California is failing its employees and its citizens. Documents show that the state and local governments in California do not have enough money saved up to pay for the retirement of its current employees. The California Public Employees’ Retirement System (CalPERS) is facing future insolvency.
These findings come from the 2015 CalPERS Actuarial Report for Pensions and the 2015 Actuarial Report for Retiree Health Benefits, which are the most recent actuarial reports available for California’s public employee pensions and other retirement benefits. It is worth noting that retirement health benefits have less legal protections than pensions in bankruptcy court, although they are politically difficult to change.
How did California get into this precarious situation? State and local governments aren’t pre-funding health benefits in California. The Public Employee Post-Employment Benefits Commission concluded that retiree health benefits need to be pre-funded just as pensions are so that retiree benefits are secure, but few local governments have done this. Instead, they use a pay-as-you-go system, where money from the budget goes to pay for post-employment benefits every year. This means that government is not investing the funds intended for health benefits, so they cannot use investment returns to help pay for benefits. The refusal to pre-fund health benefits will cost local governments billions of dollars.
Governmental refusal to pre-fund retiree health benefits causes state and local governments to drastically overstate the solvency of their retirement benefit systems. Let’s consider the state’s situation as an example. According to page 11 of the 2015 CalPERS Actuarial Report for Pensions, the funded ratio for state employee pension plans is 69.4%. Federal ERISA standards say that plans at 65% funding or below are in “critical status”. However, when we incorporate obligations for retiree benefits, the funding ratio for all of CalPERS’ state and local employees’ retirement plans is below 50% – well into the crisis zone. These numbers come from adding the assets and the liabilities in the 2015 CalPERS Actuarial Report for Pensions and the 2015 Actuarial Report for Retiree Health Benefits.
Pension and Retirement Benefits System Assets and Liabilities
|Total Pension Assets
|Total OPEB Assets
When we split obligations into how much California owes to those who have already retired and current employees, a startling fact emerges. The assets California governments have now aren’t even enough to cover what it owes to current retirees. For all employees combined, retirees are owed $134.5 billion as compared to $112.6 billion in total assets. California governments do not have enough money to pay what they owe retirees, and they have nothing at all set aside for current employees. Every year, employees have funds deducted from their paychecks to go into the pension funds. Those funds will go to retirees. By the time it’s their turn, there will be no money left for current employees. Current employees are forced to pay into a retirement system that may be bankrupt when they retire.
Even these numbers understate the severity of California’s retirement shortfall because CalPERS is using optimistic unrealistic projections for the performance of their retirement system, The numbers above are based on the assumption that pension funds earn a rate of return of 7.5%. Even CalPERS has acknowledged that this is an unrealistic rate of return, as their board voted to lower the expected rate of return to 7%. Furthermore, CalPERS is projecting a 6.2% 10-year rate of return. This means that the real retirement shortfall is billions of dollars larger than the above numbers indicate. A previous CPC study estimates that California state and local governments are $1.3 trillion in debt.
California’s generous pension benefits don’t just harm citizens hit with taxes and reductions in services. They harm government employees, some of whom are getting laid off now. Those who keep their jobs can be expected to lose some of their retirement benefits if governments are forced to declare bankruptcy. To save employee retirement benefits, reforms that reduce them to responsible levels are necessary.
David Schwartzman is a Policy Research Fellow at the California Policy Center. He is a rising senior studying economics, mathematics, and finance at Hillsdale College.