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Government & Politics
Tue June 5, 2012
Pension math spurs calls for reform
When you look up the origins of word “pension” in the dictionary, you’ll see that it comes from the Latin verb, pendo, which means to pay or value, and to weigh or hang. It’s actually the same root that gives us nouns like pendant. And back here in the 21st century, the costs of providing a defined benefit retirement programs are increasingly weighing down budget across the state.
According to some estimates, California's three largest statewide pension systems, CalPERS, CalSTRS and the UC Retirement System could have a combined shortfall of as much as $500 billion.
And a new study from Stanford University paints an equally grim picture at the local level. According to its author, public policy professor and former Democrat state assembly member Joe Nation, California's city and county pension systems are on the verge of their own crisis, with $135 billion in total unfunded liabilities. Nation's study looked at California's 24 largest municipal pension systems, from the City of Los Angeles and San Jose, to Kern County and the City of Fresno, and he says while some pension systems are doing better than others, they all share the same problems.
“There's really no one that I know that's in good shape. It’s because every single one made these overly optimistic assumptions about how much they would earn,” says Nation.
And as Fresno City Council Member Lee Brand says, when it comes to pensions, assumptions can be especially problematic. “As you get involved in the pension realm, what’s the old saying, ‘there's lies, damn lies and statistics?’ That’s certainly true here,” says Brand.
So what exactly happened? Don't fund managers account for the ups and downs the market? Nation says the problem actually started long before the recent recession.
“This really has been brewing for quite some time. Every pension system in California and across the county made assumptions about investment rates of return that were simply not realistic. Most of them assumed they would earn about 8 percent per year, that’s on their portfolio overall,” says Nation.
“And because they are typically invested in both fixed income instruments and also in others, the stock market and so-forth, to get to that number that means you would need to about 11 percent per year in the stock market. And most people would laugh at the notion that you could earn 11 percent a year in the stock market. It’s just not a realistic number.”
But what exactly is a realistic number? The truth is, it depends who you ask. Federal law requires that private pension funds tie their anticipated rates of return to the interest rate on corporate bonds. That's around 5 percent. But public pension funds don't have to follow that law, and their discount rates are typically between 7 1/2 and 8 percent.
“If you’re off just one quarter percent on your assumption, so instead of eight percent we average over the next 10 years or 20 years, 7 3/4, that has big implications. It will cost the city a lot more money or the employees a lot more money,” says Brand.
Nation's study, which was co-released by the non-partisan Stanford Institute for Economic Policy Research and the group California Common Sense, applies an assumption of a five percent return, which it terms "no-risk". And the difference between five percent and eight percent is huge, especially for the City of Fresno.
Last fall, the city hired a firm to analyze the status of various internal funds to see if any extra money happened to be lying around, including pensions. And for once, the news was actually good.
Craig Rousseau of the firm Harvey M. Rose Associates, told the city council the good news in March 2012. “The City of Fresno unlike many cities and you probably already know this, is in a unique position of being over-funded. While many pension funds are struggling and having problems, the City of Fresno’s Employee Retirement System as of June 30, 2010 was funded at about 122 percent of need, and the police and fire pension system at about 110 percent.”
The city council was exploring the possibility of using some of the extra money in the pension fund to pay for retiree healthcare, which unlike many cities isn't covered by the pension system. While the move would save the city money in the general fund, it would also require the approval of the city's independent pension board.
But when Joe Nation studied Fresno, the results were as good. Using his more conservative 5 percent return, Fresno's pension system was only 77 percent funded, short of the 80 percent that is generally considered the minimum.
Still, council member Lee Brand says the system is one of the few bright spots in the city's finances. “Our retirement system is pretty stable, very fair, and if anything on a comparative basis, city employees actually get less than their counterparts in Oakland, San Jose, Long Beach, Stockton, etcetera. As I said, that’s the bright spot that we have,” says Brand.
In fact, according to Nation's study of the 24 largest municipal pension systems in the state, the City of Fresno's system ranked first, its 77 percent funded ratio put it significantly ahead both Fresno County, which is only 49 percent funded, and Kern County, which, ausing a 5 percent rate of return is only 41 percent funded, the worst in the state. Under the higher discount rate favored by the counties, the numbers aren't much better. Fresno County is 73 percent funded, and Kern County is just 63 percent funded.
So what are some possible solutions, aside from a major improvement in the stock market? Nation says any action on the issue will probably come from the local level, and not from Sacramento.
“At some point you might have this sort of a bottom up approach or bottom up solution, where the folks at the local level might solve this, not our ‘state leaders’ who for the most part are disinterested in this,” says Nation.
But making changes to benefits promised to current employees and those who have already retired is highly controversial, and for good reason. In many cases, labor groups made concessions in pay and other compensation, in return for the security of a government pension down the road. Regina Kane, president of the Service Employees International Union (SEIU) 521 in Kern County, says part of the problem is poor management during good times.
“Six or so years ago, Kern County did not participate in allocating money into the pension fund when years were good, nor did they give employees a raise,” says Kane.
She says that too often public employees are being blamed for problems that are a lot bigger than defined benefit retirement programs.
But even Kane admits that some reforms are perhaps necessary. She says there's a difference between pensions paid to public safety workers and her members. “When you have a particular retirement package [for public safety employees] that [is] say 3 percent at 50 [years old], versus someone who is a caregiver who makes a lower salary, and whose retirement is based on 3 percent at 60 [years old], there’s a huge disparity,” says Kane.
“The [public] safety person whose salary is much higher in the first place has many more years to enjoy their retirement. And so, possibly some reforms of all retirements now should be looked at as well as ways that we can all work together to improve the whole economy by increasing jobs in a lot of areas to bring in more revenue.”
Voters in San Diego and San Jose will decide today what path they wish to take towards changing their defined benefit pension plans, and if attempts in those cities are successful, other cities will likely follow suit.
But despite the controversy, Joe Nation says it's time that cities and counties address what at least he sees as a significant problem. “Until you get people to recognize that there is a tremendous problem, you’re not going to be able to get people to sit down and work it out.