Will San Jose, San Diego Lead Pension Reform?

Originally posted at www.calpensions.com
One reason San Jose and San Diego will vote on widely watched pension reforms Tuesday: Retirement costs are eating up about 20 percent of their general fund budgets, well above the old norm.

A commission on public employee retirement appointed by former Gov. Arnold Schwarzenegger reported in 2008 that the average pension cost was 4 percent of the general fund.

The state’s second largest city, San Diego, and it’s third largest city, San Jose, have made cuts in police, fire and other services that are painfully clear to residents, and rising retirement costs are getting much of the blame.

Public pension amounts in California are based on what unions are able to obtain through collective bargaining, not what is needed for a reasonable retirement. There is a growing gap with workers in the private sector, where retirement benefits are shrinking.

Many public employees can retire at age 50 or 55 and receive a generous pension based on years of service (up to 90 percent of pay for most police and firefighters) with inflation adjustments, health coverage and an expectation of living another three decades.

A state ballot measure, Proposition 21 in 1984, lifted a lid that kept most pension fund investments in predictable bonds, enabling promises that more generous pensions could be paid by investments in volatile stocks and other higher-yielding assets.

But after a decade of below-target investment earnings, government retirement costs are going up and there is a national debate about whether public pensions are “sustainable.”

Much of the debate is focused on pension funding levels, now often about 70 percent of projected assets needed to pay future pensions, and on pension debt or “unfunded liability,” an alarming $1 trillion to $3 trillion in some national estimates.

These two measurements of pension system financial health are based on forecasts of investment earnings during the next several decades. And like any prediction of the future, earnings forecasts are far from certain.

An example of how earnings forecasts make big changes in pension funding levels and debt can be seen in the annual valuation of the California State Teachers Retirement System prepared by Milliman actuaries in April.

As of last June 30 CalSTRS had a funding level of 69 percent and a debt or unfunded liability of $64.5 billion, mainly due to earnings averaging 5.5 percent during the last decade. CalSTRS has lowered its earnings forecast from 8 to 7.5 percent.

The actuaries estimate that the total annual contribution to CalSTRS from employers and employees, 19.4 percent of pay, would have to increase by an additional 12.9 percent of pay each year (about $3.25 billion) to reach full funding in 30 years.

Now here’s the potential power of earnings. As the nation’s second largest public pension system, CalSTRS had an investment portfolio valued at $154 billion on April 30, still down from a peak of $180 billion in 2007.

But without a contribution increase, the actuaries estimate, CalSTRS could reach full funding in 30 years if earnings average 9.6 percent — or CalSTRS could be fully funded in just five years if earnings average 16 percent, and the big debt vanishes.

Of course, if earnings are below the new 7.5 percent target, as critics of public pensions think is likely, the funding shortfall widens. But the point is that earning forecasts are uncertain.

No one knows the future. So earnings in the decades ahead, which are expected to provide about two-thirds of the money needed to pay pensions, are open to debate. And in an argument, one method-derived guess is as good as another, until proven wrong.

What San Diego and San Jose share is the “real” number of current pension costs, not alarming but possibly mirage-like projections open to debate. Pension costs are already eating up a fifth of their general funds and diverting money from other services.

In San Diego, the annual required pension contribution from all funds went from $137.6 million in fiscal 2006 to $231 million this year and is projected to be about $500 million in fiscal 2025.

In San Jose, the annual retirement contribution for pensions and retiree health from all funds went from $73 million in 2001 to $247 million this year and is projected to grow about 27 percent by 2016.

All public pension systems in California share a cost-cutting problem. Powerful pension boards can set an actuarially determined contribution rate each year that must be paid by government employers. (An exception is CalSTRS, which needs legislation.)

A series of court decisions are widely believed to mean that pensions promised public employees on the date of hire become “vested rights,” protected by contract law, that can’t be cut without providing an offsetting benefit of equal value.

Most attempts to cut pension costs are bargained with unions and 1) give new hires a lower pension and 2) raise employee contributions, though CalSTRS and others say this too must be offset by a benefit of equal value.

The nonpartisan Little Hoover Commission recommended legislation giving employers a way to cut the pensions current workers earn in the future, while protecting pensions already earned, which would likely result in the courts revisiting the issue.

Now the measures in San Diego and San Jose, backed by mayors Jerry Sanders and Chuck Reed, are widely watched because they could cut pensions earned in the future by current workers, but through different methods.

The San Diego measure gives new hires, except police, a 401(k)-style investment plan instead of a pension. The city would bargain with unions for a six-year freeze on pay used to calculate pensions, which can be overridden by a two-thirds city council vote.

San Diego has struggled with a self-inflicted pension “crisis” following deals in 1996 and 2002 that cut city pension contributions and gave employees bigger pensions. Some of the fallout has been lawsuits, a moratorium on bond sales and budget cuts.

In a race for San Diego mayor, the leader in a poll last week, Councilman Carl DeMaio, is a key sponsor of the pension reform measure. The runnerup in the poll, U.S. Rep. Bob Filner, has his own pension reform proposal based on issuing bonds.

The San Diego pension measure did not spark the heated and expensive campaign battle expected by some. A Channel 10 News/USA Survey last week showed Proposition B favored by 57 percent of voters and opposed by 21 percent with 22 percent undecided.

The San Jose measure would give current workers the option of switching to a lower pension or staying in the current plan and paying off pension debt with annual contribution increases of 4 percent of pay, capped at 16 percent or half the debt cost.

A union-backed attempt to unseat Councilwoman Rose Herrera could undermine the slim council majority backing Reed’s pension reform. A poll done for the Silicon Valley Chamber of Commerce two weeks ago showed Measure B leading with 55 percent of the vote, 23 percent opposed and 22 percent undecided.

In the national media over the weekend, the San Jose measure was the subject of a lengthy page-one story in the Wall Street Journal. A Reuters story said the San Jose decision could “set an important precedent for many other cities, not only in California but across the nation.”

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/ Posted 4 Jun 12

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