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Government pensions: A partisan issue

Gov. Arnold Schwarzenegger, who dropped pensions from state budget talks, will now find out if Democratic legislative leaders share his view that retirement reform is urgently needed.

The governor said last week that he will delay pension negotiations until after a new budget is enacted. Then he presumably will renew his push to cut retirement benefits for newly hired state workers.

It’s a relatively modest proposal. Among other things, a major pension increase enacted a decade ago would be rolled back. New state employees also would have to work 25 years, instead of 20, before getting full retiree health benefits.

The governor is not, as he did briefly four years ago, proposing that all new hires be switched to a 401(k)-style plan. The “defined contribution” plans increasingly common in the private sector rely on investment earnings.

Public employee retirement systems are the last stronghold of guaranteed monthly pension checks. Pension officials sound at times as if they think their “defined benefit” plans are under siege, if not in an outright holy war with the 401(k) forces.

“Defined benefit plans can work fine in government,” said David Crane, Schwarzenegger’s pension advisor. “The issue is controlling them and properly funding them when promises are made.”

Crane said that after doing some research, and talking to reformers elsewhere, he thinks that government employees tend to have “a different mind set” than persons in the private sector.

The governor’s proposal preserves the monthly check system. But for new hires, most benefits would be cut back to the amount in effect before SB 400 in 1999, saving the state an estimated $74 billion over the next three decades.

Current and retired state workers have retirement benefits under labor contracts guaranteed by law. The governor’s proposal last month said the promises “cannot and should not” be reduced.

“I know some people who have talked about doing something with existing obligations,” Crane said. “ I don’t share that view.”

What Crane does share is the view of business leaders such as investor Warren Buffet and John Bogle of Vanguard mutual funds. They think generous government pension benefits are based on unrealistic forecasts of investment earnings. (See Calpensions 10 Mar 09: “Pension funds: A double whammy?”)

If they are right, pension debt could crowd out funding for other government programs, force tax increases and burden future generations. Crane, who helped build a San Francisco global investment firm, has been sounding the warning for years.

While on the board of the California State Teachers Retirement System, he repeatedly questioned an earnings forecast of 8 percent. His appointment was not confirmed by the Senate, ousting him in 2006 after nearly a year on the board.

Crane gave his view again last week in the Huffington Post, arguing that “the amount of our underfunding is simply staggering.“ A lengthy article in the July 11 issue of the Economist magazine shares his concern.about underfunded public pensions.

A case in point for Crane is what legislators were told about the SB 400 benefit increase, The California Public Employees Retirement System expected state pension contributions to “remain below the 1998-99 fiscal year for at least the next decade.”

Instead, state contributions to CalPERS, which were $766 million in 1998-99, had climbed above that amount four years later. The state payment to CalPERS in the fiscal year that began this month is $3.3 billion.

“What’s happening is all the promises are being made with inadequate funding,” said Crane. “People are making those decisions with inadequate information and imposing an enormous burden on future health, welfare and education programs.”

Crane, a Democrat, said Democratic legislative leaders may act on pensions, even without being prodded in a budget deal. He thinks they recognize that pension obligations are “squeezing out funding for the very programs many of them regularly champion.”

Representatives on the CalPERS board of two Democratic officials elected statewide, Treasurer Bill Lockyer and Controller John Chiang, have talked in general terms about re-examining pension benefits. (See Calpensions 14 May 09: “Smoothing costs, not cutting benefits”)

But public employee unions are a major Democratic constituency. Pension cuts are usually proposed by Republicans: Schwarzenegger, Senate GOP leaders, former Assemblyman Keith Richman, R-Northridge, and business-aligned groups.

The timing for a pension cut is not great. The governor has ordered state workers to take three furlough days a month, a pay cut of about 15 percent. The biggest union, Service Employees International Local 1000, is talking about a strike.

Union officials say generous pensions for government workers traditionally offset pay that is lower than in the private sector. If true in the past, said Crane, government pay is now equal or greater than for comparable private sector jobs.

Union officials also have said the governor’s “two-tier” pension plan creates fairness and equity problems among state workers. Crane said unequal compensation is common in the private sector.

What Democratic legislative leaders may hear, if they take up the pension issue, is an impassioned defense of the CalPERS earnings assumption, 7.75 percent a year, from the CalPERS chief actuary, Ron Seeling.

He and his staff have developed “smoothing” plans to avoid sharp contribution increases after the stock market crash last fall devastated pension funds. The CalPERS board approved a plan last month for local governments and schools. (See Calpensions 18 Jun 09: “CalPERS softens hit on local governments”)

The CalPERS board delayed action on a “smoothing” plan for the state, which is opposed by the governor. Schwarzenegger said that delaying a contribution increase would be gambling with “our kids’ money” on future investment earnings.

His administration estimated that a state contribution increase of $879 million next July would be lowered under the “smoothing” plan to about $30 million, followed by an increase in 2011 of $464 million.

At a news conference last week, Schwarzenegger said that after the state budget is done he wants to work on consolidating energy agencies, meeting future needs for water and pension reform.

“Everyone understands that we are running out of money, that we have at least $300 billion of unfunded liabilities there in the pensions,” the governor said.

“And this is not even talking about the health care for retired state employees and all this,” he said. “We’ve got to solve these things. We cannot continue promising people things that we cannot deliver.”

Reporter Ed Mendel covered the Capitol in Sacramento for nearly three decades, most recently for the San Diego Union-Tribune. His stories are available at http://calpensions.com.


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