Originally posted at Calpensions.com

The nonpartisan Legislative Analyst’s Office, saying current public pension systems are “too expensive and inflexible,” is recommending two new pension models for future hires that shift some risk to workers and lower government debt.

A new “cost sharing” plan would increase contributions from both employees and employers when a pension fund needs more money due to investment shortfalls or other reasons.

Currently, annual pension contributions from employees are generally fixed by law. So it’s the government employer, and the taxpayer, that must cover the increased cost when pension funds are hit by something like the stock market crash two years ago.

The other model is a “hybrid” combining a pension system that provides lower benefits with a 401(k)-style individual investment plan, now increasingly common in the private sector.

The report issued by the analyst yesterday said the Legislature could approve a cost-sharing or hybrid plan for the California Public Employees Retirement System, the California State Retirement System and local government pension systems.

For the more independent University of California Retirement Plan, the analyst said the state could make state contributions “contingent” on comparable changes by the UC system.

For retiree health care promised state workers, the analyst recommended legislation allowing more flexibility for future employees. The state retiree health care cost, $1.4 billion this fiscal year, is expected to be $1.6 billion next year.

But an additional $1 billion or more would be needed to begin paying for the retiree health care promised current state workers, an “unfunded liability” estimated to be about $50 billion over the next 30 years.

The analyst recommended that the state begin paying the “normal” or full cost of retiree health care by 2020, covering not only bills during the current year but setting aside enough money to cover retiree health care promised in the future as well.

“Existing benefits of our pensions systems are very generous,” Jason Sisney of the analyst’s office said in a video report. “Compared to other states Californians have typically given their public employees richer retirement benefits in recent years.

“And even after some recent changes at the state level to reduce benefits for future employees those benefits are often much more generous than the retirement benefits in the private sector.

“In the private sector defined benefit pensions and retiree health benefits – still the norm in California government – are increasingly nonexistent. A key question that we think needs to be asked is this:

“Can the substantial disparity between public- and private-sector benefits be sustained much longer? We think that it probably cannot. But we do think there are reasonable options to improve California’s public employee retirement systems.”

A chart in the slide show version of the analyst’s report says state pension costs, about $1.4 billion in 1999, have soared to about $6 billion now for CalPERS, CalSTRS and retiree health.

The retirement costs were about 2 percent of the state general fund around 2000 and are currently about 7 percent. The amount would be even higher if future costs were fully funded.

Among the problems with the current retirement systems, said the analyst, is a tendency to pass along costs to future generations, instead of paying for all of the retirement benefits promised current workers.

The analyst said the “unfunded liability” of the retirement systems is a major contributor to increasing costs. But the report also said the “often huge” debt may not be as alarming as some think.

CalPERS and other retirement systems have long-term earnings averaging more than 7 percent, said the analyst, and recent analyses based on earnings of 3 or 4 percent in the future may “substantially” overstate the debt.

It’s a reference to a widely reported study by Stanford graduate students last year that said the pre-crash shortfall of the three state pension funds was more than $500 billion, not the $55 billion reported at the time.

In addition to the two new system models, the “options for the future” recommended by the analyst include an end to “retroactive” benefit increases and contribution “holidays.”

When a booming stock market boosted investment earnings a decade ago, both CalPERS and CalSTRS gave retirees an increase in their pensions of 1 to 6 percent, depending on the amount of time they had been retired.

During the same period CalPERS dropped the annual state contribution from $1.2 billion all the way down to $150 million. As the analyst noted, CalPERS later had to increase the state contribution “just when governments faced their own budget problems.”

The analyst also called for greater “clarity about employer obligations” and the need from the moment an employee is hired “to be crystal clear about which retirement benefits can be modified and which cannot.”

As in the analyst’s report, pension changes are usually recommended for future hires because benefits promised current workers are regarded as “vested rights,” protected under contract law by a series of court decisions.

But some attorneys argue that declaring a fiscal emergency would allow the pensions earned by current workers in the future to be lowered, while pensions they have already earned would not be cut.

The analyst recommended that state funding for CalSTRS be phased out, leaving school districts and teachers to provide all of the money. But the state “probably will need to make payments for many years” to retire the existing debt.

A new staff report to the CalSTRS board this week said an additional $3.8 billion a year, about 14 percent of teacher pay, would be needed to fully fund the system over the next three decades.

The current CalSTRS contributions: teachers 8 percent of pay, school districts and other employers 8.25 percent, and the state 2 percent. The state contributes another 2.5 percent of pay to a separate inflation-protection plan for retirees.

The total state CalSTRS contribution, $1.257 billion this year, is expected to increase to $1.35 billion in the new fiscal year beginning in July, according to the state finance department.

The report to the CalSTRS board said a legal anlysis concluded that the teacher contribution cannot be raised without providing another benefit of equal value.

The report assumes that the increased contribution needed to close the gap, probably phased in over more than a decade, would come entirely from the school districts and other employers, not teachers or the state.

Because contributions from the state general fund are based on two-year-old salaries, said the report, an increase of one percent of pay would only generate a 0.922 increase – not the full one percent yielded by an employer increase.

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/