By Ed Mendel
Tuesday, January 3, 2011

An official analysis of two public pension reform initiatives last week raised an issue quickly seized by opponents — a potential cost increase of $1 billion or more a year for state and local governments during the next two or three decades.

Much of the focus in the pension debate has been on court rulings widely believed to mean that pensions promised state and local government workers on the date of hire can’t be cut, not even for future service as is allowed in private-sector pensions.

Now the analysis of the two proposed initiatives makes the point that switching new hires to cheaper retirement plans can drive up costs, mainly by cutting the cash flow used to help pay pensions under the old plan.

To replace the cash from new hires the old plans would have to switch some investments to yield cash not capital gains, lowering expected earnings. And a lower earnings forecast can increase employer contributions to the old plans and long-term debt.

The nonpartisan Legislative Analyst’s Office review of two versions of an initiative proposed by California Pension Reform, led by Dan Pellissier, said putting new state and local government hires in cheaper retirement plans could trigger major costs.

The analyst said an initiative giving new hires 401(k)-style investment plans could increase employer costs for two or three decades by “up to several billion dollars more per year (in current dollars) to cover pension costs of current and past employees.”

Over a similar period, the analyst said an initiative giving new hires a “hybrid” retirement plan combining a smaller pension with a 401(k)-style plan could cost employers “$1 billion more per year (in current dollars).”

But the initiatives also would cap employer contributions, raise the contributions of current employees to help pay off pension debt and make other cost-cutting changes virtually certain to be challenged in court by public employee unions.

The analyst’s summary of the fiscal effect of the 401(k) initiative, similar to the hybrid summary, reflects the uncertainty and concludes that government costs could go up or down:

“Over the next two or three decades, potentially significant increased annual costs or some savings in state and local government personnel costs, depending on how this measure is interpreted and administered.”

The analyst’s summary is more certain about what happens under the 401(k) initiative, and potentially under the hybrid plan depending on its structure, when most workers are in the cheaper retirement plan.

“In the long run (several decades from now), annual savings in state and local government personnel costs of billions of dollars per year (in current dollars), offset to some extent by increases in other employee compensation costs.”

The analyst thinks that if retirement benefits are cut by the initiative, pay or compensation for government jobs is likely to be increased to keep them competitive in the labor market.

A labor coalition, Californians for Retirement Security, issued a news release about the Legislative Analyst’s Office review of the initiatives that emphasizes the potential cost increase.

“LAO: GOP Pension-Slashing Measures Would Mean ‘Large Uncertainty’ and $1 Billion a Year in New Costs for at Least 30 Years,” said the headline on the labor news release. “Legislature’s Fiscal Watchdog Says Proposals Threaten Massive Legal Challenges, Reduced Returns and Would Hurt CalPERS and CalSTRS.”

The author of the initiatives, Pellissier, a former aide to a Republican governor and legislator, said part of the potential increased cost of the initiative would be covered by increased employee contributions.

Pellissier said he had expected a more detailed analysis, perhaps using data available from the 20 largest public pension plans that cover about 90 percent of the state and local government employees.

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