The typical analysis of state and local government finances is that they are primarily a function of the economy. When the economy is growing well, and especially when it is growing faster than expected, local and state government finances prosper. When the economy grows, more people are employed and employees have larger paychecks. State income and sales tax revenues increase. Property tax receipts go up because the price of housing increases. Irrespective of government policies–whether of the right or the left–a “rising tide lifts all boats,” or at least all government boats. Historically, the state of the economy usually has driven government tax revenues in good times and bad.
The conventional analysis may be changing–and in a way that may lead to unanticipated fiscal shortfalls in many state and local government agencies even in the coming, 2019-20, fiscal year. The first problem is that the stock market is headed lower. Though historically local and state government budgets have been mostly influenced by the economy, now the stock market may play as large, if not a larger, role.
Every public employee pension fund in the United States is actuarially unsound. Within California, CalPERS, CalSTRS, and the many county public employee pension plans all project continuing, year in and year out, returns on investment of approximately 7%. This means that the stock market would have to double every 10 years for already underfunded public employee pension funds to remain able to pay their guaranteed benefits.
There is no way this is going to happen. The current projected actuarial return of 7% means that the stock market would have to be close to 100,000 in 2038 for pension funds to be able to pay their benefits, which is very unlikely. In the short run, the emerging bear market will require state and local pension funds to reduce their anticipated rates of return, and this will cause every government agency in the state to feel pain. A long-term diminishment in the return on investment of even one half of one percent has been estimated to cost state and local governments $5 to 10 billion per year. It is already projected–assuming an actuarial return of 7% per year on investments–that the cost of public employee retirement contributions will close to double for state and local agencies between now and 2024. If the rate of return declines as well, these costs will grow even higher.
But it gets worse. Among the elements of the federal tax reform act of 2017 was to cap the amount of a home mortgage the interest for which can be deducted at $750,000 (the amount previously had been $1 million). This makes home purchases above $750,000 effectively, after taxes, more expensive. Moreover, another aspect of the 2017 tax reform was to cap deduction of state and local taxes at $10,000, which also makes the effective cost of owning property more, since property taxes above this amount can no longer be deducted. Finally, although increasing interest rates affect all sectors of the economy, they may influence housing the most. Moreover, increased interest rates will also have a negative effect on real estate prices, thereby resulting in lower property tax revenues than projected.
There remains, finally, the overall state of the economy, apart from the stock market and real estate prices. Here, too, in large part as a result of increasing interest rates and the trade war and general instability fostered by President Trump, the rate of economic growth appears to be declining to about half of what it recently has been–from about three to three and a half percent annual growth to about one and a half to one and three quarters percent annual growth. This, too, will diminish local and state government income.
The days of fiscal wine and roses for local and state governments are over. Long term trends are finally catching up with state and local government spending and receipts. Reform of public employee pensions is long overdue and general tightening of government expenditures will also be required–starting in the 2019-20 fiscal year. Further increases in state and local taxes are unlikely in a diminishing economy.
Lanny Ebenstein teaches in the Department of Economics at UCSB. He is the author of the first biographies of Milton Friedman and Friedrich Hayek. His most recent book, Chicagonomics: The Evolution of Chicago Free Market Economics (2015), was an “Editors’ Choice Selection” in the New York Times Book Review.
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California pension funds take a bigger share of tax revenue than the national state average, a research website shows. Why the growing costs are outpacing the norm is not completely clear.
A prime suspect for some would be overly generous pensions, particularly what critics say is an “unsustainable” increase for police and firefighters widely adopted to match a big increase given the Highway Patrol by SB 400 in 1999.
The Public Pension Database does not have information on the formulas that determine pension amounts, like the Highway Patrol’s “3 at 50” or three percent of final pay for each year served at age 50.
One problem is the wide range of pension formulas, made even more complex by a recent national wave of cost-cutting reforms. Under a California reform three years ago, most new hires must pay more toward their pensions and work longer and retire at an older age to earn the same pension as workers hired before the reform.
“Trying to compare plan benefits in one state with another state has become complicated,” said Keith Brainard, research director for the National Association of State Retirement Administrators.
Brainard started the database now operated jointly by NASRA and the Center for Retirement Research at Boston College and the Center for State and Local Government Excellence.
Several web-based seminars have been held to show how the “big data” can be used by researchers, government officials, media, and others. Trends and patterns can be identified, comparisons made, and the findings displayed in charts.
A chart on the database shows the amount of tax revenue taken by California public pensions was slightly below the national average in 2001. Then from 2003 to 2005 the California pension tax bite climbed well above the national average, maintaining a gap that by 2013 was about a third higher.
In rough terms, the public pension share of California tax revenue in fiscal 2013 was 8 percent by fiscal 2013 compared to a national average of 6 percent.
In an interview, Brainard mentioned two factors for the above-average share of tax revenue taken by California pensions. Most California government workers, including teachers and many police and firefighters, do not receive Social Security.
Only 40 percent of state and local government employees in California receive Social Security, according to the database. The Social Security coverage in some other large states: New York 99 percent, Florida 95 percent, and Texas 47 percent.
The cost of using the federal Social Security program to provide part of the retirement benefit (6.2 percent of pay each from the employer and the employee) would not show in data about the share of tax revenue taken by state and local pensions.
Another factor: The period covered by the research begins around 2000 when the three big state pension funds were spending a “surplus” from a stock-market boom not only on increased benefits but on lower employer contributions.
The California Public Employees Retirement System, which covers about half of all non-federal government workers in the state, sponsored the retroactive SB 400 rate increase for all state workers and dropped employer rates to near zero in 1999 and 2000.
Then as the stock market dipped, CalPERS had to begin raising employer rates not only to cover pension increases (AB 616 in 2001 authorized a bargaining menu for local government employees) but also to regain funding lost by the big employer rate cuts.
In addition to CalPERS, the California plans in the database include the California State Teachers Retirement System, the University of California Retirement System, the Los Angeles County Employees Retirement Association, and 11 other local systems.
The data covers most of the public pension members in California, but far from all of the pension systems. An annual report from the state controller lists 131 separate California retirement systems, many of them relatively small.
California systems in the database, with two major exceptions, paid their full Annual Required Contribution (ARC) to cover the annual or “normal” cost of pensions earned each year and the large debt from previous years, the “unfunded liability.”
Debt often is created when pension fund investments, expected by big California funds to earn 7.5 percent a year, fall short of the target, which critics contend is overly optimistic. Among other factors that can create debt is longer than expected life spans.
The California State Teachers Retirement System is listed on the database as paying only 50.9 percent of the ARC in 2013. Unlike other systems, CalSTRS could not raise employer rates. Now long-delayed legislation two years ago to pay the full ARC will more than double school rates by 2020, cutting deep into budgets.
CalSTRS spent its small and brief “surplus” around 2000 on several benefit increases and rate cuts. The pension fund was shorted when a quarter of the teacher contribution, 2 percent of pay, was diverted for a decade into a supplemental 401(k)-style individual investment plan for teachers with a guaranteed minimum return.
Three years ago, a Milliman actuarial report said if CalSTRS had kept its 1990 structure without the rate and benefit changes around 2000, pensions would have been 88 percent funded instead of 67 percent. A much smaller rate increase could have closed the funding gap.
The UC Retirement Plan is listed on the database as paying 63.9 percent of the ARC. A large surplus prompted the plan to give employers and employees a remarkable two-decade contribution “holiday.”
Most made no payments to the UC pension fund from 1990 to 2010. The surplus, driven by investment returns and other factors, peaked with a 156 percent funding level in 2000.
As painful rates were set to resume in a time of tight budgets, a UC task force said in 2010 that if normal cost contributions had been made during the two decades, the system would have been 120 percent funded instead of 73 percent.
CalPERS has not calculated how much of its current funding gap results from the pension increases and rate cuts during the surplus years. But a CalPERS chart showed that SB 400 accounted for 18 percent of the state worker employer contribution increase between 1997 and 2014.
Nearly half of the state worker contribution increase, 46 percent, was due to investment gains and losses, demographic and actuarial changes, and higher employee contribution rates. Payroll increases accounted for 31 percent of the change.
Critics say the SB 400 “3 at 50” formula has the most impact in local government, where police and firefighters are a major part of the budget. The big cities (Los Angeles, San Francisco, San Diego, San Jose, and Oakland) have their own pension systems and are not in CalPERS.
Public pensions have not recovered from huge investment losses during the recession. The Center for Retirement Research reported last monththat the 160 plans in the Public Pension Database were 74 percent funded last year, 72 percent under new accounting rules.
The Center’s report showed that from 2001 to 2015 the CalPERS funding level dropped from 111.9 percent to 74.5 percent. During the same period, the CalSTRS funding level fell from 98 to 67 percent and UC funding plunged from 147.7 to 81.7 percent.
About the Author: Reporter Ed Mendel covered the Capitol in Sacramento for nearly three decades, most recently for the San Diego Union-Tribune. He is currently a Publisher for CalPensions.com.
For Immediate Release
June 2, 2016
California Policy Center
Contact: Will Swaim
SACRAMENTO — Californians may be accustomed to living with the specter of a public pension crisis. But the federal government’s problem with its retirement systems – including Social Security – is far worse, and yet none of the three remaining major-party candidates for president has a plan to do anything about it.
The California Policy Center offers “Comparing Federal and California State Retirement Exposures,” a comparison of California and federal exposure to pension liability. You can read Marc Joffe’s full study here.
Key findings include:
On Social Security
DEBT VS. ASSETS: “Although discussion of Social Security often revolves around the trust fund, this emphasis is misplaced. Unlike CalPERS or CalSTRS, the Social Security trust fund does not contain real assets. Instead, it holds special-issue U.S. Treasury bonds. Total federal assets of $3.2 trillion are easily exceeded by $13.2 trillion of federal debt securities held by the public and $8.2 trillion of other liabilities. So the IOUs held by the Social Security trust fund compete with claims held by many external parties for a relatively small pool of federal assets.”
IMPACT ON FEDERAL DEFICIT: Using projections from the Social Security Actuaries, Joffe reports that the Social Security program is expected to add $371 billion to the annual federal budget deficit (in constant 2015 dollars) by 2040. The Social Security Actuaries say that projecting higher costs (for example, an increase in life expectancy), adds $640 billion (again, in constant dollars) to the annual deficit.
On Federal Employee Retirement Programs
UNFUNDED LIABILITIES: “The Civil Service Retirement and Disability Fund, paid $81 billion of retirement benefits in fiscal year 2015, or 2.49% of federal revenues. The system reported an Unfunded Actuarial Liability of $804.3 billion and Assets of $858.6 billion, implying a funded ratio of only 51.6%.” The Defense Department also offers pensions, and its system is worse than the Civil Service program with a funded ratio of just 35%.
Washington has Bigger Problems – and More Powerful Financial Tools
Joffe concludes that the federal government has tools to deal with a public pension crisis that the states do not:
Constitutional: “In an emergency, Congress and the president can cut or even terminate benefits to Social Security recipients, federal civilian retirees or veterans. This is not the case for the state of California.”
Currency control: “A central government controlling an international reserve currency does have more fiscal flexibility than a state which is legally obligated to balance its budget each year. So the federal government’s ability to absorb pension obligations is greater than California’s. This is fortunate, because the federal governments exposure is so much greater.”
ABOUT THE AUTHOR
Study author Marc Joffe is the founder of Public Sector Credit Solutions and a policy analyst with the California Policy Center. Joffe founded Public Sector Credit Solutions in 2011 to educate policymakers, investors and citizens about government credit risk. PSCS research has been published by the California State Treasurer’s Office, the Mercatus Center and the Macdonald-Laurier Institute among others. Before starting PSCS, Marc was a senior director at Moody’s Analytics. He earned his MBA from New York University and his MPA from San Francisco State University.
ABOUT THE CALIFORNIA POLICY CENTER
The California Policy Center is a non-partisan public policy think tank providing information that elevates the public dialogue on vital issues facing Californians, with the goal of helping to foster constructive progress towards more equitable and sustainable management of California’s public institutions. Learn more at CaliforniaPolicyCenter.org.
“Pension-change advocates failed to find funding for a measure during the depths of the 2008 recession and the havoc it wreaked on government budgets, so they won’t pass (a measure) when the economy is doing well.”
– Steve Maviglio, political consultant and union coalition spokesperson, Sacramento Bee, January 18, 2016
It’s hard to argue with Mr. Maviglio’s logic. If the economy is healthy and the stock market is roaring, fixing the long-term financial challenges facing California’s state/local government employee pensions systems will not be a top political priority. But that doesn’t mean those challenges have gone away.
One of the biggest problems pension reformers face is communicating just how serious the problem is getting, and one of the biggest reasons for that is the lack of good financial information about California’s government worker pension systems.
The California State Controller used to release a “Public Retirement Systems Annual Report,” that consolidated all of California’s 80 independent state and local public employee pension systems into one set of financials, but they discontinued the practice in 2013. The most recent one issued, released in May, 2013, was itself almost two years behind with financial data – using FYE 6-30-2011 financial statements, and it was almost three years behind with actuarial data – used to report funding ratios – using FYE 6-30-2010 actuarial analysis. Now the state controller has created a “By the Numbers” website, but it’s hard to use and does not provide summaries.
No wonder it’s so easy to assert that nothing is wrong with California’s pension systems!
The best source of raw data on California’s pensions comes from the U.S. Census Bureau. Since that data is better than nothing, here are some critical areas where roughly accurate numbers can be reported.
(1) The Cash Flow, Money In vs. Money Out
What is the net cash flow of these pensions funds? How much are they collecting in contributions and how much are they distributing in pension benefits? This information, especially if it can be compiled over a period of years, determines whether or not pension funds are net buyers or sellers in the markets. The reason this matters is because if America’s pension funds, with over $4.0 trillion in assets, are net sellers, they put downward pressure on stock prices. They’re that big.
California State/Local Pension Funds Consolidated
2014 – Cash Flow
This cash flow (above) shows that during 2014, California’s state/local pension funds, combined, collected 30.1 billion from state and local agencies, and paid out $46.1 billion to pensioners. They are paying out 50% more than they’re taking in, and this is a relatively recent phenomenon. Historically, pension funds have been net buyers in the market. Now, pension funds across the U.S., along with retiring baby boomers, are sellers in the market. This is one reason it is difficult to be optimistic about securing a 7.5% average annual return in the future, despite historical results. And as for that healthy 15.4% return on investments in 2014? That was offset in 2015, when the markets were flat. It is also noteworthy that employee contributions of $8.9 billion are greatly exceeded by the $21.2 billion in employer (taxpayer) contributions. How many 401K recipients get a 2.5 to 1.0 matching from their employer?
(2) The Asset Distribution and Portfolio Risk
What is the asset distribution of these pension funds? How much have they invested in relatively risk free, fixed income bonds, vs. their investments in stocks and other variable return assets?
California State/Local Pension Funds Consolidated
2014 – Asset Distribution
This asset distribution table (above) indicates that the ratio of riskier, variable return investments to fixed return investments is nearly four-to-one. What if stocks fail to appreciate for a few years? What if real estate values don’t continue to soar? What if there simply aren’t enough high-yield investments out there to allow these assets, valued at a staggering $751 billion in 2014, to throw off a 7.5% annual return? This is a precarious situation. If these projected 7.5% returns were truly “risk free,” the ratios on this table would be reversed, with most of the money in fixed return investments.
(3) The Unfunded Liability and the “Catch-up” Payments
What is the amount of the unfunded liability for these pension funds? And of the total amount collected and invested each year in these funds, how much is the “unfunded contribution” – the amount allocated to pay down the unfunded liability and eventually restore the systems to 100% funding – and how much is the “normal contribution” – the amount required to fund future pension benefits just earned in that particular year by active workers?
This question, for which neither the State Controller, nor the U.S. Census Bureau, can provide timely and accurate answers, is the most complex and also the most important. While consolidated data is not readily obtainable for these variables, by assuming these pension systems, in aggregate, are officially recognized as 75% funded, we can compile useful data:
California State/Local Pension Funds Consolidated
2014 – Est. Required Unfunded Contribution
The above table estimates that at a 75% funded ratio, at the end of 2014 the total pension fund liabilities for all of California’s state and local government pension funds was just over $1.0 trillion, with unfunded liabilities at $250 billion. The middle portion of the table shows, using conventional formulas adopted by Moody’s investor services for analyzing public pensions, that if the annual rate-of-return projection is lowered to a slightly more realistic 6.5% (already being phased in by CalPERS), the unfunded liability jumps to $380.1 billion, and the funded ratio drops to 66%. For a detailed discussion of these formulas, refer to the California Policy Center study “A Method to Estimate the Pension Contribution and Pension Liability for Your City or County.”
The lower portion of the table spells out just how deep a hole California’s state and local public employee pension systems have dug for themselves. Using standard amortization formulas, and a quite lengthy 30 year payback term, at a 6.5% rate-of-return assumption, it would take a payment of $29.1 billion per year to return California’s pension funds to 100% funded status by 2046. Since the total payments into California’s pension funds – refer back to table 1 – were only 30.1 billion in 2014, it is pertinent to wonder just how much the normal contribution was, in aggregate, in 2014, vs. the unfunded contribution.
One promising pension transparency project is being directed by professors Joshua Rauh and Joe Nation via Stanford University’s Institute for Economic Policy Research. Their “Pension Tracker” website has already compiled an impressive body of data, especially useful at the local level. Hopefully they, or someone, will get eventually compile and present accurate data, both locally and statewide, not only showing cash flows, but differentiating between the normal contributions and the unfunded contributions.
In the absence of data, here’s a rough guess: Approximately 1.5 million active state and local government workers in California probably earned pension eligible income of at least $100 billion in 2014. If the “normal contribution” is 16% of payroll, that equates to $16 billion per year. This is a very conservative estimate.
Mr. Maviglio, and all of his colleagues who wish, like many of us, to save the defined benefit pension, are invited to explain how California’s pension systems will ever become healthy, if, best case, their required unfunded contribution is $29.1 billion per year, their required normal contribution is $16 billion per year, and the total payments actually being made per year are only $30.1 billion. That’s a shortfall of $15 billion per year.
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California was once the State that everyone looked up to. With the best weather and natural resources, we were full of hope and innovation. We had the best public schools, a world class system of higher education, the best freeways, infrastructure to provide fresh water to our growing population, which also doubled as a source of clean energy through hydro-electric power, a business-friendly environment where entire industries grew in entertainment, aerospace, and technology, making our economy virtually recession-proof.
Then in 1978, then-governor Jerry Brown signed an executive order that imposed union-shop collective bargaining on public agencies in California, and the rise of public sector union power began.
Today, public sector unions are the most powerful political force in our State. They control a majority of our State Legislature and might control a supermajority in November if a few swing districts fall their way. No politician, Democrat, Republican or Independent, acts without considering how it will affect the union agenda.
These government unions press 100% for a progressive agenda, and they consistently agitate for increased spending. In two areas, the quality of our public education system, and the financial health of our cities and counties, the consequences of government union power have been catastrophic.
The teachers’ unions, usually a local affiliate of the California Teachers Association, control most of our school boards, leading to control of our public schools. It is more than a coincidence that our public schools rank near the bottom in every category in the fifty United States.
As lobbyists for staff and teachers, who are paid to run our public schools, public sector unions fight to maintain the status quo. They protect incompetent teachers, they permit excellent teachers to be dismissed in layoffs, they actively oppose charter schools, they fight poor parents who try to employ Parent Trigger Laws, and they conduct an active campaign 24/7 against any form of school choice.
The financial power of teachers unions:
- There are over 266,255 public school teachers in California.
- Each pays at least $1,000 in union dues annually.
- The CTA acknowledges spending up to 40% of those dues explicitly on politics. That is $106 million per year.
- If the lawyers in Friedrichs are right—that all public union spending is political—the actual total is $266 million per year.
- Unions for non-teacher staff also are active. There are 215,000 school staff employees who are members of the CSEA (California State Employees Association), who each pay approximately $500 annually in dues. If all of those dues are spent on politics, that adds $107 million more for political spending annually.
- The total spent by public education unions alone is estimated to be $373 million per year – just in California.
Police and firefighter unions do the most damage at the local level. They have attained unsustainable pensions, known as “3%@50”, meaning that a member of that bargaining unit is eligible at age 50 for a pension equivalent to 3% of his highest salary times their number of years of service. While the age of eligibility has been raised for new public safety employees entering the workforce, the vast majority of active police and firefighters still retain these “3%@50” benefits. So at age 50, a 20-year veteran can retire with a pension equivalent to 60% of their highest year’s salary, which can be manipulated through spiking, and a 30-year veteran is eligible for 90% of his or her highest salary.
These pension requirements are held under the “California Rule” to be irreversible. In other words, once they have been adopted, democracy is incapable of turning off the spigot. With the spigot running constantly, communities go bankrupt. First, they cut other services. Then they increase taxes. Then they refuse to pay bondholders, so no one will invest again.
Current unfunded liabilities in California:
At CalPERS: $93.5 billion (ref. page 120, “Funding Progress,” CalPERS 6-30-2015 financial report).
At CalSTRS: $72.7 billion (ref. page 118, “Funding Progress,” CalSTRS 6-30-2015 financial report).
Local Unfunded Liabilities add considerably to this total, since CalPERS, with assets of $301 billion, and CalSTRS, with assets of $158 billion, only constitute 62% of California’s $752 billion in state and local pension fund assets. If all of these systems in aggregate were 75% funded, which is probably a best case estimate given the poor stock market performance since the official numbers were released, the total unfunded pension liabilities for California’s state and local government workers would be $256 billion.
And $256 billion in unfunded liabilities, a staggering amount, still understates the problem for two reasons: First, these pension funds may not succeed in securing a 7.5% average annual return in the coming decades. If not, then they will not earn enough interest to prevent their funding ratios from getting even worse. Also, this doesn’t take into account “OPEB,” or “other post employment benefits,” primarily health insurance. The unfunded OPEB liability just for Los Angeles County is officially recognized at over $30 billion.
A realistic estimate of the total unfunded liabilities for retirement obligations to state and local workers in California is easily in excess of $500 billion. These benefits, which are financially unsustainable and far more generous than the taxpayer funded benefits available to ordinary private sector workers, were forced upon local and state elected officials through the unchecked p0wer of government unions.
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Bob Loewen is the chairman of the California Policy Center.
Last month an article entitled “Pensions as Economic Stimulus” was posted to Fox & Hounds Daily. The author, Charles Beckwith, is a former CalPERS senior financial manager. Beckwith’s article, while thoughtful, invites a response. Because California’s pension systems may stimulate the economy in some ways, but equally significant ways, they are killing the economy.
Beckwith’s primary argument is this: California’s pension systems pay out over $3.0 billion per month to retired state and local government workers, who go out and spend this money, “at auto repair shops, home improvement centers, tuition for grandchildren, hair salons, rent, and at a thousand other small and large businesses.”
The problem with this reasoning rests on a fundamental assumption Beckwith makes, which is that all the money taken from taxpayers to fund these pension investments would not have created a similar economic stimulus if they had been free to spend it themselves. Mr. Beckwith goes on to extol the virtues of professional financial managers placing pension fund investments around the world, then pouring the returns back into California’s economy, but when he does this, he ignores the actual cash flows in and out of California’s state and local pension systems.
To dive deeper into the cash flows of California’s pension systems, unfortunately we must rely on the scandalously outdated, yet most recent available consolidated financial report for California’s pension systems, the Public Retirement Systems Annual Report for the fiscal year ended 6-30-2011, released over two years ago. But the proportions have probably not changed all that much in the last four years. And as can be seen on page xxii, figures 12 and 13, during that fiscal year taxpayers contributed $27.6 billion to California’s state and local government pension funds, and retirees collected $36.2 billion. This is a net benefit of $8.6 billion per year – IF you assume 100% of retirees still live in California.
A May 2015 analysis conducted by the Sacramento Bee on CalPERS retiree payments showed that 15% of their participants live outside California – if we assume that percentage is true for all California’s state and local government retirees, then that $36.2 billion shrinks to an in-state total of $30.8 billion. This more likely net benefit, $3.2 billion per year, represents a mere 0.14% of California’s $2.3 trillion economy.
That’s nothing, Mr. Beckwith. In the most recent year for which we have consolidated numbers, pension funds took $27.6 billion from taxpayers, then gave 30.8 billion back to retired government workers living in California. That’s $3.2 billion, net, that trickled down to private sector participants in an economy over 700 times larger.
With benefits come costs, and in this area, Beckwith, along with virtually every other defender of state and local government pensions, skirts the unpleasant realities. A California Policy Center study completed earlier this year, “California City Pension Burdens” used State Controller data to compile the employer pension contributions as a percent of total revenue from taxes and fees for every city in California. It estimated that pension fund contributions in 2015 for all California’s cities would amount to 6.9% of ALL revenue into those cities – including cities who run their own utilities – water, power, waste management. Equally significant, using figures provided by the pension systems, it showed that on average, these pension contributions would increase by 50% between now and 2020, to eventually constitute 10.3% of all revenues to California’s cities. These estimates do not take into account the current and projected funding for retirement healthcare, certain to add additional costs. Nor do they take into account the inadequate funded status of CalSTRS, or the many independent pension systems serving California’s counties, which are also supported by taxpayers in those cities.
In many cities, of course, pension burdens cost far more than 6.9% of all revenues. In San Jose, the total is 13.9% of all revenue. San Diego, 9.3%. And the already announced 50% increase to these employer pension contributions depends on a perilously weak assumption; that markets will continue to deliver 7.5% average annual returns on investment for the next several decades. Good luck with that.
At what percent of total revenue will everyone agree that funding public employee retirement benefits are “crowding out” other services and constitute the hidden agenda behind ALL proposed increases to taxes and fees? 10%? We’re already there. 20%? That’s reality already in many cities and counties. 30%? That’s where we’re headed.
Mr. Beckwith goes on to defend the defined benefit, writing that “the structure and strategy of a defined benefit plan cannot be debunked. It is a social benefit that should be available to all Americans in both private and public employment to assure a stronger American economy and social stability.” But he doesn’t explain what he means by “structure and strategy,” providing yet another frustrating example of why most reformers have given up on the defined benefit and almost universally advocate moving state and local workers onto individual 401K plans.
Constructive solutions to California’s state and local government worker defined benefit plans would include a “structure” that permits reductions to benefits – such as a suspension of retiree cost-of-living increases, or a reduction in rates of future annual benefit accruals – when market returns fail to meet expectations. And they might include a “strategy” that would return to the financially sustainable system that existed prior to Prop. 21, passed in 1984, which greatly loosened restrictions on investing in stocks, enabling much higher and much riskier rate-of-return projections, and before SB 400, passed in 1999, that started the process of retroactively increasing pension benefit formulas for what eventually became nearly all of California’s state and local government workers.
In an otherwise nuanced article, Beckwith’s one foray into demagogy was when he characterized investment setbacks as the result of the “Wall Street induced economic recession.” Because ever since Prop. 21 passed over 30 years ago, pension funds and “Wall Street” have been joined at the hip. When you’ve got nearly $4.0 trillion in state and local government pension funds chasing 7.5% annual returns, with no consequences other than to cut services and increase taxes to cover your shortfalls, you are indelibly part of the problem with financial special interests in America.
Pensions as they are today, Mr. Beckwith, are an economic burden to everyone in California who doesn’t have one, but has to pay for it anyway.
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Author’s Note: The original title of this post was “CalSTRS CEO Jack Ehnes Recommends 50% Increase to CalSTRS Pension Benefits.” That was inaccurate. What Ehne’s specifically recommended per the quote immediately below this note was “income replacement of 80 percent to 90 percent to maintain a similar lifestyle in retirement,” in reference to his assertion that presently “the median CalSTRS pension replaced less than 60 percent of final salary for the members who retired last year.” To be perfectly accurate, Ehnes’ is recommending a 50% increase in CalSTRS participant retirement income. While he does not specifically recommend increasing their pension benefit by 50%, in order for teachers to achieve a 50% increase in their retirement income, either some other employer paid form of compensation would have to increase – for example, supplemental 401Ks, fed by either greater teacher salaries or greater employer matching, or both, or something else – or teachers would have to live more frugally in order to save more retirement funds on their own without an increase to compensation. Which is it? While this note constitutes a retraction of the original title, and the author apologizes for the misconceptions that resulted, it is still necessary to wonder why pension fund executives are suggesting that 60% income replacement for a public servant is inadequate, when private citizens may consider themselves extraordinarily lucky to secure a retirement income anywhere close to that amount.
“The median CalSTRS pension replaced less than 60 percent of final salary for the members who retired last year. CalSTRS recommends income replacement of 80 percent to 90 percent to maintain a similar lifestyle in retirement. Public educators do not receive Social Security benefits for their CalSTRS service.”
– Jack Ehnes, Chief Executive Officer, CalSTRS, Introduction to CalSTRS Comprehensive Annual Financial Report 2014, page 11)
Here we go again – a recommendation for another 50% pension benefit increase. Will it be retroactive this time? That went well last time. Remember SB 400, quietly passed for CHP officers during a robust bull market in 1999, and by 2005 rolled out to nearly every state/local agency in California? No consequences whatsoever.
And, here we go again – somehow getting a CalSTRS pension instead of Social Security is a monstrous sacrifice!
Social Security recipients making roughly what veteran teachers make can expect to receive a benefit at age 68 that is roughly equivalent to 25% of their final year’s earnings. Twenty-five percent. The average teacher receives 2.5 times that much each year via their pension, starting about seven years earlier. Mr. Ehnes thinks that’s not enough. He ought to know better. If every Californian retiree got a pension equivalent to what a CalSTRS recipient currently gets, it would cost over $600 billion per year. Where’s that money going to come from, Mr. Ehnes?
There’s a lot to chew on for anyone trying to wade through CalSTRS most recent publicly available annual financial report. This additional gem, also coming from Mr. Ehnes himself, illustrates just how out of touch the pension bureaucrats have become:
“The funding approach in AB 1469 is predicated on the actuarial assumption that CalSTRS will earn a 7.5 percent annual rate of return throughout the life of the plan.” (CalSTRS 2014 CAFR, page 8)
Jack Ehnes is referring to California Assembly Bill 1469, passed in May 2014, which will phase in massive contribution rate increases over the next several years, mostly from taxpayers, so that CalSTRS will be fully funded by around 2047. That is, in exchange for even higher contributions from taxpayers, CalSTRS will get its financial house in order “in about 32 years.”
But what if “throughout the life of the plan,” CalSTRS is unable to earn a 7.5 percent annual rate of return? Does it matter at all that recently reported gains were logged during this latest bull market that’s running out of steam? Will even more massive contribution rate increases be the solution? According to the most recent data available, CalPERS is currently $73 billion in the hole, or only 67% funded. (CalSTRS 2014 CAFR, page 158)
The problem with seasoned financial professionals like Jack Ehnes fostering expectations like this – bull market returns of 7.5% for the next 32 years, and pensions for teachers that need to elevate from the current 60% of salary to “80 per cent to 90 percent” of salary, is that people who aren’t financial professionals actually believe them.
From professional government union supported PR firms, to the rank-and-file workers they assist to prepare op-eds, unrealistic expectations from people like Jack Ehnes are packaged into propaganda designed to destroy public support for pension reform.
For an example of this, look no further than the August 22 guest op-ed in the Sacramento Bee, “Another View: State pension funds are recovering,” purportedly written by Lydia Petitjean, a public school secretary and CSEA union official. Pettijean’s lead sentence is pure propaganda:
“Perhaps an oil slick is clouding the crystal ball of Stephen Eide of the Koch brothers-funded Manhattan Institute when he suggests that the effort to undermine the retirement security of millions of Californians – disguised as ‘pension reform’ – is gaining steam.”
This is sophomoric trash talk. It is vacuous, cynical drivel. The Manhattan Institute is a respected organization, Stephen Eide is a policy analyst with unimpeachable integrity and proven financial acumen, the Koch Bros have little if anything to do with the Manhattan Institute, and “oil slicks” is an image calculated to elicit disgust, but has nothing to do with pension reform. Nothing.
Anti-reformers like Lydia Petitjean base much of their rhetoric on a false premise – that big moneyed “Wall Street” special interests would like get their hands on all that pension money. This is patently false. As it is, the finance industry benefits immensely from government pension funds, because they have an enormous amount of money already invested on Wall Street – $4.0 trillion in assets nationwide. The pension funds relentlessly advocate, and then manage, benefit plans so generous that they are forced to invest in high-risk, high-return financial instruments that the financial industry is all to happy to invent and sell to them. Even better, when they don’t hit their numbers, the taxpayers bail them out. And even if every government worker’s defined benefit plan was converted to a 401K tomorrow, the same pension systems, CalSTRS and CalPERS and all the rest, would still be the administrators.
There’s nothing there, Ms. Petitjean. Not even “oil slicks.”
The reality is maybe pension reformers just want to prevent the pension systems and their government union allies from running every city and county in California into the ground.
Sooner or later, if public employees hope to keep their defined benefit pensions, they will have to accept lower benefit formulas. When the next market downturn hits, and it will, people like Jack Ehnes will have a lot of explaining to do, and people like Lydia Petitjean will have to make a tough decision:
Do they want to become oppressors of the private sector taxpayer in partnership with some of the most aggressive financial predators in the world, so they can enjoy retirement benefits several times better than Social Security recipients? Or do they want to share the same economic challenges as the people they supposedly serve, and work towards feasible solutions to retirement security in America for everyone?
* * *
CALIFORNIA POLICY CENTER PENSION STUDIES
California City Pension Burdens, February 2015
Evaluating Public Safety Pensions in California, April 25, 2014
How Much Do CalSTRS Retirees Really Make?, March 2014
Comparing CalSTRS Pensions to Social Security Retirement Benefits, February 27, 2014
How Much Do CalPERS Retirees Really Make?, February 2014
Are Annual Contributions Into CalSTRS Adequate?, November 2013
A Pension Analysis Tool for Everyone, April 2012
“The six-year bull market is admittedly long in the tooth.”
CalSTRS Chief Investment Officer Chris Ailman, Sacramento Bee, July 17, 2015
If what Mr. Ailman really means is equity investments may not be turning in double digit returns any more, that makes the recent performance of CalSTRS and CalPERS all the more troubling. Because according to their most recent financial statements, CalSTRS only earned 4.8% last year, and CalPERS only earned 2.4%. That leaves CalSTRS 68.5% funded, and CalPERS 77% funded.
Are we at the top of a bull market? Take a look at this chart:
S&P 500, Last Twenty Years Through June 21, 2015
The S&P index, which reflects U.S. equity trends reasonably well, enjoyed a five year bull market that crested in mid-2000, then another one that ran five years from September 2002 to October 2007, then this current bull market, which began 6.5 years ago. The bull market ending in September 2000 saw a 170% rise in the S&P, the one that peaked in October 2007 rose 90%, and this current one has yielded a 188% rise. So far.
Is today’s bull market “long in the tooth”? It sure looks that way.
There’s more to this, however, than the new reality of globalized, largely automated equity trading that condemns stock indexes to unprecedented volatility – or the graphically obvious fact that we’re at another peak.
There’s something stock traders call “fundamentals,” in this case creating economic headwinds that all the high-frequency trading and hedges in the world can’t avoid. About the same time that CalSTRS and CalPERS announced they missed their earnings targets, Reuters published this: “Calpers chief looks to cut volatility as fund enters negative cash-flow era.”
In plain English, this “negative cash-flow era” means that CalPERS has crossed a big line financially. They are now going to be selling more investments each year than they buy. They are going to be net sellers in the markets. While the superficial explanation for this is “baby boomer retirements,” that is incorrect. Government staffing is not directly driven by population demographics. In government, new hires replace retirees and headcounts trend upward. The real reason CalPERS is entering a negative cash flow era is because the retroactive pension benefit enhancements that started in 1999 and rolled through agency after agency for the next six years or so are now translating into large numbers of people retiring with these enhanced pensions, replacing earlier retirees who had modest pensions. Meanwhile, new hires are, increasingly, accepting more realistic reduced retirement promises, and paying proportionately less into the funds.
If CalPERS were the only pension fund becoming a net seller in the market, it wouldn’t really matter. But all the major pension funds, everywhere, are becoming net sellers. That’s nearly $4.0 trillion in assets under management in the U.S. that suddenly are shedding assets faster than they’re acquiring them. When supply rises, prices drop. This is a headwind.
There are other headwinds. If government staffing doesn’t directly reflect population demographics, the general population obviously does. Between 1980 and 2030 the percentage of Americans over 65 will rise from 11% to 22% of the total population. And ALL of these seniors will be net sellers of assets.
If that weren’t enough, there is the small matter of the United States – along with most of the rest of the world – arguably in the terminal phase of a long-term credit cycle. Total market debt as a percentage of GDP in the United States is over 300%, higher than it was in 1929. When interest rates fall to zero, playing the debt card to stimulate economic growth doesn’t work anymore. And when interest rates rise, asset values fall and debt service becomes untenable. We’ve painted ourselves into an economic corner.
In the face of this reality, unconcerned and all-powerful, the government union band plays on. Today the Los Angeles based City Watch published an early version of what will become an irresistible torrent of propaganda opposing the proposed Reed/DeMaio pension reform initiative. The title says it all “Measure of Deception: Initiative Would Gut Retirement Benefits for Millions of Californians.”
Take a look at the average full career CalPERS pension per former employer. Bear in mind the average public sector retirement age is 61, and that the average Social Security benefit is around $15,000 per year. Is there no middle ground between “gutting” and restoring financial sustainability?
Restoring pension systems to financial sustainability in the face of economic headwinds will require two major changes in policy. First, pension benefit plans would need to change in the following ways: (1) Increase employee contributions, (2) Lower benefit formulas, (3) Increase the age of eligibility, (4) Calculate the benefit based on lifetime average earnings instead of the final few years, and (5) Structure progressive formulas so the more participants make, the lower their actual return on investment is in the form of a pension benefit. Finally, enroll all active public employees in Social Security, which would not only improve the financial health of the Social Security System, but would begin to align public and private workers to share the same sets of incentives. Taking these steps will repair the damage caused by SB 400 in 1999, which set the precedent for retroactive pension benefit increases.
Second, completely change the investment strategy of public pension systems to return to lower risk investments. Along with choosing, say, high-grade corporate bonds over global hedge funds, these lower risk investments could include investment in revenue producing civil infrastructure. A thoughtful article recently published in Governing, “How Public Pensions Are Getting Smart About Infrastructure,” explores this possibility. Not only would massive investment by pension funds in revenue producing infrastructure create millions of jobs, repair neglected public assets, and constitute a low risk investment, over their life-cycle many of these projects actually produce excellent returns. Moving to lower risk investments will repair the damage caused by Prop. 21, narrowly passed in 1984, that “deleted constitutional restrictions and limitations on the purchase of corporate stock by public retirement systems.”
Given the financial headwinds they face, it is going to take courage and creativity to save defined benefits for public sector workers. But depending on what direction these reforms take, they have the potential to greatly benefit the overall economy.
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CALIFORNIA POLICY CENTER PENSION STUDIES
California City Pension Burdens, February 2015
Evaluating Public Safety Pensions in California, April 25, 2014
How Much Do CalSTRS Retirees Really Make?, March 2014
Comparing CalSTRS Pensions to Social Security Retirement Benefits, February 27, 2014
How Much Do CalPERS Retirees Really Make?, February 2014
Are Annual Contributions Into CalSTRS Adequate?, November 2013
A Pension Analysis Tool for Everyone, April 2012
“Our demands, they’re not radical. When did it become radical to have class sizes that you could actually teach in? When did it become radical to have staffing and to pay people back after eight years of nothing?”
– Alex Caputo Pearl, President, UTLA, February 26, 2015, Los Angeles Times
If the 35,000 members of the United Teachers Los Angeles, the union that represents employees of Los Angeles Unified School District, actually go on strike, in large part it will be because they want an 8.5% salary increase and the district is only offering them 5%. They also want smaller class sizes – tough to do when you’re passing out salary increases. But how much do these teachers actually make?
If you review the most authoritative source of public information on LAUSD salaries, the California state controller’s public pay website you will get the impression they aren’t making much. The summary page for LAUSD shows “average wages” of $40,506 per year and employer paid “average retirement and health” benefits at $10,867 per year.
This is extremely misleading. These “averages” include part-time workers such as student teachers and substitute teachers. But the “Raw Export” tab of the state controller’s website yields more comprehensive information.
If you eliminate part-time workers and eliminate workers who were hired or left employment mid-year – based on screening out of the data any individual record where the recorded “base pay” is 10% or more less than the stated “minimum pay for position” for that record – a very different compensation profile emerges. In reality, teachers who worked full-time during 2013 for the LA Unified School District made direct pay that averaged $72,781, and they collected employer paid benefits averaging $17,012, meaning their total pay and benefits package was $89,793. And they collected this in return for working between 163 and 180 days per year (ref. UTLA/LAUSD Labor Agreement, page 30).
Properly estimating how much LAUSD teachers make, however, requires at least two important additional calculations, (1), normalizing their pay to take into account their extraordinary quantity of vacation time, and (2) taking into account the state of California’s direct payments into CalSTRS as well as the necessity to increase CalSTRS contributions in order to pay down their unfunded liability.
Normalizing for vacation time is easy. Using the larger number referenced in their labor agreement, 180 days per year of work, based on 260 weekdays per year, means LAUSD teachers work 36 weeks a year and get 16 weeks off. The typical private sector worker rarely gets more than four weeks off, two weeks of vacation and two weeks of paid holidays. While many professionals earn more than two weeks of vacation, they are also required to be perpetually on call and often work far more than 40 hour weeks. Many entry level or low income workers don’t get paid for any holidays or vacation. It is reasonable to assume the typical teacher works 12 weeks less per year than the average private sector worker. This translates into a $24,260 value on top of the average LAUSD teacher’s direct pay of $72,781 per year.
“Eight years of nothing.” Really, Mr. Caputo Pearl?
Normalizing for the value of pensions is not easy, but using similarly conservative assumptions we can develop reasonable estimates. For starters, from the CalSTRS website, here’s what the state contributes:
“The state contributes a percentage of the annual earnings of all members to the Defined Benefit Program. Under the new funding plan, the state’s contribution is increasing over the next three years from 3.041 percent in 2013–14 to 6.328 percent beginning July 1, 2016. The state also contributes an amount equal to about 2.5 percent of annual member earnings into the CalSTRS Supplemental Benefit Maintenance Account. The SBMA account is used to maintain the purchasing power of benefits.”
Sticking with current contributions – 3.041% plus 2.5%, based on “member earnings” referring to “direct pay,” that adds another $4,033 to the average earnings of an LAUSD teacher.
In summary, LAUSD teachers are threatening to strike because they only make – using real world equivalents – $97,041 in direct pay, plus $21,045 in employer paid benefits. The average full-time LAUSD teacher earns total compensation worth $118,086 per year. Throw onto direct pay the 5% offer from the district, worth another $4,852 per year, and you have a total average teacher compensation proposed to go up to $122,938 per year.
Any critic of this analysis who happens to be an LAUSD teacher is invited to work 48 weeks a year instead of 36 weeks a year, or, of course, give up their pension benefit. Otherwise, these are the numbers. To verify them, download this spreadsheet analysis which uses payroll and benefit data provided by LAUSD to the California State Controller’s office: LAUSD_2013_Compensation-Analysis.xlsx (10.0 MB).
No reasonable person should fail to sympathize with the challenges facing teachers in Los Angeles public schools. But the solution is not higher pay. The solution is to purge the system of bad teachers, reward excellent teachers, give principals more autonomy, stop promoting and retaining teachers based on seniority, measure teacher effectiveness based on the academic success of their pupils, and, gasp, improve the ratio of teachers to support staff. As it is, during 2013 LAUSD spent $2.6 billion on full-time and part-time teachers, and $2.1 billion on full-time and part-time other staff. Do they really need to spend 45% of their payroll outside the classroom? The solution is also to lower the cost of living for everyone, through supporting government policies that encourage competitive development of land and resources.
Finally, this estimate of the value of average total compensation for LAUSD full time teachers is still dramatically understated, because CalSTRS remains wallowed in an underfunded position that is officially recognized at $73.7 billion.
To the extent the leadership of the UTLA and their membership subscribe to “left wing” political sentiments, remember this:
There are currently $4.0 trillion of state/local U.S. government worker pension fund assets overseen by managers who rampage about the entire planet demanding annual yields north of 7.0% per year. This is a financial maelstrom of cataclysmic proportions that is corrupting the entire global economy. It is an act of wanton aggression against honest capitalists and private households attempting to save for retirement. Ongoing annual returns of this size require asset bubbles which require risky investments and cheap credit – antithetical to sustainable economic growth.
Remember this as you fight to enhance your compensation and defend your pensions as they are – you have exempted yourself from economic reality and are recklessly gambling with the future of the people you supposedly serve. Through your pension funds, you are benefiting from capitalism in its most aggressive and parasitic form.
Remember all this when you go on strike because you’ve had “eight years of nothing.”
* * *
“Calpers argued that the California constitution’s guarantee of contracts shielded pensions from cuts in bankruptcy. The fund also asserted sovereign immunity and police powers as an ‘arm of the state,’ including a lien on municipal assets.”
– Wall Street Journal Editorial, “Calpers Gets Schooled,” February 8, 2015
If you want powerful evidence of crony capitalism at its worst, look no further. In the Stockton bankruptcy trial, the pension fund serving that city’s employees threatened to seize municipal assets to pay pension fund contributions. They’ve made similar threats to other cities that protest against the escalating contribution rates. And they’ve made the cost to exit pension plans confiscatory. It is hard to imagine a bigger or more blatant example of collusion between business interests and government employees at the expense of ordinary private citizens.
In the Stockton bankruptcy case, judge Christopher Klein’s ruling left pensions untouched, but at least the judge was openly disgusted with CalPERS, stating “CalPERS has bullied its way about in this case with an iron fist insisting that it and the municipal pensions it services are inviolable. The bully may have an iron fist, but it also turns out to have a glass jaw.” (ref. San Jose Mercury Editorial, February 18, 2015)
Much has been made of the CalPERS’ “glass jaw,” referring to Klein’s contention that cities do have the legal right in bankruptcy to reduce pensions – even though he did not allow pension benefit reductions in this case. But there is another “glass jaw” facing CalPERS and all pension funds, the biggest “glass jaw” of all. They rely on annual returns of 7.5% per year to stay solvent, and as a result, sooner or later, the investment markets are going to deliver these funds a knockout punch.
Professional investors claim they can always beat returns of 7.5% per year, and many of them can. But public sector pension funds control over $4.0 trillion in assets, which makes them too big to beat the market. And the idea, courtesy of pension fund managers, that the investment market can deliver a long-term average return of 7.5% per year implies that 7.5% per year is a “risk free” rate.
For a quick reality check, here are the “risk free” rates of return currently available to investors in the United States:
- Citigroup Pension Liability Index (recommended by Moody’s for pension funds) = 3.48%
- U.S. Corporate Bonds = 2.98%
- U.S. Treasury Bond, 30 Year = 2.59%
- Bank Certificate of Deposit, 5 Year = 2.25%
- U.S. Treasury Bond, 10 Year = 1.97%
Even in the cases where cities failed to make some of their annual pension payments, the financial impact was trivial compared to the primary cause of insolvency, which is that pension funds are not required to make “risk free” investments that are actually risk free. Because if they did, they would project low single digit annual rates of return instead of high single digit annual rates of return. It’s that simple.
A little over one year ago, the California Policy Center released a study “Are Annual Contributions Into CalSTRS Adequate?,” which utilized formulas provided by Moody’s investor services for that purpose. Using those formulas, the following table shows how lower rates of return impact CalSTRS:
Impact of Lower Rates of Return on CalSTRS
Based on 6-30-2012 Financial Statements, $ = Billions
Just in case this is all merely abstruse gobbledegook that savvy political consultants recommend politicians avoid since nobody understands it anyway, pay particular attention to the columns on the far left and far right. The left column’s top row shows the official rate of return used by CalSTRS, 7.5%, and the right column’s top row shows how much they should contribute each year based on that official rate of return. Never mind that CalSTRS, like nearly all pension systems, uses creative accounting to avoid making an adequate payment to reduce their unfunded liability. In FYE 6-30-2012, for example, CalSTRS only made an unfunded contribution of $1.1 billion, not $7.0 billion (column five, top row) which would have represented a responsible payment against their unfunded liability.
It’s worth noting that for CalPERS, we can’t even get data on how they break out their normal contributions and their unfunded contributions because doing so would require sifting through the financials of every one of their participating entities. But there is nothing uniquely troubling about CalSTRS. As calculated in a more recent California Policy Center study, released last week “California City Pension Burdens,” in 2014 all state and local government pension funds in California, on average, were only 75% funded.
Imagine what would happen if CalSTRS had to pay $25 billion per year (column six, row five), instead of what they actually paid in 2012, $5.8 billion? Replicate these methods with nearly any pension fund in California, and you will almost always get similar results. And anyone who thinks a rate of return of 3.5% (column one, row five) is overly pessimistic should refer to the actual “risk free” rates of return shown in the previous bullet points. Better yet, consider this: The federal funds lending rate today, the amount the federal reserve charges to banks, is 0.25% – that’s one-quarter of one percent. This is free money. That money is essentially being given to banks rates to turn around and loan at very low rates to corporations and consumers who use the cheap credit to buy things which, temporarily, stimulates the economy which causes asset values to rise – we are repeating 2008 all over again.
Pension funds depend on continuously expanding debt fueled asset bubbles for solvency. That is how they earn high returns that are anything but “risk free.” That is their glass jaw. Hopefully, when the bubbles pop and the glass jaws shatter, as an “arm of the state,” with “police powers,” CalPERS, CalSTRS, and every other pension fund in California won’t seize every municipal asset we’ve got and impose genuinely punitive taxes, so they can keep on paying those benefits.
* * *
More Taxes and Tuition Buy Time for the Pension Bubble, November 25, 2014
The Amazing, Obscure, Complicated and Gigantic Pension Loophole, November 18, 2014
Public Pension Solvency Requires Asset Bubbles, April 29, 2014
Add ALL Public Workers to Social Security, March 25, 2014
Pension Funds and the “Asset” Economy, February 18, 2014
Unions and Bankers Work Together to Protect Unsustainable Defined Benefits, November 26, 2013
A Member of the Unionized Government Elite Attacks the CPC, November 19, 2013
Adjustable Pension Plans, April 16, 2013
“As the result of California Courts refusing to uphold the language of the High Speed Rail bonds, the opponents of any bond proposal, at either the state or local level, need only point to High-Speed Rail to remind voters that promises in a voter approved bond proposal are meaningless and unenforceable.”
– Jon Coupal, October 26, 2014, HJTA California Commentary
If that isn’t plain enough – here’s a restatement: California’s politicians can ask voters to approve bonds, announcing the funds will be used for a specific purpose, then they can turn around and do anything they want with the money. And while there’s been a lot of coverage and debate over big statewide bond votes, the real money is in the countless local bond issues that collectively now encumber California’s taxpayers with well over $250 billion in debt.
Over the past few weeks we’ve tried to point out that local tax increases – 166 of them on the November 4th ballot at last count, tend to be calibrated to raise an amount of new tax revenue that, in too many cases, are suspiciously equal to the amount that pension contributions are going to be raised over the next few years. For three detailed examples of how local tax increases will roughly equal the impending increases to required pension contributions, read about Stanton, Palo Alto, and Watsonville‘s local tax proposals. It is impossible to analyze them all.
As taxes increase, money remains fungible. More money, more options. They can say it’s for anything they want. And apparently, bonds are no better.
At last count, there are 118 local bond measures on the November ballot. And not including three school districts in Fresno County for which the researchers at CalTax are “awaiting more information,” these bonds, collectively, propose $12.4 billion in new debt for California taxpayers. All but six of these bond proposals (representing $112 million) are for schools. Refer to the list from CalTax to read a summary of what each of these bonds are for – “school improvements,” “replace leaky roofs,” “repair restrooms,” “repair gas/sewer lines,” “upgrade wiring,” “renovate classrooms,” “make repairs.”
To be fair, there are plenty of examples of new capital investment, “construct a new high school,” for example, but they represent a small fraction of the stated intents. On November 4th, Californians are being asked to borrow another $12.3 billion to shore up their public school system. They are being asked to pile another $12.3 billion onto over $250 billion of existing local government debt, along with additional hundreds of billions in unfunded retirement obligations for state and local government workers. They are being asked to borrow another $12.3 billion in order to do deferred maintenance. We are borrowing money to fix leaky roofs and repair restrooms and sewers. This is a scandal, because for the past 2-3 decades, California’s educational system has been ran for the benefit of unionized educators and unionized construction contractors who work in league with financial firms whose sales tactics and terms of lending would make sharks on Wall Street blush. These special interests have wasted taxpayers money and wasted the educations of millions of children. Their solution? Ask for more money.
Nobody should suggest that California’s public schools don’t require investment and upgrades. But before borrowing more money on the shoulders of taxpayers, why aren’t alternatives considered? Why aren’t educators clamoring for reforms that would cut back on the ratio of administrators to teachers? Why aren’t they admitting that project labor agreements raise the cost to taxpayers for all capital investments and upgrades, and doing something about it? If their primary motivation is the interests of students, why aren’t they supporting the Vergara ruling that, if enforced, will improve the quality of teachers in the classroom at no additional cost? Why aren’t they embracing charter schools, institutions whose survival is tied to their ability to produce superior educational outcomes for far less money? Why don’t they question more of these “upgrade” projects? Is it absolutely necessary to carpet every field in artificial turf, a solution that is not only expensive but causes far more injuries to student athletes? Is it necessary to spend tens of millions per school on solar power systems? Does every high school really need a new theater, or science lab? Or do they just need fewer administrators, and better teachers?
And to acknowledge the biggest, sickest elephant in the room – that massive, teetering colossus called CalSTRS, should teachers, who only spend 180 days per year actually teaching, really be entitled to pensions that equal 75% of their final salary after only 30 years, in exchange for salary withholding that barely exceeds what private employees pay into Social Security? Thanks to unreformed pensions, how many billions in school maintenance money ended up getting invested by CalSTRS in Mumbai, Shanghai, Jakarta, or other business-friendly regions?
How much money would be saved if all these tough reforms were enacted? More importantly, how much would we improve the ability of our public schools to educate the next generation of Californians? Would we still have to borrow another $12.3 billion?
Here’s an excerpt from an online post promoting one of California’s local school bond measures: “It will help student academic performance, along with ensuring our property values. If you believe that strong schools and strong communities go hand in hand, please vote…”
Unfortunately, such promises are meaningless and unenforceable. The debt is forever.
* * *
“CalSTRS has a $70-plus-billion unfunded liability – even with assumed investment earnings that Brown deems ‘highly unlikely’ – and says it needs about $5 billion more a year to regain solvency.”
– Dan Walters column, “Brown budget reflects state’s massive debt,” May 25, 2014, Sacramento Bee
Those “investment earnings” that Walters quotes Brown as finding “highly unlikely,” refer to the long-term annual return on investment projection of 7.5% used by CalPERS (ref. FYE 6-30-2013 CalSTRS Annual Report, page 29).
So what happens if investment earnings generated by CalSTRS are destined to, as even California’s union-friendly Governor Brown attests, achieve more “likely,” lower returns? In November 2013, using data from CalSTRS FYE 6-30-2012 Annual Report, the California Policy Center released a study “Are Annual Contributions Into CalSTRS Adequate?,” that examined this question.
The first objective of this study was to calculate how much CalSTRS was actually paying down on their unfunded liability. Here’s what it found:
“For the fiscal year ended 6-30-2012 the California State Teachers Retirement System, CalSTRS, collected $5.8 billion. Of this $5.8 billion, $4.7 billion was the normal contribution and the remaining $1.1 billion was a ‘catch-up’ payment to reduce the unfunded liability, which as of 6-30-2012 was officially estimated to be $71.0 billion.”
Based on these numbers, which are all pulled directly from CalSTRS official disclosures, it should come as no surprise that Gov. Brown’s CalSTRS bailout plan requires annual contributions into CalSTRS to double. When you are paying down mortgage of $71 billion – the imperfect analogy that nonetheless applies quite accurately in this context – and in a given year you only pay $1.1 billion (one seventieth), you will never pay off your mortgage. Rather, you will incur negative amortization, owing more every year.
Where will this money come from?
To put this challenge in perspective, it is relevant to note just what CalSTRS retirees are getting. According to 2012 data provided by CalSTRS, as summarized in a March 2014 California Policy Center study “How Much Do CalSTRS Retirees Really Make?,” the average CalSTRS employee after a 30 year career currently retires with a pension of $51,500 per year; their average retirement age is 62. How many private sector employees can work 180 days a year for 30 years and retire with a guaranteed annuity this big – including annual cost-of-living adjustments? The conventional wisdom of retirement planners is to save approximately 25 times the amount you intend to eventually withdraw each year to live on. That’s $1.3 million. How many people can work 180 days a year for 30 years and save $1.3 million?
The idea that CalSTRS participants can save this much money via their 8.25% payroll withholding is ludicrous. And the idea that contributing 8.25% to CalSTRS vs. 6.4% to Social Security justifies a pension benefit this much higher than what participants can expect from Social Security is equally unfounded. Here is the conclusion of a February 2014 California Policy Center 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 CalSTRS bailout – and it is a bailout – will cost California’s taxpayers an additional $5.0 billion per year, and only if, as Governor Brown says, the “highly unlikely” average returns of 7.5% per year are realized. But as documented in the aforementioned study “Are Annual Contributions Into CalSTRS Adequate?,” using a 20 year payback period, here’s what lower rates of return mean for California’s taxpayers:
- At 7.5% per year, unfunded contribution = $7.0 billion per year (increase of $5.9 billion over what was actually paid).
- At 6.2% per year, unfunded contribution = $9.6 billion per year.
- At 4.8%, unfunded contribution = $12.2 billion per year.
The 20 year amortization period, recommended by Moody’s investor services, used in the study, resulted in an estimate $900 million over the latest figures from Governor Brown. This minor discrepancy validates these calculations more than anything else – they probably used a 30 year payback period. Fine. Let’s continue.
- At 7.5% per year, the normal contribution necessary to CalPERS, i.e., not the “catch up” payment on the underfunding of prior years, but just the payment necessary to cover future pensions earned in each most recent year, is $4.7 billion per year.
- At 6.2% per year, the normal contribution = $5.8 billion per year.
- At 4.8%, the normal contribution = $7.2 billion per year.
To summarize: In the FYE 6-30-2012 CalPERS, assuming a long-term return of 7.5% per year, received contributions (normal and unfunded) of $5.8 billion; they should have collected total contributions of $11.7 billion ($10.7 billion using Brown’s numbers). But if their rate of return going forward drops to 6.2% per year, they would have had to collect $15.4 billion. Got that? If the highly unlikely 7.5% average annual return isn’t realized, and only 6.2% is realized instead, taxpayers will pitch in nearly $10 billion more per year, just to bail out CalSTRS.
The money is not there.
And why is the 7.5% return “highly unlikely?”
(1) Pension funds are starting to pay more in benefits than they collect via contributions, for the first time ever. As a result, pension funds, who own over 20% of all U.S. equities, are becoming net sellers in the market instead of net buyers, pushing prices down.
(2) The U.S. population is aging, with citizens over age 65 projected to represent 22% of the population by 2020, compared with just 11% in 1980. All of them will be slowly selling off their retirement assets instead of buying and saving assets for retirement – twice as many people as a generation ago – also pushing prices down.
(3) A major factor in the market rise of the past 40 years was the accumulation of debt and progressively lower interest rates, which flooded the economy with cash and caused rapid stock price appreciation as companies profited from debt-fueled consumer spending – those days are over.
(4) Pension funds are now too big to consistently beat the market, assuming they ever could.
There is a larger question, however. Why is it that government unions, and their progressive partners, are so anti-corporate, when it is corporate profits that fuel the high returns of their pension funds? Why is it they urge us to blame pension challenges on banks, when it is the banks that lowered interest rates to literally zero (accounting for inflation), in order to create the asset bubble that keeps their pensions marginally solvent? Why is it they blame corporations for caring more about shareholders than workers, when their pensions are dependent on the pension funds reaping massive shareholder benefits from this supposedly misplaced priority?
Ultimately, the solution to the pension crisis facing CalSTRS that is most consistent with progressive principles would be for teachers from now on to collect Social Security instead of pensions, and for existing participants in CalSTRS to collect a pension benefit that is reduced by precisely the amount CalSTRS is underfunded – i.e., a 30% cut to benefits, across the board, to everyone. That solution would epitomize “fairness,” a concept of which they speak so eloquently, and so often.
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Ed Ring is the executive director of the California Policy Center.
The title of this post expresses what is probably the greatest example of a monstrous hypocrisy – that public employee unions, and the pension funds they control, are supposedly helping the American economy, and protecting the American people from “the bankers.” Overpriced “bubble” assets caused by banks offering low interest rates hurt ordinary working people in two ways – they cannot afford to buy homes, and they are denied any sort of viable low risk investment opportunity. But without an endlessly appreciating asset bubble, every public employee pension fund in the United States would go broke.
The inspiration for this post is a guest column published on April 27th in the Huffington Post entitled “The Real Retirement Crisis,” authored by Randi Weingarten, the president of the American Federation of Teachers. The totality of Weingarten’s column, a depressing plethora of misleading statistics and questionable assertions, compels a response:
Weingarten writes: “America has a retirement crisis, but it’s not what some people want you to believe it is. It’s not the defined benefit pension plans that public employees pay into over a lifetime of work, which provide retirees an average of $23,400 annually…”
Here we go again. This claim is one of the biggest distortions coming out of the public sector union PR machine, and despite repeated clarification even in the mainstream press, they keep using it, faithfully counting on low-information voters to believe them. “An average of $23,400 annually.” Not in California. In the golden state, public employee pensions average well over $60,000 annually (ref. “How Much Do CalSTRS Retirees Really Make?“), if you adjust for a 30 year career working in public service. And in most cases public employees also receive supplemental retirement health benefits worth additional thousands each year.
With respect to the causes of the 2007-2008 financial crisis, Weingarten continues: “It’s not the cost of such [defined benefit] plans, which may ultimately cost taxpayers far less than risky, inadequate and increasingly prevalent 401(k) plans.”
What! Exactly how can 401K plans ever cost taxpayers more than defined benefit plans? This is absurd. Public sector defined benefit plans represent fixed payment obligations regardless of levels of funding. When they’re underfunded, the taxpayer makes up the difference. A 401K plan that is underfunded creates no lingering obligation to the taxpayer. If someone from the public sector has an underfunded 401K plan, then they will get whatever government assistance or lack of assistance that someone from the private sector might get. That’s tough, but fair. It is hypocritical to pretend to care about workers, but put the welfare of public sector workers above the welfare of private sector workers. If we are to spend taxes on government administered retirement programs, then everyone should earn benefits according to the same formulas and incentives – whatever they are.
Weingarten then suggests we expand Social Security: “Social Security, which is the healthiest part of our retirement system, keeps tens of millions of seniors out of poverty and could help even more if it were expanded.”
This is a great idea. Why not give every public employee Social Security? Why not insist on this? Social Security is progressive, meaning that high income people get far less back than low income people. Since the public sector workers make far more, on average, than private sector workers, their participation in Social Security will have a significant positive impact on the solvency of Social Security (ref. “Add ALL Public Workers to Social Security“). Why aren’t public sector unions insisting they participate? Don’t they value the progressive benefit formulas? Don’t they want to expand the system? Could it be they are hypocrites?
Here’s a macroeconomic “big picture” quote from Weingarten: “And while the stock market and many pension investments have rebounded, for numerous Americans the lingering economic downturn, soaring student debt, diminished home values, the responsibility of caring for aging parents and other financial demands have made it hard, if not impossible, to save for retirement.”
What Weingarten doesn’t acknowledge is the shared agenda that public sector unions and union controlled pension funds have to perpetuate the asset bubble that’s killing middle class families (ref. “Pension Funds and the “Asset” Economy“). California’s artificially inflated home prices are driving young families out of the state where they were born, preventing them from living near their aging parents, depriving their children of a relationship with their grandparents. But pension fund solvency requires ongoing appreciation of real estate and publicly traded stock even if they are already overpriced. As for student debt – if middle class families didn’t have built into their tuition payments the costs for overpaid, over-pensioned, and under-worked unionized faculty, a bloated workforce of unionized college administrators, and subsidies that make college virtually free for low income students, their “student debt” would be manageable because their rates of tuition would be far lower. Does Weingarten care about the “middle class,” or might hypocrisy be at work here?
Here’s another Weingarten quote that invites a rebuttal: “Defined benefit plans not only help keep retirees out of poverty, every $1 in pension benefits generates $2.37 in economic activity in communities.”
The problem here is that ALL investments generate economic activity. You don’t have to run it through a pension fund. If taxpayers get to keep the money they would have paid to fund a public employee’s pension, they’ll invest it or spend it too. In California’s case, as is proudly proclaimed in, for example, CalPERS press releases, “9.5% of CalPERS investment portfolio is reinvested in California.” Nine-point-five percent. The other more than ninety percent goes to other states and countries, presumably places with business climates that aren’t poisoned by the policy agenda of public sector unions. How does that help California’s economy?
Finally, Weingarten alludes to a new initiative being advocated by public sector unions to provide enhanced retirement security to private sector workers. She writes: “The AFT is engaged in a broad-based effort with a bipartisan group of state treasurers, other unions, asset managers and even some large Wall Street firms to vastly expand retirement security through pooled, professional asset management.”
Here is shameful hypocrisy disguised, once again, as altruism. Because these private sector defined benefit plans will not guarantee participants a 7.5% return on investment. They will have to conform to ERISA, meaning the future retirement liabilities that will be offset by invested assets will have their present value calculated at conservative rates. This double standard guarantees the “normal contribution” for public employees in order to generate a given defined benefit will be remain far less than that required of private citizens. Some observers have even suggested these private defined benefit plans, where the assets will be co-mingled with public sector defined benefit plans, will be used as piggy banks to shore up the public sector plans. After all, if the assets are co-invested and earn a rate of return that exceeds the discount rate used to value the future liabilities for the private retirees, but falls short of the discount rate used to value the future liabilities for the public sector retirees, then the surplus from the private sector’s fund will be applied to the deficit in the public sector fund. Why not? It is easy to be diabolical, and hypocritical, when your critics have to dive so far into the weeds to challenge your logic or your morality.
Weingarten doesn’t have to deal with weeds, however, or wonks, or the tough realizations that are the reward of complex analyses. She just has to say things that are emotionally resonant, then let her multi-million dollar PR machine feed it to the masses.
When interest rates were lowered in the 1990’s, stock prices soared, forming what was later called the internet bubble. When that bubble popped in 2000, interest rates – and credit criteria – were lowered even further, forming the real estate bubble. Through it all, pension funds banked profits on artificially inflated asset values, ordinary citizens went into debt to their eyeballs to buy homes and pay tuition for their children, and the unions that controlled the pension funds negotiated massive increases to pay and pension benefits as if these bubbles could last forever. When reality finally returned in 2008, the government unions and their banker allies handed struggling taxpayers the bill, holding onto their excessive pay, benefits, bonuses and pensions, and engaged in quantitative easing and other fiscal shenanigans calculated to perennially inflate new asset bubbles, and the pensions that depend on them.
That is the real story, Ms. Weingarten.
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Ed Ring is the executive director of the California Policy Center
Public pension systems in California, most notably CalPERS and CalSTRS, are quick to cite their average pension amount as evidence that their pension benefits are reasonable. In addition to the pension plans themselves, many defenders of public pension plans will cite these averages themselves when attempting to counter claims that pension benefits have become excessive in recent years.
There are three very important factors that need to be accounted for when computing a raw average and using this value as an indication for what a public employee can expect to receive in retirement benefits.
Reason #1 – Failing to Adjust for Years of Service Worked
The biggest and most widely documented factor is overlooking years of service. Most analyses of average benefits include the implicit assumption that the pension benefit cited is for a full career (30 years or more) of service.
Including the pension amounts of those who have not worked a full career produces an average value that is much lower than what those who have worked a full career are receiving. Since a full-career employee is the benchmark used in measuring the equity of pension benefits, it is only appropriate to use the data that reflects that.
Reason #2 – Failing to Account for Beneficiaries
Many pension plans maintain their records in a way that makes the most sense for processing payments, but are incredibly misleading when used to calculate average pension amounts. The case of beneficiaries is a prime example of this. When a public employee qualifies for a pension, there are set guidelines for each plan depending on how beneficiaries are treated, but most plans default to the surviving spouse. In many cases, the retiree can designate additional beneficiaries as well.
So when calculating average pension amounts, if beneficiaries aren’t accurately identified and segregated from active service retirement amounts, the resulting average will be skewed downward. This is because any beneficiary payment will always be a portion of the full retirement amount, which will be incorrectly treated as if it were its own separate benefit amount. An example found on Transparentcalifornia.com illustrates this effect.
In the San Jose Police and Fire Pension Plan, there is no distinction between beneficiary and active service retirees. Consider, however, the following case of multiple beneficiaries. An individual with a retirement year of 2007 and years of service value of 25.02 received a $76,120 pension amount in 2013. Two more entries share the last name of this individual, as well as identical years of service and year of retirement but both only received $7,100 in 2012. As it is inconceivable that a San Jose police or fire retiree could retire with 25 years of service and receive an annual pension of just $7,100, these three separate entries – $76,120, $7,100, and $7,100 – are all components of one pension. So in this case, even when screening to isolate averages for pensioners with 25+ years of service, a $90,320 pension for one individual would impact the averages as three separate pensions of $30,107.
Reason #3 – The Same Pension Amount Reported in Fragmented Parts
Another potential error is when one employee’s pension is reported in fragmented parts, to account for either a divorced spouse receiving a portion of their pension, or even in cases where the retiree changed departments and received a pension amount under two or more different formulas. As indicated above, for every instance this occurs the pension amount will be reported at least 50% lower than its true value in raw average calculations.
It is entirely reasonable for pension plans to keep their payment records in a format that is most efficient and accurate for them. The observations made above are in no way suggesting that any of the data made available by the various plans is compiled in an intentionally misleading way. However, it is the responsibility of anyone who uses pension averages in their arguments, either for or against pension reform, to accurately interpret this data. Public relations professionals who represent pension systems and public sector unions often ignore reasons why pension benefits are far more generous than the statistics they come up with would indicate.
As demonstrated above, when it comes to frequently cited average pension amounts, there is much more to the story than it would appear at first glance.
Robert Fellner is a researcher at the Nevada Policy Research Institute (NPRI) and joined the Institute in December 2013. Robert is currently working on the largest privately funded state and local government payroll and pensions records project in California history, TransparentCalifornia, a joint venture of the California Public Policy Center and NPRI. Robert has lived in Las Vegas since 2005 when he moved to Nevada to become a professional poker player. Robert has had a remarkably successfully poker career including two top 10 World Series of Poker finishes. Additionally, his economic analysis on the minimum wage law won first place in a 2011 essay contest hosted by the George Mason University.
Summary: The California State Teacher’s Retirement System (CalSTRS) is California’s 2nd largest public employee pension fund, serving roughly 2% of California’s population. At present, its unfunded liability is officially estimated at $71 billion. While much of the discussion over pension reform focuses on projected rates of investment returns, which greatly affects the required annual contributions to the fund, too often the actual amount of the average CalSTRS pension is omitted from these discussions. Even worse, the average pension amounts frequently cited for CalSTRS retirees are often misleading because they fail to take into account years of service, or the impact of pension benefit enhancements in recent years.
In this study, we analyze data from CalSTRS 2012 pension records to assess the true value of the average CalSTRS pension. We do so by factoring in years of service data to extrapolate an average “full career” amount, represented by both 30 and 43 year terms. We find that the average CalSTRS retiree can presently expect to receive a $51,500 pension for having worked a 30 year career, and a $73,817 pension for a 43 year career.
This study also analyzes 2012 pension averages broken out by the retiree’s retirement date and finds a significant disparity between the amount received by those who have retired more recently as compared to those who have retired earlier. For example, if a CalSTRS participant had retired in 2012 after working 30 years, they could expect an initial annual pension of $57,645; after 43 years, $82,625. The average 2012 pension for a CalSTRS participant who retired 20 years ago, in 1992, is much lower; $38,517 if they had worked 30 years; after 43 years, $55,207.
When discussing how much public employees receive in pension benefits, in order to make accurate comparisons and avoid misleading the public, it is vital to adjust the data to reflect averages based on full careers in public service. It is also vital to provide averages that reflect current benefit formulas, since the more generous formulas currently in effect are what inform the scale of pension liabilities in the future. This study addresses these concerns.
The pay and benefits of public employees is a discussion of increasing relevance to taxpayers. As noted in a CPPC study published on February 1st, 2014, “How Much Do California’s State, City and County Workers Really Make?,” in California, personnel costs are estimated to consume 40% of total city budgets, 41% of the state budget for direct operations, and 52% of county budgets. In many cities and counties the percentage is much higher. And these averages don’t include personnel costs for outside contractors, nor do they include payments on debt that is directly related to personnel costs, such as pension obligation bonds.
Meanwhile, even when budgets are balanced, as may be the case this fiscal year at least for the State government, there is an overhang of debt obligations facing California’s state and local governments that are only manageable as long as interest rates remain relatively low. Another CPPC study published in April 2013 entitled “Calculating California’s Total State and Local Government Debt,” estimated California’s total state and local bond debt at $382.9 billion as of June 30, 2012. That same study reported California’s officially recognized state and local unfunded obligations for retirement health insurance and pension obligations at $265.1 billion. Using more conservative assumptions regarding pension fund performance, the study estimated these retirement obligations on the part of California’s state and local governments could increase by an additional $389.8 billion. In all, it is quite likely that California’s taxpayers currently owe over $1.0 trillion in total debt and unfunded retirement obligations incurred by state and local government, and most of that is for retirement benefits for state and local government employees.
In this environment it is important to present factual information relating to public sector compensation. With respect to retirement benefits, it is helpful to present complete and accurate aggregate data, in order for policymakers and taxpayers to determine whether or not current benefit formulas are fair and financially sustainable. This study analyzes data from CalSTRS, using nearly a quarter-million records obtained from CalSTRS for 2012. In particular, this study presents data showing, by year of retirement, what the average pension benefits were in 2012. The study then normalizes these benefits to account for full careers using two benchmarks – the public sector “full career” expectation of 30 years, and the private sector “full career” expectation of 43 years.
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METHODS AND ASSUMPTIONS TO ACQUIRE DATA
This study precisely replicates the methods used in a CPPC study released on February 14th, 2014, “How Much Do CalPERS Retirees Really Make?” The analysis and charts developed for this study can be evaluated by downloading the following spreadsheet. Please note the file size is 23 MB.
The source data was acquired from the website www.TransparentCalifornia.com, an online resource produced through a joint-venture involving the California Policy Center and the Nevada Policy Research Institute. The data on the Transparent California website, in this case, was acquired directly from CalSTRS, and has not been altered. Since the focus in this study involves aggregate data, the names of individual participants have been removed from the downloadable spreadsheet that accompanies this analysis.
Because the information provided by CalSTRS included “year of retirement” and “years of service,” it is possible to normalize the information to produce “full career” equivalent pensions. It is vital to make this analysis, because no statistic representing average pensions can be evaluated apart from knowing how long most participants actually worked. It would be analogous to saying that an active worker only was paid $100 for a day’s work, without knowing how many hours they worked. Did they work ten hours and earn $10 per hour, or did they only work one hour and earn $100 per hour? Without looking at how many years participants worked to earn their pensions, we cannot even begin to have a productive discussion as to whether or these pensions are fair and appropriate or not.
From a standpoint of financial sustainability it is also vital to know how many years of service the average pensioner logged. Using the payroll analogy again, if a person only worked one hour in a day and made $100, and the employer needed someone at that post for ten hours, than the employer cost was actually $1,000 per day, whereas if that person worked a ten hour day and made $100, then the employer cost was only $100. This is precisely what is at stake when evaluating the overall cost to taxpayers of public sector pensions. For example, if the average years of service for a pensioner is only 20 years, and a private sector career is actually 40 years, then the taxpayer is essentially paying for two pensions for each position that would have been filled by one person working 40 years.
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AVERAGE LENGTH OF SERVICE AND AVERAGE PENSION – TOTAL POOL OF PARTICIPANTS
In Table 1 it can be seen that nearly a quarter-million retirees collected pension benefits through CalSTRS during 2012, and that the average pension was $43,821 during that year. Inexplicably, this average is considerably higher than the averages frequently cited by spokespersons for CalSTRS and public sector unions representing CalSTRS participants. But the average CalSTRS retiree worked for 25.53 years. It is not reasonable to suggest that someone who has only worked perhaps two-thirds the duration of a normal career should expect a retirement benefit that might be more appropriate for a full career. And it is impossible to discuss, much less determine, whether or not CalSTRS retirement benefits are appropriate, without taking into account how long a retiree has worked in order to earn their retirement benefit.
Table 1 – Basic CalSTRS Data, 2012
The next table, below, depicts how much these overall average pension amounts would increase if the retiree pool had turned in an average “years of service” of 30 years, which is a typical duration to use when considering public sector careers, as well as 43 years, which is typical for any private sector worker who hopes to receive the full Social Security benefit.
These calculations are made by dividing the average annual pension for a CalSTRS participant in 2012, $43,821, by the average years of service, 25.53. The result, $1,717, is the amount the average CalSTRS retiree accrued in annual pension benefits for each year they worked during their careers. This amount is multiplied by 30 to show what a current CalSTRS retiree could expect, on average, if they had worked 30 years; $51,500. This amount is multiplied by 43 to show what a current CalSTRS retiree could expect, on average, if they had worked 43 years; $73,817.
Table 2 – CalSTRS Average Pensions Assuming Full Careers
Just as when considering current compensation for public employees, total compensation – direct pay plus employer paid benefits – is the only truly accurate measurement of how much they make, when considering retirement pensions for retired public employees, pensions adjusted to show what they would have been if the recipient had spent their entire career working and paying into the pension system, i.e., “full career equivalent pensions,” are the only accurate measurements of how much they are really getting in retirement. But there is another crucial variable that must be considered to complete this analysis, which is how much full career equivalent pensions are paying to CalSTRS retirees who retired in recent years.
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AVERAGE PENSION ADJUSTED FOR FULL-CAREER – SHOWN BY YEAR OF RETIREMENT
Because the data provided by CalSTRS includes not only years of service for each participant, but also the year they retired, it is possible to calculate average “full-career” pension benefits based on the year they retired. It is important to do this because pension benefits for California’s state and local government workers were steadily enhanced over the past decades, especially after 1999 when SB 400 was passed by the California state legislature. In general, pension formulas have been altered to bestow pension benefits that are approximately 50% better today than they were 20 years ago. At the same time, pension benefits are calculated on rates of pay, which themselves have increased at a rate exceeding inflation for at least the last 20 years.
Table 3 depicts the unambiguous impact of these trends. The last column to the right on the table, “Avg Pension, 43 Years Svc” shows what retirees would be really getting in pension benefits if they had worked 43 years – from age 25 through age 67 (one may substitute age 22 through age 64, or whatever, of course). As seen, the 14,247 retirees in 2012, had they worked 43 years, would have collected average annual pensions of $82,625.
In general, pensions adjusted to reflect a full career in the private sector exceeded $80,000 per year starting with those CalSTRS participants retiring in 2001. They decrease sharply for participants who retired prior to 2001. In 1999 and 2000 they were less than less than $70,000 but more than $60,000. Participants who retired between the years 1986 and 1998 collect pensions today – again, had they worked a full private sector career – greater than $50,000 and less than $60,000. Participants who retired before 1986 collect pensions today that are less than $50,000.
It is hard to find a data set that shows a greater correlation than this one: The earlier you retired, the less you’re going to get in your pension today. That is because pension formulas were enhanced for California’s state and local government workers over the past 10-20 years – especially starting around 1999. Not only were they enhanced, but they were enhanced retroactively, meaning that someone nearing retirement who had been accruing pension benefits at a rate of 2.0% per year, for example, suddenly began accruing pension benefits at a rate of 3.0% per year not only for the years remaining in their career, but for every year they worked.
To speculate as to why it was possible to retroactively enhance pension formulas through legislative action, yet it is purportedly unconstitutional and therefore impossible to merely reduce these formulas for active workers from now on, would go beyond the scope of this modest analysis.
Table 3 – CalSTRS Average “Full Career” Pensions By Year of Retirement
Table 3 (Data) – CalSTRS Average “Full Career” Pensions By Year of Retirement
It is probably necessary to reiterate as to why full-career equivalent pensions are the only accurate measurement to use when discussing whether or not today’s public sector pension benefits are appropriate or financially sustainable. The reason is simple and bears repeating: Defenders of pensions as they are use “averages” that don’t seem terribly alarming. Notwithstanding the fact that a self-employed person in the private sector would have to earn over $100,000 per year and contribute 12.4% of their lifetime earnings in order to collect the maximum Social Security benefit of $31,704 at age 68, which is considerably less than the average CalSTRS pension of $43,821, that average CalSTRS pension is based on an average years of service of 25.53 years. Somebody who has only worked for 25 years should not have an expectation of a pension that exceeds the maximum Social Security benefit that requires 12.4% of a six-figure annual income and 43 years of work. Few, if any participants in CalSTRS are contributing more than 12.4% of their pay into their pension account. The taxpayers make up the difference.
When debating the financial sustainability of CalSTRS and the other pension funds serving California’s state and local government workers, there are many issues. How the unfunded liability is estimated is the topic of intense debate, focusing primarily on what rate-of-return these funds believe they will average over the next few decades. That rate-of-return estimate also is a primary determinant of how the “normal contribution” is calculated. There are myriad aspects to the debate over how to adequately fund public sector pensions. But missing from that debate far too frequently is an honest assessment of just how much, on average, these pensions are really worth to the recipients.
This study has presented a calculation of what CalSTRS’s average pension benefit is based on years worked as well as year of retirement. It has normalized that data to show that a retiree who worked 30 years and retired last year, on average, can expect a pension of over $57,000 per year, and if they worked 43 years and retired last year, on average, can expect a pension of over $82,000 per year.
About the Authors:
Robert Fellner is a researcher at the Nevada Policy Research Institute (NPRI) and joined the Institute in December 2013. Robert is currently working on the largest privately funded state and local government payroll and pensions records project in California history, TransparentCalifornia, a joint venture of the California Policy Center and NPRI. Robert has lived in Las Vegas since 2005 when he moved to Nevada to become a professional poker player. Robert has had a remarkably successfully poker career including two top 10 World Series of Poker finishes. Additionally, his economic analysis on the minimum wage law won first place in a 2011 essay contest hosted by the George Mason University.
Ed Ring is the executive director for the California Policy Center. As a consultant and full-time employee primarily for start-up companies in the Silicon Valley, Ring has done financial accounting for over 20 years, and brings this expertise to his analysis and commentary on issues of public sector finance. Ring has an MBA in Finance from the University of Southern California, and a BA in Political Science from UC Davis.
“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
CalSTRS Contributions Inadequate; Unions Call Reformers “Right-Wing Ideologues,” November 12, 2013
Are Annual Contributions Into CalSTRS Adequate?, November 8, 2013
Saving Pensions Will Require Unions To Face Reality, August 27, 2013
Calculating California’s Total State and Local Government Debt, April 26, 2013
How Lower Earnings Impact California’s Total Unfunded Pension Liability, February 18, 2013
Is it possible that the California Legislature is finally coming to grips with the public employee pension crisis? We certainly hope so.
For years, our political leadership has behaved more like ostriches with their heads buried in the sand regarding the many billions of dollars of “unfunded liabilities” in California’s pension funds. Unlike most retirement plans in the private sector, government workers get “defined benefit” plans that guarantee fixed payments to retirees, no matter how well the underlying investments have performed.
A good sign is that Assembly leaders now say they will take on the massive shortfall in the State Teachers Retirement System (CalSTRS) that provides retirement, disability and survivor benefits for California’s 868,493 teachers and their families. Speaker John Perez says he wants to find a way to begin paying down the $80 billion unfunded liability for teacher pensions and the Assembly will hold a hearing on the issue this month.
While CalPERS, the other major public employee pension system, is in a weak position, CalSTRS is close to falling into the abyss. However, neither of the systems is likely to ever go over the edge because taxpayers are obligated to maintain their solvency, no matter the cost. This means the sooner the unfunded liability is addressed, the less long-term cost to taxpayers.
Unfortunately, until now, Sacramento’s approach to these unfunded liabilities is probably why the phrase “kicking the can down the road” was coined. Even Governor Brown, who has espoused government frugality and responsibility — while increasing state spending — ignored the unfunded pension systems in his proposed state budget.
In fairness to Brown, two years ago, he proposed a fairly decent pension reform package. But by the time the Legislature got through with the governor’s plan, all that remained was some modest changes to address the worst of pension abuses including a few to prevent “pension spiking.”
Like alcoholics attending their first AA meeting, Speaker Perez and his colleagues deserve credit for taking the first step by acknowledging the problem and making a commitment to address it. Of course the Speaker may have been nudged along after seeing poll results, including one by PPIC that shows that over 80 percent of adults believe that the money spent on pensions is a problem for state and local government budgets. The poll further reveals that more than 70 percent would favor a change from a defined benefit — a guaranteed monthly payout at retirement — to a defined contribution system, similar to a 401(k) plan.
Perez suggests that it may be necessary to hike payments into the pension plan made by the state, school districts and individual teachers. While much of the costs would ultimately fall back on taxpayers — even if teachers pay more, they will, no doubt, be seeking even higher pay raises in compensation — the idea of shared sacrifice to solve a problem is a reasonable place to start the debate. And if pension reform were added to the mix, perhaps a win-win result can be obtained for both taxpayers, who will have a smaller long-term bill, and teachers, who would benefit from a more secure retirement system.
Taxpayers will be watching closely with the hope that we can soon applaud both the Speaker and his colleagues for substantive results, because if this problem is not tackled in earnest now, Californians and future generations of Californians will be facing very destructive consequences.
Jon Coupal is president of the Howard Jarvis Taxpayers Association — California’s largest grass-roots taxpayer organization dedicated to the protection of Proposition 13 and the advancement of taxpayers’ rights.
One of the biggest unreported, blockbuster stories in modern America is the alliance between public sector unions and the speculative banking industry. It is a story saturated in greed, drowning in delusion, smothered and marginalized by an avalanche of propaganda – paid for by taxpayers who fund both the public sector unions and the public employee pension funds.
The problem with public sector defined benefit pensions can be boiled down to two cold factors: They are too generous, and they rely on rate-of-return assumptions that are too optimistic. The first is the result of greed, the second of delusion. To indulge these vices requires corruption, and it is a rot that joins public sector unions with the most questionable elements of that Wall Street machine they so readily demonize.
If you honestly review the numbers, the greed is obvious. The average pension for a public servant who has worked 30 years or more in public service is more than four times what the average social security benefit is for someone who has worked 40 years or more in the private sector. To cite examples – the average CalPERS retiree who retired in the last five years, after 30 years service, collects a pension of $67,980, for CalSTRS, the average for recent retirees with 30+ years of service is $66,828 per year. Most of California’s independent city and county pension funds are even more generous; Orange County’s employee retirement system, for example, pays the average recent retiree with 30+ years of service a pension of $81,000.
These numbers are ridiculously out of step with reality. If every Californian over the age of 55 got a pension that averaged $65,000 per year, it would cost over $650 billion per year, one-third of California’s entire GDP. But the average public employee who works from age 26 through age 55 will easily collect that much. This is impossible to justify, and impossible to sustain. The average Social Security benefit for a 68 year old new retiree: $15,000 per year.
Greed is compounded with corruption and delusion, when in response for calls to bring public sector pensions into line with what is affordable and fair, unions and pension bankers claim 7.5% annual rates of return can be sustained forever. Their first mistake is suggesting that 7.5% rates of return is all they need. Current levels of underfunding mean either annual contributions go way up, or returns have to greatly exceed 7.5%. For example, CalSTRS is 67% funded, and to avoid becoming more underfunded, they must either earn 11.2% per year, or they must make a supplemental “unfunded contribution” of $4.1 billion per year – last year their unfunded contribution was only $1.1 billion. We are at the top of another bull market and in the terminal phases of a long-term credit cycle – anyone want to bet that CalSTRS is going to earn 11.2% a year for the next 30 years?
In an attempt to earn in excess of 7.5% per year, pension funds are increasingly turning to hedge funds, whose charter, essentially, is to earn over-market returns. To do this, they do all the things that public sector unions are supposedly opposed to and wishing to protect us from – opaque private equity deals, currency speculation, high-frequency trading – all those manipulative tools used by the super-wealthy, super empowered Wall Street players to siphon billions out of the economy. Except now they’re using tax dollars, channeled to them via government payroll departments, and cutting the government workers in on the skim. And if it goes south? Taxpayers pay for the bailout. And even if these funds can keep the lights on for a few more years before the whole scam collapses, isn’t it inherently exploitative for a government-ran pension fund, operated for the benefit of government employees, to aspire to over-market returns? To the extent the market is manipulated and over-market returns are extracted for an elite few, value investors with their individual 401Ks are penalized. That fact is irrefutable, simple algebra.
Which brings us to sheer abuse of power. Hypocrisy aside – and how much more hypocritical can it be for union leaders to hurl the word “profit” the way most of us might utter obscenities, yet ignore the fact that only “profits” can impel pension funds to appreciate at rates of 7.5% per year or more – it is raw power, sheer financial and legal might, that enables pension funds, with unions cheering them on every step of the way, to sue city after bankrupt city to ensure their “contracts” are inviolable, that the pension money keeps pouring in, even if it means raising taxes via court order, then selling the parks, selling the libraries, closing government offices and “furloughing” public servants, and giving raw deals to newly hired employees. But as courts will eventually sustain, perhaps out of financial necessity, the moral worth or worthlessness of a contract supersedes its technical validity. Power is a ship. Financial reality is a lighthouse.
Public sector retirement benefits – like all taxpayer funded entitlements – should provide an austere safety net, like Social Security. Pensions should not enable a retirement lifestyle of luxury and ongoing leverage, exempting government workers from the challenges to save and prepare that face every other American citizen. Nor, in the process, should they impoverish taxpayers, enrich banks, and flush the social contract into oblivion.
The reason pension reform doesn’t happen isn’t merely due to the greed and exceptionalism of public sector unions. Despite their overwhelming power, unions probably couldn’t stop reforms all by themselves. Public sector unions receive formidable political, legal and financial support, along with intellectual cover in the form of delusional financial projections, from their partners in the financial sector, corrupt, crony capitalists who indeed give capitalism a bad name.
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Ed Ring is the executive director of the California Public Policy Center.
Preface: Earlier this year the California Policy Center published a study evaluating the Orange County Employee Retirement System (OCERS) to explore this same question: Are Annual Contributions into OCERS Adequate? That study adopted a unique focus, evaluating contributions into OCERS not based on percent of payroll, but by looking at the actual amount of cash being contributed each year. In particular, the study evaluated how much cash each year was being contributed to reduce the unfunded liability. This report performs the exact same analysis, using the exact same template. Different numbers; same story. Pension analysts and pension activists are encouraged to download the spreadsheets (CalSTRS, OCERS) used in both of these studies, and use them to perform similar analysis for whatever pension systems they are concerned about. For whatever pension fund they choose to analyze, it is quite likely they will find that the amount of money being contributed to reduce the unfunded liability is alarmingly low.
Summary: For the fiscal year ended 6-30-2012 the California State Teachers Retirement System, CalSTRS, collected $5.8 billion from employees and employers to invest in their pension fund. Of this $5.82 billion, $4.7 billion was the so-called “normal contribution,” which was a payment to cover the present value of future pensions earned during FYE 6-30-2012 by actively employed participants. The other $1.1 billion that was collected and invested in the fund was a “catch-up” payment to reduce the unfunded liability, which as of 6-30-2012 was officially estimated to be $71.0 billion.
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.
This study also finds that the $4.7 billion normal contribution into CalSTRS for FYE 6-30-2012 was based on a rate-of-return assumption of 7.5%. The study shows that lowering the rate-of-return projection from 7.50% to 6.20% would require the normal contribution to increase by another $1.1 billion; lowering it from 7.50% to 4.81% would require the normal contribution to increase by another $2.5 billion. The rate of 6.2% represents the historical performance of U.S. equity investments (including dividends) between 1900 and 1999. The rate of 4.81% is the Citibank Pension Liability Index rate as of July 2013, which is the lower risk rate recommended by Moody’s Investor Services for pension liability forecasting.
The conclusion of this study is that CalSTRS relies on optimistic long-term earnings projections and very aggressive unfunded liability repayment schedules in order to pay the absolute minimum into their pension fund. If CalSTRS is required to even incrementally lower their rate-of-return projections – something that market conditions may eventually dictate – their funded ratio which is already only 67.0% will fall precipitously. Unless extremely favorable market conditions occur for the next several years without interruption, in order for CalSTRS to remain solvent, they need to dramatically cut retirement benefits, or increase their annual contributions by 50% or more per year.
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The purpose of this brief study is to assess whether or not the $5.82 billion contributed during the fiscal year ended 6-30-2012 into the CalSTRS pension fund was sufficient to ensure the long-term solvency of the fund. Using methods recommended in July 2012 and finalized in April 2013 by Moody’s Investor Services, and elucidated in a recent CPPC study “A Method to Estimate the Pension Contribution and Pension Liability for Your City or County,” this study will perform what-if scenarios, estimating the size of the CalSTRS unfunded liability at various rates of return.
This study will also discuss whether or not the current contributions, both normal and catch-up, add sufficient assets to the CalSTRS fund to ensure solvency, and how much contributions would need to increase using more conservative assumptions regarding return on investment and payback periods. Finally, throughout this study an attempt will be made to discuss and explain key concepts of pension finance, in keeping with the CPPC’s mission to inform and involve more people in discussions of sustainable public finance. The tables in this study were produced on an Excel spreadsheet that can be downloaded here:
DOWNLOAD SPREADSHEET: Analysis-of-CalSTRS-Pension-Liability-and-Contributions.xlsx
The officially recognized amounts for key variables used in this study, including the total contribution to the pension fund, normal contribution, “catch-up” contribution to reduce the unfunded liability, as well as the total assets, total liabilities, and unfunded pension fund liability, were all drawn from publicly available CalSTRS financial reports.
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HOW MUCH WAS CalSTRS UNDERFUNDED AS OF 6-30-2012?
The underfunding of any pension fund is calculated by subtracting from the amount of the total invested assets the present value of the liability to pay pensions in the future. Because these future pension obligations are intended to be paid sometime between next year and 50-60 years from now, the liability today is calculated by adding up the net present values of the estimated payments to be made for each year in the future. If the total value of the pension fund’s invested assets is equal to the present value of all future pension payments, the fund is said to be 100% funded.
Using data from the CalSTRS “Defined Benefit Program Actuarial Valuation as of June 30, 2012,” here are the officially recognized amounts for CalSTRS assets, liabilities, and underfunding at the end of last year :
- Actuarial accrued liability (AAL) = $215.19 billion
- Valuation value of assets (VVA) = $144.23 billion
- Unfunded Actuarial Accrued Liability = $70.96 billion
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HOW MUCH WAS CONTRIBUTED INTO CalSTRS IN FYE 6-30-2012?
Again using data from CalSTRS “Comprehensive Annual Financial Report, FYE 6-30-2012,” the total contribution into the pension fund in 2012, via direct payments by participating employers and withholding from participating employee paychecks, was $5.82 billion .
Annual pension fund contributions have two components, the “normal contribution,” and the “unfunded contribution,” which is the amount paid towards reducing the plan’s unfunded liability. The “normal contribution,” simply stated, needs to be an amount equal to the present value of future pension payment obligations earned in the current year.
Normal Contribution: The total employer and employee normal cost for FYE 6-30-2012 was $4.69 billion as documented on page 15 of the Milliman actuarial report for CalSTRS, “Defined Benefit Program Actuarial Valuation.” .
Unfunded Contribution: The amount paid into the CalSTRS pension fund during their FYE 6-30-2012 to reduce their unfunded liability is not explicitly disclosed on official documents. But logic dictates the total unfunded contribution to be the difference between the total contribution, $5.82 billion, and the normal contribution, $4.69 billion, or $1.13 billion.
- Total contribution = $5.82 billion
- Normal contribution = $4.69 billion
- Unfunded contribution = $1.13 billion
The remainder of this report will consider whether or not this level of contributions is adequate by estimating required contributions based on more aggressive payback terms, as well as more conservative rate-of-return projections. The first step is performing these what-ifs is to estimate how the unfunded liability is affected by changes to the rate-of-return projections.
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HOW DO LOWER RATES OF RETURN AFFECT CalSTRS UNFUNDED PENSION LIABILITY?
To be 100% funded, a pension plan must have invested assets equal to the present value of all future pension payments. For every participating employee, whether they are active or retired, actuaries estimate their salary growth, their year of retirement, their initial pension, their subsequent pension payouts based on COLAs, and their life expectancy. The present value of all these future payments is how much a fully funded pension plan’s assets must be worth.
The rate at which these future payments are discounted per year must be equivalent to whatever rate the pension fund managers believe they will earn interest, on average, over the life of the fund. The theory is that if no future work were performed, and no future pension benefits were earned, and no additional money were contributed to the fund, the assets currently invested in a fully funded plan would earn enough interest to support every future pension payment until the last participant died of old age.
Since the amount of assets in a pension plan is a known, objective quantity, the debate over how much unfunded liability a plan may have centers on what assumptions are used to estimate the present value of the future payments, i.e., the “Actuarial accrued liability (AAL),” which CalSTRS valued as of 6-30-2013 at $215.2 billion. In order to assess whether or not that amount is overstated or understated, we can use a short-cut formulated by Moody’s Investor Services in their July 2012, “Moody’s Adjustments to US State and Local Government Reported Pension Data.”
In order to revalue a pension fund’s liabilities without having access to every actuarial calculation from every fund, what Moody’s does is estimate the midpoint of the future payments stream. They select 13 years into the future, which is quite conservative. Using a longer duration than 13 years will greatly increase the sensitivity of the liability to changes in the projected rate-of-return. Here is their rationale :
“To implement the discount rate adjustment, we propose using a common 13-year duration estimate for all plans. This is a measure of the time-weighted average life of benefit payments. Each plan’s reported actuarial accrued liability (“AAL”) is projected forward for 13 years at the plan’s reported discount rate, and then discounted back at 5.5%. This calculation results in an increase in AAL of roughly 13% for each one percentage point difference between 5.5% and the plan’s discount rate. For example, a plan with a $10 billion reported AAL based on a discount rate of 8% would have an adjusted AAL of $13.56 billion, or 35.6% greater than reported.
We recognize this duration estimate may be higher than warranted for some plans and lower than warranted for others. Each pension plan has a unique benefit structure and demographic profile that affects the time-weighted profile (duration) of future benefit payment liabilities. However, plan durations are not reported, and calculating duration individually for each plan is not feasible. Our proposed 13-year duration is the median calculated from a sample of pension plans whose durations ranged from about 10 to 17 years. Plans with shorter durations usually are closed or have a preponderance of older or retired members.”
Here is the formula that governs this readjustment:
Adj PV = [ PV x ( 1 + official %i ) ^ years ] / ( 1 + adjusted %i ) ^ years
Table 1, below, shows how much the CalSTRS unfunded liability will increase based on two alternative rate-of-return projections, both of which are lower than the official rate of 7.50% currently used by CalSTRS. Here they are:
Case 1, 6.2% – here is the rationale for this rate-of-return, excerpted from the report “Pension Math: How California’s Retirement Spending is Squeezing The State Budget”  authored by Joe Nation, a Ph.D., Stanford Institute for Economic Policy Research, and former California Democratic assemblyman: “This 6.0 to 6.5 percent figure is based on the performance of a hypothetical fund containing 80 percent equity and 20 percent income instruments between 1900 and 1999. It assumes an equity rate based on the 20th-century Dow Jones industrial annual average of 5.3 percent, plus 2 percent in dividends, less 0.5 percent in fees. Combined with income instruments with a net rate of return of 4.5 percent, this hypothetical fund would have earned an average annual rate of 6.2 percent.”
Case 2, 4.81% – the rationale for this rate-of-return comes from Moody’s Investor Services “Moody’s Revised New Approach to Adjusting Reported State and Local Government Pension Data,” released in April 2013 : “For adjustments to pension data, Moody’s will use the Citibank Pension Liability Index (Index) posted on the date of the valuation instead of its original proposal to apply a single rate for all plans each year.” Citigroup Pension Discount rate as posted by the Society of Actuaries in July 2013 was 4.81% .
Table 1 makes the revaluation method specified by Moody’s transparent. To download the spreadsheet that contains all of these tables, click here: Analysis-of-CalSTRS-Pension-Liability-and-Contributions.xlsx, and refer to the first tab “unfunded liability.” To make the logic of these calculations as plain as possible, the spreadsheet cells where assumptions are input are shaded in yellow, and the result cells at the bottom are shaded in green. Column 1 shows the baseline case, using the official projected interest rate of 7.50%, meaning the end result is unchanged. Column two uses the “case 1″ lower rate of 6.20%, column three uses the “case 2″ rate of 4.81%. The first three rows show how the officially reported unfunded liability is calculated. The first four rows of the second second section, “Revaluation of Unfunded Pension Liability,” projects the liability forward 13 years to develop a future value at the official rate of return, 7.50%. The final three rows of the second section then calculate the present value using the baseline rate of 7.50%, the case 1 rate of 6.20%, and the case 2 rate of 4.81%.
As can be seen, even with what is probably an unrepresentative duration of only 13 years, if the pension fund is only projected to earn 6.2% instead of 7.50%, the unfunded liability estimate jumps from $70.0 billion to $107.8 billion, and at a projection of 4.81%, more than doubles to $154.93 billion. These are not implausible scenarios.
TABLE 1 – RECALCULATING CalSTRS UNFUNDED PENSION LIABILITY
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HOW DO LOWER RATES OF RETURN AFFECT CalSTRS UNFUNDED CONTRIBUTION?
Table 2, below, shows how much CalSTRS should be paying back each year to reduce their unfunded liability if they were to pay it back using the terms of a conventional amortized loan with level payments each year. And this “level payment” method is what has been adopted by Moody’s Investor Services in their Moody’s Revised New Approach to Adjusting Reported State and Local Government Pension Data, “Moody’s adjusted net pension liability will be amortized over a 20-year period on a level-dollar basis using the interest rate provided by the Index.” 
When reviewing Table 2, bear in mind that the payment made in FYE 6-30-2012 into the CalSTRS pension fund towards reducing their unfunded liability was $1.13 billion. As the baseline case in column 1 shows, if this payment were calculated using a level payment, 20 year term as recommended by Moody’s Investor Services, they would have had to pay $6.96 billion during 2012, more than six times as much. This observation merits repetition: By applying repayment terms that Moody’s Investor Services – the largest credit ratings agency in the world – has recommended public sector pension funds adopt, and without changing the return-on-investment assumptions that many analysts (including Moody’s who recommend using the Citibank Pension Index rate which typically is under 5.0%), CalSTRS is underpaying their unfunded contribution by a factor of more than six times.
Columns 2 and 3 in Table 2 help illustrate why it isn’t excessive to specify a 20 year, level payment plan to eliminate a pension plan’s unfunded liability. Because the amount of the unfunded pension liability, the principle being repaid, will fluctuate according to how much fund managers think the invested assets are going to earn. And as Table 1 shows, the amount of the unfunded liability is extremely sensitive to these changes.
In column 2, case 1 shows the impact of a 6.20% rate of return projection for the CalSTRS pension fund. The unfunded pension liability increases from the official $70.0 billion to $107.8 billion, which more than offsets the using the lower 6.20% rate to calculate the required payments. In case 1, a 6.20% projected rate of return for the CalSTRS pension assets will equate a $9.55 billion annual payment to reduce their unfunded liability. In case 2, a 4.81% projected rate of return for the CalSTRS pension assets will equate a $12.2 billion annual payment to reduce their unfunded liability.
Note: The first table in the Appendix to this report shows more detail on how CalSTRS is currently incurring negative amortization, i.e., how the unfunded pension liability will increase each year if only $1.13 billion is paid annually toward reducing that liability, as well as how the unfunded pension can be eliminated within 20 years using the higher payments calculated using the level payment method.
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HOW DO LOWER RATES OF RETURN AFFECT CalSTRS NORMAL CONTRIBUTION?
No discussion of whether or not sufficient funds were contributed to CalSTRS during FYE 6-30-2012 would be complete without considering the “normal contribution,” which was $4.69 billion. The normal contribution is defined as how much future pension obligations were earned by actively employed participants during the current year, in this case, during the 12 month period ended 6-30-2012. If a pension plan is considered to be 100% funded, the normal contribution is the only payment necessary.
Table 3, below, revalues the normal contribution using methods recommended by Moody’s Investor Services. Again, a shortcut of this type is necessary because it is impossible with publicly available information to apply various rates of return to estimated future annual pension payments accrued during 2012 according to the actuarial profile for every actively employed participant in CalSTRS. Instead, the normal payment, representing the present value of the entire stream of future pension payments earned by actively working participants in the most recent year, is recalculated, using the official rate-of-return projection, 7.50%, at a future value set 17 years from now, representing the average remaining service life of active employees. This future value is then discounted back to present value using the lower rate-of-return, in our cases, at 6.20% and 4.81%. This process will yield a higher required normal contribution. Here’s how Moody’s describes this method in their July 2012 proposal “Moody’s Adjustments to US State and Local Government Reported Pension Data.” 
“The ENC [employer’s normal cost] adjustment reflects the lower assumed discount rate and the use of a 17-year active employee duration estimate for all plans – i.e., each plan’s normal cost is projected forward for 17 years at the plan’s reported discount rate, and then discounted back at 5.5% [based on the Citibank Pension Liability Index, as Moody’s specifies, which has dropped subsequently dropped to 4.81% – this study uses two lower rate scenarios, 6.20% and 4.81%], after which employee contributions are deducted to determine the adjusted ENC. The 17-year duration assumption reflects our estimate of the average remaining service life of employees based on a sample of public pension plans. We acknowledge that this is a simplifying assumption that may be too long or too short for different plans. Using this approach, a reported ENC payment of $100 million based on an 8% discount rate would grow to $149 million based on a 5.5% discount rate.”
As case 1 and 2 show on Table 3, lowering the CalSTRS pension fund’s rate-of-return projection from 7.50% to 6.20% increases the normal contribution by $1.1 billion; if it is lowered from 7.50% to 4.81% the normal contribution increases by $2.5 billion.
TABLE 3 – RECALCULATING CalSTRS NORMAL PENSION CONTRIBUTION
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Using evaluation formulas and unfunded liability payback terms recommended by Moody Investor Services in April 2013, this study shows that if the CalSTRS “catch-up” payment is calculated based on a level payment, 20 year amortization of the $70.0 billion unfunded liability – still assuming a 7.50% rate-of-return projection – this catch-up payment should be $6.96 billion per year, rather than the $1.1 billion unfunded payment that was actually made. The study also estimates 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.
This study also estimates that the $4.7 billion normal contribution into CalSTRS for FYE 6-30-2012, based on a rate-of-return assumption of 7.50%, would have to increase to $5.5 billion based on lowering the rate-of-return assumption to 6.20%. Further, the study shows that by lowering the rate-of-return assumption from 7.50% to 4.81% would require the normal contribution to increase to $6.9 billion.
The 2nd table in the appendix, “Required rate-of-return at various levels of underfunding,” shows why underfunding is a slippery slope by illustrating how much higher rates have to be just to keep the underfunding from getting worse. Pension spokespersons have consistently stated that annual earnings in any mature fund will always greatly exceed annual contributions. On the table, the 5th column “baseline” shows how much earnings have to increase at CalSTRS current official level of 67.02% funded. At that level of funding, as can be seen, just in order for the unfunded liability to not increase, CalSTRS currently has to earn an annual return of 11.2%. At that sustained rate-of-return, the surplus earnings beyond the projected 7.50% do not reduce the unfunded liability at all, they merely prevent it from getting larger.
To recap, for the fiscal year ended 6-30-2012, here are some CalSTRS financial highlights as determined in this study:
- Lowering the earnings projection to 6.20% increases the normal contribution by $1.1 billion per year; lowering it to 4.81% increases the normal contribution by $2.5 billion per year.
- The unfunded “catch-up” contribution of $1.1 billion did not lower the officially recognized unfunded liability of $71.0 billion, in fact, it grew by $4.2 billion (ref. Appendix 1, baseline case).
- If the earnings projection is lowered from 7.50% to 6.20% the unfunded liability increases from $71.0 billion to $107.8 billion; if it is lowered to 4.81% the unfunded liability increases to $154.9 billion.
- At the official return projection of 7.50%, if the unfunded liability is paid back according to 20 year level payment amortization terms, the annual catch-up payment would have been $6.9 billion.
- Using 20 year level payment amortization terms, at a return projection of 6.20% the annual catch-up payment should have been $9.6 billion; at 4.81%, it should have been $12.2 billion.
- An annual return projection of 6.20% represents the long-term appreciation of equities , an annual return projection of 4.81% represents the Citibank pension liability index rate as of July 2013 .
The conclusion of this study is that CalSTRS relies on optimistic long-term earnings projections and very aggressive unfunded liability repayment schedules in order to contribute the absolute minimum each year into their pension fund. As a result, their unfunded liability increased during FYE 6-30-2012 by over $4.0 billion. If CalSTRS is required to even incrementally lower their rate-of-return projections further – something that market conditions may eventually dictate – their funded ratio which is already only 67.0% will fall precipitously. Unless extremely favorable market conditions occur for the next several years without interruption, in order for CalSTRS to remain solvent, they need to dramatically cut retirement benefits, or increase their annual contributions by 50% or more per year.
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(1) CalSTRS Defined Benefit Program Actuarial Valuation as of June 30, 2012, page 32, Table 8
(2) CalSTRS “Comprehensive Annual Financial Report, FYE 6-30-2012, page 41, “Statement of Changes in Fiduciary Net Assets.”
(3) Milliman: Defined Benefit Program Actuarial Valuation, as of June 30, 2012, page 15, Section 4 “Actuarial Obligation, Normal Cost.”
(4) Moody’s Adjustments to US State and Local Government Reported Pension Data, request for comment, July 2nd, 2012, page 6.
(5) Pension Math: How California’s Retirement Spending is Squeezing The State Budget, Stanford Institute for Economic Policy Research, page 13, December 2011.
(6) Moody’s Revised New Approach to Adjusting Reported State and Local Government Pension Data,” ref. “The Adjustments,” item 1, April 2013.
(7) Citigroup Pension Discount Curve, Society of Actuaries, July 2013
(8) Moody’s Revised New Approach to Adjusting Reported State and Local Government Pension Data, ref. “The Adjustments,” item 3, April 2013.
(9) Moody’s Adjustments to US State and Local Government Reported Pension Data, ref. page 8, section four, part one “New discount rate applied to normal cost.”
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APPENDIX – TABLE 1 – UNFUNDED LIABILITY AMORTIZATION SCENARIOS
APPENDIX – TABLE 2 – REQUIRED RETURN AT VARIOUS LEVELS OF UNDERFUNDING