 billion, not $1.4 billion as assumed by the budget writers.

But the analyst’s contrarian view turns optimistic with a projection for “fairly modest growth“ in the state‘s CalPERS contribution.

“This is in contrast to consistent warnings from the system in recent years that state contribution rates are on track to increase significantly over time — due to the need to cover added liabilities resulting from the system’s 2008-09 investment declines and recent demographic experience of the system,” the analyst said.

In addition to assuming that the earnings target will not change, the analyst gives two other reasons for its projection.

–The analyst assumes that state workers will receive just one pay raise, a 3 percent hike in 2012 or 2013 under the new contracts. CalPERS forecasts assume annual pay raises.

–The analyst assumes that CalPERS earnings will hit the current target, 7.75 percent, each year. Because a panel of experts thinks averaging 7.75 percent earnings during the next decade is unlikely, CalPERS is considering lowering the target.

The CalPERS chief actuary, Alan Milligan, said he had not yet reviewed the analyst’s outlook and did not want to speculate about the forecast of “modest growth” in the state pension payment.

In the most recent long-term projection from CalPERS actuaries, issued last December, the state payment in fiscal 2015-16 is expected to be $5.2 billion, well above the $3.9 billion forecast by the analyst for the same year.

But conditions have changed since then. CalPERS actuaries were expecting the state payment last year, $3.3 billion, to increase to $3.5 billion in the current year as big losses in the 2008 stock market crash are phased in over three years.

Then the CalPERS actuaries added about $100 million in February to pump up levels in some funds and $300 million in April because a new decade-long study showed that members were living longer, earning more pay and retiring earlier.

As a result, the CalPERS board would be imposing a $600 million increase in the state payment, up 18 percent to $3.9 billion, at a time when the state faced another huge budget gap and was struggling to make deep spending cuts. So action was delayed.

What helped the board decide to impose the $600 million increase in June was a Legislative Analyst report. Only $87 million of the increase would come from the deficit-ridden general fund, the rest from various special funds such as transportation.

But conditions have changed again. CalPERS investments earned 13.3 percent last fiscal year, well above the assumed return of 7.75 percent. The new contracts increase employee contributions, lowering state payments by a similar amount.

“My expectation is that I will be coming back in December with an agenda item to actually set the contribution rates reflecting the changes to employee contribution rates,” Milligan told the CalPERS board last month.

The Legislative Analyst expects the state contribution to CalPERS this year to be about $3.6 billion, nearly 60 percent coming from the general fund.

The state payment to the California State Teachers Retirement System is expected to be $1.3 billion this year, growing to more than $1.5 billion in fiscal 2015-16 under current law.

CalSTRS is underfunded, but unlike CalPERS lacks the power to raise employer contribution rates. A CalSTRS drive to build support for legislation increasing contributions includes a $600,000 public relations contract.

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