Pensions have role in UC’s competitive edge

In the competition for top talent, the University of California has been able to offer something increasingly rare among leading private universities: a generous lifetime pension.

Now a much lower cap on pensions for new UC employees is part of an agreement to freeze UC resident tuition for two years announced last week by Gov. Brown and UC President Janet Napolitano.

The pay used to calculate most pensions would be limited to the maximum salary taxed for Social Security, $117,000 last year, far lower than the current IRS limit on pensionable pay, $265,000.

In exchange for the pension cap and tuition freeze, the state will dip into a new budget reserve approved by voters last year and give UC a total of $436 million over three years to help pay down its pension debt, used for UC pensions.

“This is not free money,” Brown said while proposing a revised state budget. “They are paying down a debt which will put them in a stronger position, and that’s part of the policy of this administration — to pay down debt.”

The pension cap for new UC employees would be the same as the cap imposed by Brown’s pension reform two years ago on new employees of the state and many local governments.

The pay used to calculate most pensions would be limited to the maximum salary taxed for Social Security, $117,000 last year. That’s much lower than the current IRS limit on pensionable pay, $265,000, currently used for UC pensions.

To reduce soaring pension costs, UC adopted a lower formula for new employees two years ago similar to Brown’s reform for state and local government. New employees must work five more years to get the same pension provided by the old formula.

One reason the lower pension cap was not adopted two years ago presumably was the view found in a survey of UC faculty and staff cited in the UC President’s Task Force on Post-Employment Benefits final report five years ago.

With little variation among employment and age groups, the survey found that 82 percent of respondents said the retirement program is an important reason they stay at the university.

“High satisfaction among plan members gives the University a competitive edge in recruiting and retaining top quality faculty and staff,” said the task force report, “so changes need to be carefully viewed for potential disruption.”

Some universities offer “buyout” packages to encourage elderly employees to retire, an added employer cost.

A stark example of how big pensions are valued: Three dozen of the highest-paid UC executives threatened in 2010 to sue if UC did not remove the IRS limit on pensionable pay, which was $245,000 then.

Under the agreement announced last week, UC Regents will by July 1 next year adopt a change that gives new employees a choice of a pension with the lower cap, a 401(k)-style individual investment plan or a “hybrid” combination of the two.

A number of leading private universities, like private-sector corporations, offer 401(k) retirement plans rather than pensions. Employers avoid long-term debt, while shifting the risk of under-performing retirement investments to the employee.

UC has looked at retirement plans offered by its competitors. One result of 401(k) plans, the task force found, is that some universities offer “buyout” packages to encourage elderly employees to retire, an added employer cost.

“We think a potential hybrid approach that combines a DC [401(k)] and a DB (pension) plan would offer new employees an attractive combination of security and portability,” Dianne Klein, a UC spokeswoman, said via e-mail last week.

“It will be important that UC maintains the competitiveness of its benefit programs in comparison to other institutions to continue to attract and retain the best faculty,” she said.

Much of the UC pension funding shortfall is the result of a remarkable contribution “holiday” that began with a big funding surplus. For two decades, from 1990 to 2010, employers and employees did not contribute to the UC Retirement Plan.

Pensions were paid with earnings from the plan’s investment fund. Half way through the contribution holiday, the funding surplus peaked in 2000 with 156 percent of the projected assets needed to pay future pension obligations.

Four years ago UC began borrowing to help close the pension funding gap.

Then during the recession the projected surplus faded like a mirage, finally vanishing in the stock market crash in 2008, leaving UC with the painful task of restarting pension contributions during a time of deep budget cuts.

This year UC employers are contributing 14 percent of pay to the pension fund, and most employees are contributing 8 percent of pay. A UC complaint is that the state has declined to resume pension contributions that stopped when the holiday began in 1990.

An unusual step has prevented employer contributions, once expected to reach 20 percent of pay, from climbing above 14 percent of pay and further squeezing campus budgets.

Four years ago UC began borrowing to help close the pension funding gap. By last July UC had borrowed $1.8 billion from internal sources and $937 million more from external sources.

Borrowing to pay pension costs can pay off in another way, if money loaned at a low interest rate is invested and earns a higher rate. The UC pension fund, valued at $52.8 billion last June, is expected to earn 7.5 percent a year, which critics say is too optimistic.

The “arbitrage” looks good so far. Last fiscal year the UC pension fund returned earnings of 17.8 percent. The UC short term investment pool, the source of the internal borrowing, earned about 1.5 percent.

But borrowing to pay pension costs is a gamble. The city of Stockton sold $125 million worth of pension obligation bonds in 2007 and put the money in its CalPERS investment fund, just in time for big losses during the recession and stock market crash.

The $436 million UC receives from the state will not be used to pay off the pension loans, the spokeswoman said. The state money, $96 million this year and $170 million in each of the two following years, will be used to pay down pension debt.

Last June the UC plan had a pension debt or “unfunded liability” of $60.4 billion. The plan had 80 percent of the projected funding needed to pay future pensions using the actuarial value of assets, 87 percent using the market value of assets.

In hindsight, if Regents had not declared a contribution holiday in 1990 would UC have been spared the need for pension loans, pension-cutting deals with the governor that may dull the competitive edge, and much of the pressure to increase student tuition?

The task force report in 2010 gave one measure of the contribution holiday’s impact on pension funding: If normal cost contributions had been made during each of the past 20 years, UC pensions would have been 120 percent funded instead of 73 percent.
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Ed’s Note: Reporter Ed Mendel, a regular contributor to Capitol Weekly, covered the Capitol in Sacramento for nearly three decades, most recently for the San Diego Union-Tribune. His stories are at Calpensions.com, which he edits.