Public Sector Pension Plans Do Not Pass the "Smell Test"

“Pew’s relationship with the Arnold Foundation does not pass the smell test,” said Meredith Williams, Denver-based executive director of the National Council on Teacher Retirement.

– “Pension Funds Press Pew to Cut Arnold Foundation,” Philanthropy Today, March 4, 2014

If you’re looking for an example of how, increasingly, political debate in America is framed as a battle between tainted – and very powerful – special interests who harbor nefarious personal agendas, instead of a rational exchange of competing facts and logic aimed at finding optimal solutions, look no further.

Apparently, across the United States, any reputable nonprofit, from Pew and PBS to your underfunded start-up, now has to refuse gifts from major donors unless they happen to be (1) funded by public sector unions, or (2) originate from the pockets of left-wing billionaires. Everything else is tainted. Everything else fails the “smell test.”

Apart from the absurdity of tagging individuals and organizations with terms as archaic as “right-wing” and “left-wing,” when it is left-wing government unions that have joined forces with right-wing crony “capitalists” to exterminate what remains of America’s private sector middle class and small business community, the tactic of tainting the messenger results in a tragic smothering of constructive dialog.

When debate focuses on facts, the truth, and sound policy, emerges. When debate focuses on which participant stinks more, truth doesn’t matter. And the likely truth that should be debated is this: If anything doesn’t pass the “smell test,” it is the long-term financial solvency of public sector pensions as they are currently formulated. They are on a collision course with reality.

Over the past several months the California Public Policy Center has produced numerous short studies assessing public sector pension plans in California. Since the National Council on Teacher Retirement is probably concerned primarily with teachers pensions, here are two points from those studies, submitted for genuine debate, regarding CalSTRS:

CalSTRS Contributions Are Well Below Levels Necessary to Maintain Solvency

The officially recognized amount of CalSTRS unfunded liability is $71 billion. In their fiscal year ended 6-30-2012, CalSTRS made an “unfunded payment” towards reducing that liability of $1.1 billion. If CalSTRS were to adhere to the GASB and Moody’s recommended repayment schedules – which take effect later this year – that payment would have to be many times greater – to quote from the study “Are Annual Contributions Into CalSTRS Adequate?”

Using evaluation formulas and unfunded liability payback terms recommended by Moody Investor Services in April 2013, this study shows that if the “catch-up” payment is calculated based on a level payment, 20 year amortization of the $71.0 billion unfunded liability – still assuming a 7.5% rate-of-return projection – this catch-up payment should be $7.0 billion per year. The study also shows that if the CalSTRS pension fund rate-of-return projection drops to 6.20%, the unfunded liability recalculates to $107.8 billion and the catch-up payment increases to $9.6 billion per year. At a rate-of-return projection of 4.81%, the unfunded liability recalculates to $154.9 billion and the catch-up payment increases to $12.2 billion per year.

CalSTRS Retirees Collect Pension Benefits Far In Excess of Social Security Retirees

Here is a quote from a press release issued by CalSTRS in opposition to the proposed citizen initiative, the Pension Reform Act of 2014, (already DOA for 2014, by the way), “California’s educators do not participate in Social Security, retire on average around age 62, and earn a retirement income that replaces only about 56 percent of their salary.”

The implication here seems to be that CalSTRS retirees would prefer to be part of Social Security. So here’s the comparison between a typical CalSTRS benefit and the Social Security benefit, from the study “Comparing CalSTRS Pensions to Social Security Retirement Benefits.”

“At age 62, the average CalSTRS retiree collects 56% of their final salary in the form of a pension, whereas, depending on their income, the average Social Security recipient collects between 29% and 36% of their final salary in the form of a retirement benefit. At age 65, the oldest age necessary to collect the full CalSTRS benefit, a CalSTRS retiree with 35 years experience will collect a retirement benefit equal to 84% of their final salary. At age 65 a Social Security recipient will collect a retirement benefit between 30% and 35% of their final salary.

The study then examined how much more a CalSTRS participant might have accumulated based on having 8.0% of their paycheck withheld vs. only 6.4% for a Social Security participant. For a CalSTRS paticipant retiring at age 65 with a final income of $80,000, the study estimated the value of this extra 1.6% in annual contributions to equal $138,502 after 35 years of withholding. This is equal to just over three years of the difference in the amount of a typical annual CalSTRS pension and a typical Social Security annual retirement benefit, i.e., it does not come close to closing the gap between the typical Social Security benefit vs the typical CalSTRS benefit.”

What these two points exemplify ought to be quite clear, and ought to be the topic of debate that relies on facts, logic and fairness, instead of competition to discredit the messengers – or their sources of funding: (1) Public sector pensions are not financially sustainable without major changes to contributions and benefit formulas, (2) Public sector pensions provide far more retirement security than Social Security, despite requiring comparable mandatory levels of withholding from employee paychecks.

Anyone who actually reads material from the Arnold Foundation will likely be impressed by the level of scholarship and objectivity they bring to their analyses. The open minded reader may wish to peruse this solution paper, “Creating a New Public Pension System,” authored by Arnold Foundation scholar Josh McGee, a Ph.D economist who has studied public pensions for many years.

Solving America’s public sector pension crisis, and it is a crisis, doesn’t necessarily require abandoning defined benefit plans. But they will have to be converted to “adjustable defined benefit” plans that can, for example, freeze COLAs, lower benefit formulas (at least) prospectively, and raise required employee contributions, whenever necessary, in order to preserve solvency, protect taxpayers, and spread the sacrifice among all participants – new hires, active veterans, and retirees – in order to minimize the sacrifice any single class of participants might have to experience.

Ultimately, what doesn’t pass the “smell test” is the alternative to reform: Increasing the tax burden on private sector workers and small business owners in order to subsidize public employee retirement plans that offer benefits many times better than Social Security.

Are America’s public sector pension plans financially sound, or are they are a rotting, stinking carcass, sprayed with public relations perfume and papered over with pretty ideological colors? Are they healthy financial contributors to America’s prosperity, victims of unwarranted attacks from “right-wing” ideologues, or are they an oppressive, inequitable, gargantuan, putrescent bubble that shall someday pop, pouring a reeking stench across the economic landscape of this nation?

That is the debate that ought to rage, focusing on facts, not pheromones.

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Ed Ring is the executive director of the California Public Policy Center

RELATED RECENT POSTS AND STUDIES

Comparing CalSTRS Pensions to Social Security Retirement Benefits, February 28, 2014

Pension Reform Comes to Ventura County, February 25, 2014

The Fall of Pacific Grove – Conclusion: The “California Rule” Cannot Stand, February 25, 2014

Pension Funds and the “Asset” Economy, February 18, 2014

How Much Do CalPERS Retirees Really Make?, February 13, 2013

How Does “Zero-point-Eight at Sixty-Eight” Sound for a Pension Plan?, February 11, 2014

Why Middle Class Private Sector Workers Are NOT “Ripping Off the Next Generation,” December 17, 2013

How Unions and Bankers Work Together to Protect Unsustainable Defined Benefits, November 26, 2013