Home / Archive / Impractical Payouts
Thursday, May 17, 2012
Feature: June 2006
Impractical Payouts
Is a pension crisis dulling California’s competitive edge?
Story by Rich Ehisen
Reforming the state’s public-employee pension system is always a hard sell around the Capitol. But with California’s annual public-employee pension obligation inching toward $3.5 billion by 2009, reform advocates continue to call for drastic changes to the government retirement system.
Government pension systems are predominantly of the defined-benefit variety, which guarantees retirees a certain percentage of their regular salary for life. Right now, workers contribute between 5 and 7 percent of their income to the system, with investment returns and government picking up the balance. That is a great deal for taxpayers when the bulls are running on Wall Street, but when the market tanks, taxpayers have to pick up the tab.
At stake is not the state’s ability to pay pensions; that is guaranteed by law. What is at risk is government’s ability to pay up while also funding virtually every other public service, including schools, police and firefighters.
If tax revenue stays stagnant or declines, state and local governments are looking at only two options: major budget cuts or significant tax hikes. Neither is good for California, a state already fighting a reputation for being too expensive for business.
Republican Assemblyman Keith Richman, a strong pension-reform advocate, notes that several California cities, counties and school districts are facing “significant unfunded-pension liabilities,” meaning the cost of their current pension obligations is higher than what they have set aside to pay for them.
“Bakersfield is spending 17 percent of its total budget on pensions,” he says. “Orange County has an unfunded pension liability of about $2 billion. Their fiscal condition is actually worse than it was before they declared bankruptcy.”
But others counter that major cities like San Francisco and San Jose are at least 100 percent funded. Ron Seling, chief actuary for the California Public Employees’ Retirement System, which manages around 2,000 pension systems, contends that the state is perfectly capable of meeting its current and future obligations. Seling says many of CalPERS’s plans are more than 100 percent funded, and that the system as a whole is more than 85 percent funded, above the national average of about 83 percent.
“This notion of unfunded liabilities is truly unfortunate,” Seling says. “That term gives the impression that there is some tremendous debt that we don’t have enough money to pay. CalPERS has more than $200 billion in assets, and we’re paying out about $5 [billion] to $6 billion a year in benefits. The interest income alone is more than enough to pay those benefits.”
That, according to Richman, is not the point. He says the primary issue is how much fluctuation there is in the state’s mandated annual contribution, from around $1 billion in 1995 to just $157 million in 2000, then back up to $2.5 billion last year.
To slow that roller coaster, Richman wants public employees moved from a defined-benefit retirement plan into a defined-contribution plan, which he contends would give the state year-to-year cost certainty. Pension reform, he says, is critical to the state’s long-term ability to remain a major player in the global economy.
“The situation with public employers is very similar to what private companies like United Airlines and General Motors have found themselves in. These high employee-legacy costs — pensions and healthcare — are going to make our society less competitive in the global economy,” Richman says.
“There is enormous political pressure to offer generous pension benefits,
but something’s eventually got to give.”
— Scott Pattison, executive director, National Association of Budget Officers
“In order to stay competitive, we need a well-educated populace, and we also need to invest in infrastructure like broadband, roads and highways, water, energy and open-space preservation,” he continues. “These skyrocketing pensions and retiree healthcare costs are largely about our ability — or inability — to invest in these and other important needs for California.”
California is not the only state battling the roller coaster nature of pension funding. State and local governments in 14 other states are also feeling the pinch.
A 2004 report from Wilshire Associates, a Santa Monica-based pension consulting firm, notes that as of 2003, the 123 largest state and city funds in the country were collectively $366 billion short of being able to meet their retirement-funding liabilities, a whopping $611 million turnaround from where they stood in 2000.
Some pension experts think the situation could be even worse than it appears. Another 2004 report, this one from Barclays Global Investors, one of the nation’s largest pension fund investment managers, says many states are publicly softening the impending payout blow by using accounting practices not generally accepted in the private sector. Using private industry’s more rigid standards, Barclays estimated states are actually more than $700 billion in the red on pension funding.
Though the dot-bomb certainly played a major role in the current pension malaise, lawmakers on both sides of the aisle are also to blame for handing out gobs of enhanced benefits to government-employee unions during the good times.
The state’s nonpartisan Legislative Analyst’s Office says that at least $600 million of fiscal year 2004’s $2.5 billion pension obligation was a direct result of increases handed out during the tech boom. That doesn’t sit well with some taxpayer organizations.
“Politicians have systematically over a period of years completely over-obligated the system,” says Larry McCarthy, president of the California Taxpayers’ Association, a Sacramento-based group.
“The stock market spike was just an excuse to justify giving public employees even greater benefits,” he says. “They did not have the political courage to say no when public-employee unions demanded that they give up the store.”
Neither did local governments, says Sacramento County Supervisor Roger Dickinson. “When the state increased their benefits, it immediately put enormous pressure on us to increase our own benefits,” Dickinson says.
Sacramento City Budget Manager Russ Fehr agrees, noting that “once the state acted, we were kind of stuck. Locals just really didn’t have a chance.” Fehr says the city is currently 83 percent funded for civilian employees and 88 percent funded for safety workers.
Geoffrey Davey, Sacramento County’s chief financial and operations officer, says 93 percent of the county’s current obligations are funded. He also concurs that the state’s actions heavily influenced local governments afraid of losing scores of their employees to the state payroll. By trying to forestall that possibility, Davey says small suburban cities like Roseville, Elk Grove and West Sacramento actually surpassed the state’s enhanced benefit package.
“The state and Sacramento County both offer the ‘2 percent at 55’ option, meaning that someone working 30 years and retiring at 55 would receive 2 percent of their salary for every year of service,” Davey says. “That equals 60 percent. But many of the smaller cities offer 2.7 percent, meaning those retirees will get 81 percent of their final salary as a pension for life.”
With dollars scarcer these days, many state and local governments have turned to pension-obligation bonds, which allow governments to take low-interest loans and then invest the money in hopes of earning enough back to cover their pension obligations. But those bonds also have to be paid back with interest, which creates problems.
“This notion of unfunded liabilities is truly unfortunate.”
— Ron Seling, chief actuary, CalPERS
Facing growing bond payments in 2004, Sacramento County refinanced almost $1 billion worth of bonds, which Dickinson says bought the county “about five years of much lower pension bond debt service payments” that helped avoid deep cuts to county services. He warns, however, that this year those payments will significantly increase. He says the Board of Supervisors has since squirreled away $50 million to help pay the county’s future pension costs.
Dickinson also notes that, unlike the state and many other local governments, Sacramento County negotiated a trade-off with the union, giving increased pension obligations in exchange for a one-year reduction in cost-of-living allowances. “Most local governments just gave the benefits without getting the trade-off,” he says.
Richman says situations like Sacramento County’s are not unusual. “There has been more than $12 billion in pension-obligation bonds issued by local governments just over the last decade,” says Richman. “The debt service on that is about $800 million a year, almost equivalent to the money the state took from cities and counties in 2004. Those bonds will require the citizens of those municipalities to be paying them for the next 20 to 30 years.”
In 2005, Richman authored a measure that would have placed new state employees into defined-contribution plans, but it never even got out of committee. Gov. Schwarzenegger championed the proposal long before he went to bat with the rest of his Year of Reform agenda, but was met with such a ferocious counterattack from public-employee unions — which claimed the measure would have ripped death benefits out of the hands of police and firefighter widows — that he bid a hasty retreat and dropped the issue.
Nonetheless, Richman, who is running for state treasurer in November, introduced Assembly Constitutional Amendment 23 this year, which would enact a mandatory hybrid pension plan for all public workers.
It would move those employees into a defined-benefit system — with a much smaller guarantee — supplemented by an employee-funded defined-contribution plan. It would also place all state and local government employees on the same footing, with no ability for one municipality to outbid another with benefit enhancements.
Not surprisingly, several leading state employee unions have already voiced their official opposition to the plan, including CalPERS, the California State Teachers’ Retirement System and the California Retired Teacher Association. Richman says that kind of response is why he doubts ACA 23 will fare any better than his previous reform efforts.
“I think it is next to impossible to get a legislative solution to the pension crisis,” he says. “The overwhelming likelihood is that it is going to require an initiative in order to solve this problem,” something he vows to pursue if ACA 23 fails to gain traction in the Legislature.
That possibility irks Seling, who says Richman and others are using questionable logic to justify their efforts.
“The contribution 10 years ago was $1.2 billion. Through some incredibly good investment returns, we lowered that to less than $150 million,” Seling says. “Then the market crashed and that $150 million has turned into the $2 billion. Now Richman and others want to use the $150 million as a starting point without acknowledging that we saved them over a billion dollars before.”
Scott Pattison, executive director for the National Association of Budget Officers in Washington, D.C., says the pension reality in California and across the nation is somewhere between Richman’s predictions of fiscal calamity and the “What, me worry?” viewpoint of most pension operators.
“We’re still talking decades down the road before this really comes to a head, but there has to be at least some concern now about the long-term ramifications of these obligations,” says Pattison.
“There is enormous political pressure in many states to continue offering these generous pension benefits, but something’s eventually got to give,” he says. “People are starting to look at the numbers and are thinking they just won’t be able to sustain those generous benefit programs for the ensuing decades.”
But Dickinson contends that in spite of the fiscal ups and downs associated with generous pensions, they help keep good people in the public sphere.
“Politicians have completely over-obligated the system.”
— Larry McCarthy, president, California Taxpayers’ Association
“We’re looking for something different in government,” he says. “We’re looking for people who are committed to public service, not just committed to maximizing their compensation.”
Sacramento City Councilman Kevin McCarty echoes that sentiment, saying that better benefits are key to getting and keeping the best government employees.
“A lot of times government salaries are not competitive with the private sector, so one thing we do have to offer is our benefits,” McCarty says. “For us, [pensions] are a big, big thing for recruitment and retention of the best and the brightest.”
Pattison, however, questions the need for pensions as a recruitment tool. “That may have been true 15 years ago. These days, state and local government employment is actually quite attractive to most people. Except at the most senior levels, the salaries are not necessarily less and they don’t come with the often significant pressure to put in really long hours seen in the private sector.”
Data from the federal Bureau of Labor Statistics supports that. In 2005, state and local government workers averaged more than $23 per hour, far more than the approximately $16.50-per-hour average of their private-sector counterparts.
The private-sector average is brought down by the preponderance of minimum-wage jobs, but as Pattison notes, “If you are talking about hiring a chief financial officer for a multibillion-dollar state agency for $120,000, then yes, that person probably could make twice that in the private sector. But I really don’t think someone making $40,000 at an administrative position in something like the state Public Health Department could go out and get an equivalent position with similar duties in the private sector.”
Even if major pension reform happens, there is already another 500-pound gorilla waiting in the wings: new accounting rules for 2007 from the Governmental Accounting Standards Board, which sets accounting standards for all public-sector organizations, will require governments to fully disclose their overall benefits costs, including pensions and retiree healthcare, and to fully fund those costs every single year.
In February, the state Legislative Analyst’s Office issued a report that indicated that the cost of California providing healthcare to its retired state employees and their families is “now approaching $1 billion per year.” Under the new rules, the Legislative Analyst’s Office estimates that the state’s unfunded healthcare liability is “in the range of $40 billion to $70 billion — and perhaps more.”
That, says the California Taxpayers’ Association’s McCarthy, is reason enough for taxpayers to get behind changing the system.
“At some point there has to be a groundswell from the citizens,” he says. “The question is, ‘Are taxpayers indignant enough to do something about this?’ At some point you have to believe they will support reform.”
