Originally posted at CalPensions.
By Ed Mendel.
An initiative proposed by five mayors last week, aimed at allowing cuts in pensions and retiree health care earned in the future, could put a spotlight on another growing problem: debt passed to future generations.
The point of the drive led by San Jose Mayor Chuck Reed is to allow state and local governments to cut budget-threatening future retirement costs that are now apparently locked in by court rulings, while protecting pension amounts already earned.
But the proposed state constitutional amendment, which faces a number of hurdles (see previous post), also requires a government agency with pensions or retiree health care less than 80 percent funded to prepare a plan to reach full funding in 15 years.
Most pension funds try to get to full funding in 30 years. Shortening the period to 15 years would require larger annual payments, perhaps one way to dramatize the size of the debt and the urgency to begin paying it down.
In this case, Reed said, the 15-year period is an estimate of the amount of time that the average worker will remain on the job. The term used by actuaries is the “average remaining service period.”
The initiative intended to give struggling government employers an optional tool to solve their retirement-cost problem, not a prescribed method, does not require that the plan to reach full funding in 15 years be put into effect.
“Preparing a plan would be required,” Reed said last week. “But implementing a plan is not required.”
Retirement benefits, such as pensions and retiree health care, are regarded as part of pay. So if the cost of benefits are not fully paid while the worker is on the job, some would argue that a debt is unfairly passed to others who did not receive the services.
Actuaries worry about reducing or avoiding “intergenerational” transfer of debt. Tightening its debt payment periods, the California Public Employees Retirement System decided in April to phase in a rate increase to get to full funding in 30 years.
Much of the recent pension-funding debate has been about whether pension fund investment earnings forecasts used to offset or “discount” debt, now 7.5 percent a year for CalPERS, are too optimistic and conceal massive debt.
And following legislation pushed by former Gov. Arnold Schwarzenegger, CalPERS has begun showing what happens to employer rates if investment earnings are 2 percentage points above or below the earnings forecast.
But like Reed’s proposed initiative, the legislation also directs CalPERS to show what happens to rates if pensions are fully funded in the “average remaining service period,” estimated at 10 years in a recent report.
Standard CalPERS debt payment (green) and 10-year period (red)
What is the impact, if any, of showing another way that retirement costs are being pushed into the future? A previous disclosure had mixed results.
In a stark intergenerational transfer of debt, most government employers have pay-as-you-go retiree health care. No annual pension-like contributions are made to invest and help “prefund” the cost of retiree health care promised current workers.
A government accounting change in 2004 directed employers to begin reporting retiree health care debt or “unfunded liability.” A CalPERS retiree health care investment fund created in 2007 now has $3.1 billion from about 350 local governments.
Unlike those local governments, the state has not begun prefunding and last year spent $1.3 billion on retiree health care. Controller John Chiang estimates the state owes $64 billion for retiree health care promised current state workers over the next 30 years.
It’s not clear whether passing debt to future generations will be added to the equity and fairness issues already facing public pensions.
Private-sector pensions are being replaced by 401(k) individual investment plans that shift risk from the employer to the employee. Reform legislation giving lower pensions to new hires, but not to current workers, means persons with the same job can get unequal pay.
Last week, the opinion pages of the New York Times and Wall Street Journal both had articles about a “legendary investor” who has been touring college campuses to urge students to mobilize against what one of the writers called “generational theft.”
Stanley Druckenmiller, 60, a retired hedge fund founder said to be worth $2.9 billion, often was joined by Geoffrey Canada of the Harlem’s Children Zone in appearances at Stanford, Berkeley, USC and other campuses.
The two are said to be convinced that only a mass youth movement, similar to opposition to the Vietnam war, can “break through the web of special interests” and force politicians to enact reforms.
“With graph after graph, they show how government spending, investments, entitlements and poverty alleviation have overwhelmingly benefited the elderly since the 1960s and how the situation will only get worse as our over-65 population soars 100 percent between now and 2050, while the working population that will have to support them — ages 18 to 64 — will grow by 17 percent,” Thomas L. Friedman wrote in the Times.
“This imbalance will lead to a huge burden on the young and, without greater growth, necessitate cutting the very government investments in infrastructure, Head Start, and medical and technology research that help the poorest and also create the jobs of the future.”
Friedman and James Freeman in the Journal did not say that Druckenmiller mentions public pensions in talks about “all the cans we’re kicking down the road.” But pension issues seem likely to be included if there is a movement for generational fairness.
In a request for a title and summary for the initiative last week, Reed was joined by mayors Miguel Pulido of Santa Ana, Tom Tait of Anaheim, Pat Morris of San Bernardino and Bill Kampe of Pacific Grove — all Democrats except Tait, a Republican.
“As mayors of California cities, we have seen firsthand how the rising cost of public employee retirement benefits has forced cities, counties and other government agencies to cut public services, layoff hard-working employees and defer badly needed improvements to critical infrastructure,” the mayors said in a letter last week.
State court rulings are widely believed to mean that retirement benefits offered on the date of hire become “vested rights,” protected by contract law, that cannot be cut unless offset by a new benefit of equal value.
The initiative (see website) is a constitutional amendment intended to “clarify” the law and allow cuts in retirement benefits earned by current workers in the future, while protecting benefits already earned through time on the job.
The mayors need a not unfavorable title and summary from Attorney General Kamala Harris, money to gather signatures to place the initiative on the ballot and a campaign for voter support.
A coalition of well-funded public employee unions (see website), which has already conducted polling on the issue, contends that the initiative breaks promises to workers and that retirement system issues should be handled through negotiations.
A CalPERS statement last week, suggesting a legal challenge, said passage of the initiative could jeopardize “all contractual rights in California” and “a better solution would be to help those without pensions find ways to save for retirement.”
If the initiative makes the ballot, passes and survives legal challenges, pensions or retiree health care plans less than 80 percent funded would have to prepare a plan for full funding in 15 years with specific steps, such as lower benefits or higher contributions.
After a review period, a hearing would get public response before the plan is formally adopted. Then this process — plan preparation, public hearing, formal adoption — would be repeated each year until the pension or retiree health care plan is 100 percent funded.