A new report says CalSTRS needs $4.5 billion more a year to fully fund pensions over the next three decades, a 75 percent increase in the $6 billion total annual payments now being made by teachers, school districts and the state.
There is no cheap fix in the report. A final draft, scheduled to be considered by the CalSTRS board this week, was prepared after meetings with stakeholder groups as directed by a Senate resolution asking for options to address a funding shortfall.
An additional $3.6 billion a year would yield 80 percent funding, $2.9 billion would prevent the investment fund (roughly $160 billion now) from running out of money, and $1.5 billion would push back the estimated run-out date from 2047 to 2058.
One of the less costly rate increase that falls short of full funding, but eliminates or lengthens the CalSTRS run-out date, would allow school districts to report a smaller pension debt under new government accounting rules that take effect next year.
The report said the partial funding could result in “significantly reducing the employer’s liabilities on their financial statements, and increasing their ability to issue bonds for other parts of their programs.”
The nation’s second largest public pension fund also is one of the oldest, formed in 1913. This is its centennial year. Somehow CalSTRS evolved without the self-preserving power of most California public pension systems.
The California State Teachers Retirement System board cannot set annual payments that must be made by employers, needing legislation instead.
In 2004 CalSTRS began telling the Legislature it was underfunded, suggesting a rate increase. The first sign of movement was a Senate resolution last year, SCR 105, calling for at least three funding options by Feb. 15.
But with a state budget back in the black after a decade of deficits, the powerful teacher unions that hold sway over school funding want to restore classroom cuts. And Gov. Brown wants to shift funding to schools in low-income areas with English learners.
The new report looks at scenarios in which the start date for a rate increase is delayed several years, and then the increase is phased in over several years, allowing more time to adjust to the change but adding to the total cost in the long run.
A legal issue that should be resolved, said the report, is whether increasing the employer CalSTRS contribution would increase the Proposition 98 school-funding guarantee. The state attorney general and legislative counsel have conflicting opinions.
CalSTRS has about 70 percent of the projected assets needed to cover pension obligations over the next 30 years — the same as the funding level of the larger California Public Employees Retirement System, which is regarded as acceptable by some experts.
But CalSTRS projects that, without a rate increase, the funding level will continue to drop, depleting the investment fund by 2047. With no revenue from investment earnings, pay-as-you-go pension costs would jump to an estimated 50 percent of pay.
If CalPERS funding drops to an alarming level, its board has the power to give employers a rate hike. Both pension funds say a key goal is to keep the funding level moving in the right direction, up not down.
CalSTRS received $6 billion in contributions last year and paid $10.7 billion in benefits. Teachers contribute 8 percent of pay, school districts and other employers 8.25 percent of pay, and the state 5.2 percent of pay.
The report said most of the CalSTRS revenue during the last quarter century, 58 percent, came from investment earnings. The new funding estimates assume investments will earn an average of 7.5 percent in the future.
Critics say the earnings forecast used by both CalSTRS and CalPERS is too optimistic, concealing massive debt. Over the last 20 years, the report said, CalSTRS earnings hit the target, averaging 7.5 percent.
But earnings were high in the first decade and low in the second. Now the main cause of the CalSTRS $64 billion “unfunded liability” is said to be “weak financial markets since 2000,” when a high-tech bubble burst.
“If investment returns had equaled the currently assumed rate of return of 7.5 percent since 2000, the DB Program (defined benefit pensions) would have had sufficient assets as of June 30, 2011, to fund 103 percent of its liabilities,” said the report.
Because earnings are likely to miss the 7.5 percent earnings target in the future, producing either a CalSTRS shortfall or surplus, the report suggests that a rate increase include a way to make an adjustment in 10 to 15 years.
Another factor in the current CalSTRS underfunding not spelled out in the report is that contributions were cut and pensions increased when the booming market around 2000 briefly created a surplus.
A half dozen bills boosted CalSTRS pensions in various ways, most with the intent of encouraging teachers to stay on the job longer. The state contribution to CalSTRS was cut by about a half one percent of pay.
A bigger cut diverted a quarter of the teacher pension contribution (2 percent of pay from the total of 8 percent of pay) into a new “cash balance” individual investment plan with a guaranteed minimum return based on the 30-year Treasury bond.
A legislative analysis of the bill that created the Defined Benefit Supplement, and diverted a quarter of the teacher pension contribution for a decade, echoes what CalPERS erroneously told the Legislature about its SB 400 pension increase in 1999.
“No (state) general fund effect and no effect to the solvency of STRS,” said the Assembly floor analysis of AB 1509 in 2000, unusually brief for legislation shifting billions of dollars. “The STRS surplus will absorb the cost of DBSP (Defined Benefit Supplement Program).”
In the new report, CalSTRS is said to be a low-cost provider of pensions. Some have suggested that state costs could be cut by putting teachers in the federal Social Security program with a lower CalSTRS pension.
But an independent actuary concluded that providing the same benefit through a CalSTRS-Social Security combination would cost more, said the report, mainly because Social Security has no investment earnings.
The total contribution to CalSTRS from members, employers and the state is 21.5 percent of pay, said the report, well below the total contribiution to CalPERS and Social Security for non-teaching school employees, 30.8 percent of pay, and most state workers, 40 percent of pay.
Those CalPERS members, in addition to receiving Social Security, have a more generous pension formula, providing 2 percent of final pay at age 55 for each year served. The CalSTRS formula is “2 at 60.”
Gov. Brown’s pension reform gives all non-safety new hires a “2 at 62” formula. The report said the median pension for new CalSTRS members drops from 53 percent of final pay to about 47 percent, assuming similar age and service.
“The benefits that will be paid to future members are comparable to the benefits paid to those receiving typical corporate pension plan benefits, when the latter’s Social Security benefits are included,” said the report.
Ed’s Note: 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/