State pension costs: pay now or pay more later

If CalPERS can wait until next year to raise rates for more than 1,500 local government agencies, why impose a $600 million rate hike on the deficit-ridden state this year?

A number of questions may be asked after the CalPERS board, at the request of state Treasurer Bill Lockyer, voted last week to delay a decision on the state rate hike until next month.

Among other things, a big rate hike as the state struggles to close a $19 billion state general fund deficit might strengthen the case for pension reform. Each dollar spent on future pension costs could be used today to ease cuts in health, welfare and schools.

A problem for public pension funds, which get most of their money from investment earnings, is that they need rate hikes to recover losses in a down economy — a time when government sponsors are most likely to have deficits of their own.

The list of states enacting pension reforms, 16 in a report issued in February by the Pew Center on the States, has grown by nine in a report issued this month by the National Conference of State Legislatures.

“This is turning out to be a pivotal year in public pension policy, as states move to bring down escalating retirement costs that threaten their governments’ stability,” said a story last week on Stateline.org, a news site sponsored by the Pew Charitable Trusts.

Public pensions are regarded as contracts that can’t be cut. Among the cost-cutting reforms are increased employee contributions, lower benefits and later retirement ages for new hires, and reduced pension cost-of-living adjustments.

Schwarzenegger last year proposed lower benefits for new state hires. Senate Republican Leader Dennis Hollingsworth of Murrieta has a bill this year, SB 919, that would cut benefits for new hires and extend retirement ages.

One thing that emerges from the Pew report in February, “The Trillion Dollar Gap: Underfunded State Pension Systems and the Roads to Reform,” is how California public pension systems differ from those in many states.

The legislatures in many states set the annual contribution that the state pays to the pension fund. In California, the California Public Employees Retirement System and most local retirement systems set the rate paid by government agencies.

Pension benefits in many states are set by the legislature. In California, most pension and other retirement benefits are set through contract negotiations with labor unions, with local CalPERS members choosing from options set by legislation.

The methods used to forecast future pension funding and spending obligations vary in California. A governor’s commission two years ago urged the creation of a statewide panel, enacted by SB 1123, to be a clearinghouse for actuarial best practices.

In recent years the CalPERS actuarial policy used to determine the rates that must be paid by government employers has evolved, often amid proposals for cost-cutting reforms.

In March 2005, CalPERS adopted a policy intended to avoid rate shocks. One change extended the “smoothing” period for calculating investment gains and losses from three years to 15 years, well beyond the industry standard.

The new policy came as Schwarzenegger, readying his ill-fated “Year of Reform” initiatives for the November ballot that year, briefly backed a proposal to switch all new state and local government hires to 401(k)-style individual investment retirement plans.

Last June, the governor objected when CalPERS further loosened the policy adopted in 2005, reducing the rate shock from losses in the historic market crash by phasing in the increase over three years.

Schwarzenegger said 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.

“Our pension system needs reform,” the governor said, “and without meaningful and sustainable pension reforms that reduce future costs, the state should decline to participate in any effort to shift more costs to our children.”

The CalPERS board adopted the three-year phase in for local governments, but delayed action on the state rate. Several weeks later the governor introduced his proposal to cut pension benefits for new state hires.

Last December the CalPERS board adopted a policy for the state rate expected to result in a $200 million increase on July 1 from the current $3.3 billion payment. The Schwarzenegger administration had sought a $1.2 billion increase.

Opponents suggested that the administration was trying to boost support for a pension reform initiative aimed at the November ballot this year. The drive to gather signatures for the initiative failed, lacking financial support.

The additional funding sought by the Schwarzenegger administration would have boosted the CalPERS funding level to 80 percent, regarded by many as the acceptable minimum. The $200 million increase would leave the funding at 60 percent.

The new state budget the governor proposed in January for the fiscal year beginning July 1 did not pursue the funding conflict, assuming instead a $200 million increase in the state contribution to CalPERS.

When the actuaries recommended a $600 million increase last week, they cited investment losses, a CalPERS board desire for a higher funding level, and a new study showing members are living longer, earning more and retiring earlier.

A CalPERS committee unanimously approved the $600 million increase. But at a meeting of the full board the next day, Lockyer, a board member, proposed a delay until next month to study the impact on the pension fund of not raising the rate this year.

“An additional $600 million burden on a state budget that has a $20 billion deficit — it seems to me it’s imprudent on our part, particularly when we are talking about what might be funding year 31 of a long-term pension investment,” Lockyer said.

CalPERS funding is calculated over a 30-year period. The only “no” vote on Lockyer’s proposal for a delay came from an administration representative, Greg Beatty of the state Department of Personnel Administration.

The phased-in rate increase CalPERS approved last June for the more than 1,500 local governments does not begin until July 1 of next year, a year after the state increase and nearly three full years after the market crash in the fall of 2008.

The CalPERS actuaries are said to need the time to calculate the rates for the 2,000 local government retirement plans. The rates for the state and non-teaching school employees take less time.

Unlike CalPERS, the underfunded California State Teachers Retirement System lacks the power to set its own contribution rates. But the Legislature apparently sees no urgent need for a rate hike to replace CalSTRS losses.

The state has a massive debt for retiree health care promised current workers, about $50 billion over the next 30 years. But it sets aside virtually no money for future retiree health care, using pay-as-you-go funding, $1.4 billion next year.

The nonpartisan Legislative Analyst said last week that delaying a rate hike will cost taxpayer dollars, due to the lost opportunity to invest the increase. In effect, the state would be borrowing at the CalPERS assumed earning rate, 7.75 percent.

But the analyst said CalPERS may have overstated the rate increase by assuming payroll growth that will not happen because of furloughs. And much of the $600 million rate increase comes from special funds, not the deficit-ridden general fund.

“In any event, it is important for the Legislature to understand that the widely quoted CalPERS
actuarial estimate of a $600 million state payment increase in 2010-11 is (1) going to be borne largely by funds outside of the general fund and (2) almost certainly not going to increase the already-identified general fund budget problem in 2010-11 by $600 million,” said the analyst.

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