Pension Reform Comes to Ventura County

“401Ks carry no guarantee, and that’s the distinction between a defined contribution system and a defined benefit system.”  – Rick Shimmel, executive director of the Ventura County Deputy Sheriffs’ Association, February 20, 2014, Fox News Soundbite

Truer words were never spoken, Mr. Shimmel. But when the “guarantee” can’t be lowered to levels that are merely unfair and burdensome, as opposed to monstrously unfair and financially catastrophic, then replacing “guarantees” with uncertainty and risk becomes the only option.

The latest attempt at pension reform in California is the Ventura County Pension Reform Initiative, affecting an affluent and idyllic coastal region that includes cities to the north of Malibu and south of Santa Barbara. It’s hard to imagine a nicer place to serve as the latest battleground in the pension wars.

What Shimmel objects to is the provision of the pension reform that creates a 401K “defined contribution” plan for all new hires to the county. The virtue of such as system is that the only commitment the employer makes is to deposit an agreed percent of each participant’s salary into a tax-deferred retirement account. Once the employee retires, they will draw on the retirement account until it’s gone. And if they run out of money, the employer – i.e., the taxpayer – doesn’t have to replenish their account.

How could it not have come to this? Despite well-orchestrated statewide protests against reformers who threaten the “modest pensions” of “working families,” Ventura County is no exception in terms of just how out of proportion their retirement benefits are compared to private sector norms. Take a look at this “VCERA Retirement Benefit Calculator” to do some informal Ventura County pension analysis:  A public safety employee making final compensation of $100,000 with 30 years service can retire at age 55 with a pension of $78,594 per year. Many of us look at these numbers too much. Exactly what part of $78,594 for the rest of your life, starting at age 55 – “guaranteed” and including COLA adjustments – doesn’t sound rather excessive? If you wanted to save enough to pay yourself that much for 30 years using a 401K account, according to the conventional wisdom of responsible investment advisors, you would have to save between $1.97 and $2.59 million. How many 55 year old workers can save that kind of money? But wait, there’s more. While on the VCERA retirement benefit calculator webpage, take a look at their “Retirement Compensation Definition:”

“In addition to base salary, compensation earnable may include, but is not limited to:
Flexible Benefit Credit (total)

Educational Incentives
Employer-paid employee retirement contributions
Employer-paid FICA
Assignment and shift bonuses

Automobile allowance
Annual Leave or Vacation Redemption, limited to the hours you actually redeemed during the normal course of active service, and within the 12 or 36 month period to be used for the measurement of final compensation, not to exceed the number of hours actually accrued during that measurement period, reduced by the number of hours you were required to use in order to qualify to redeem annual leave or vacation.
30 year incentives
Uniform Allowances
Overtime that is scheduled as part of your normal work week”

“Employer-paid employee retirement contributions” and “employer paid FICA” count as “Retirement compensation” for the purposes of calculating a pension. Is this a joke? Automobile allowance? Uniform allowances? Vacation time? “Scheduled overtime”? Using this assortment of criteria, it must be common for full-time senior employees to break $100,000 in eligible final compensation, and many will break $200,000. Skeptical? Go to the TransparentCalifornia website and look up “Ventura County Pensions.” Too bad they didn’t provide the researchers with “years of service,” to debunk the absurdly low averages that are continuously used to mislead voters – averages that include people who only worked a few years.

Ventura’s pension reform has a good chance of being passed by voters, should it make it onto the ballot. But it represents not so much an ideal solution as the only solution that might be expected to survive court challenges. This is a shame. Here is a summary of some pension reform options:

(1) Move to a 401K plan for new hires and make marginal reforms to existing defined benefit plans. Benefits: It will probably survive a court challenge. Drawbacks: It won’t beneficially impact pension fund cash flows for decades, and it creates two very distinct tiers of public servants. An example of this is the Ventura County Pension Reform Intiative (text).

(2) Require all new employees to earn pensions according to lower benefit formulas that are financially sustainable, make marginal reforms to existing defined benefit plans.  Benefits: It will survive a court challenge. Drawbacks: It still won’t beneficially impact pension fund cash flows for decades, if ever. An example of this is CalSTRS “2% at 60” plan for participants hired after 1-1-2013.

(3) Require all active employees, new and existing, to earn pensions from now on according to lower benefit formulas that are financially sustainable.  Benefits: This program will create immediate significant reductions to required annual contributions.  Drawbacks: It still creates two tiers of employees, favoring veteran employees and retirees, because it does not retroactively reduce any formulas or benefits. Also, even though this reform only impacts future pension benefit accruals, by affecting existing employees it is an allegedly unconstitutional violation of “vested contractual rights.” An example of this reform is the state pension reform initiative “Pension Reform Act of 2014” (text) championed by San Jose Mayor Chuck Reed – and probably tabled till 2016, thanks to the power of public sector unions and their political partners, the public employee pension funds.

(4) Suspend cost-of-living adjustments for all pensions for all retirees collecting in excess of, say, $75,000 per year, and concurrently, lower pension formulas on a pro-rata basis, retroactively affecting vested pension benefits and prospectively affecting ongoing pension accruals, for all new and all existing employees, by the additional amount necessary to restore 100% solvency to the fund. Benefits: Solves the problem overnight, and spreads the sacrifice equitably among ALL public servants, rather than punishing the new employees to protect the veterans. Drawbacks: There are legal arguments supporting the position that such measures violate “vested contractual rights.” For examples of this option, look to Detroit and Rhode Island. But the sooner this option is exercised, the less onerous the sacrifices.

An aside: It’s funny how the questionable legality of retroactive pension benefit enhancements never bothered the defenders of defined benefits.

What defenders of defined benefit pensions such as Rick Shimmel should consider is this:  What options three and four accomplish – however unpleasant they may be to veterans accustomed to the current system – is preservation of the defined benefit. What option four offers is conversion to an “adjustable defined benefit” that “adjusts,” whenever necessary, in a manner that preserves solvency, protects taxpayers, and spreads the sacrifice among all participants – new hires, active veterans, and retirees – in an equitable manner, minimizing the sacrifice any single class of participants might have to experience. Social Security, by the way, is an adjustable defined benefit.

What reformers who focus on conversion to 401k plans are doing, unfortunately, is facing reality. The reality is that unions and pension funds refuse to accept meaningful compromises – leaving nothing but the nuclear option of 401K conversions to detonate amidst the palm trees and sandy beaches of Ventura County. Many of the union spokespersons can be forgiven for some of their intransigence, because they are being mislead by spokespersons and strategists representing pension funds into thinking the financial challenges these funds face are manageable without major upheaval. They are not.

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

CalSTRS Contributions Inadequate; Unions Call Reformers “Right-Wing Ideologues”

During the most recent year for which there is publicly available data, the fiscal-year-ended 6-30-2012, the California State Teachers Retirement System contributed a $1.1 billion payment towards paying off an unfunded liability of $71.0 billion. This fact, and much more, came out in a California Public Policy Center study released last week “Are Annual Contributions Into CalSTRS Adequate?

Now let’s suppose you have borrowed $71,000, and you are paying a 7.5% interest rate on this borrowed money. Do you think you would ever have this debt paid off, if you only paid $1,100 per year? How would that work? Isn’t 7.5% interest on $71,000 equal to $5,300? Wouldn’t a mere $1,100 payment put you further in the hole by $4,200? Wouldn’t you owe $75,200 by the end of the year, more than the $71,000 debt you started with?

Multiply by a billion and you’ve got CalSTRS.

And this same disastrous, wishful thinking is playing out in nearly every “professionally managed” public sector pension fund in California. Every year, the combined unfunded liability for these plans grows by $10 billion or more. Why? Because they are employing graduated payment schedules that incur negative amortization, in order to avoid demanding that California’s already over-taxed citizens and bankruptcy challenged cities and counties give even more to the pension funds.

Where is $10 billion a year – or more – going to come from?

Pension finance is complicated. An unfunded liability is caused whenever the present value of the future pension costs, for all participants in the plan, exceeds the value of the assets currently invested. If you think the plan is going to do very well, you expect those assets to earn higher rates of interest. This lowers the unfunded liability. But the $71 billion shortfall is CalSTRS own number, based on their own optimistic projections. They claim they will earn 7.5% per year, on average, forever. Scarier, they believe they will earn 4.5% after inflation, on average, every year, forever. Don’t believe this? Go to page 56 of CalSTRS “Notes to Financial Statements.” See for yourself.

The point? $71 billion is the low number. Adhere to less optimistic forecasts, as recommended by GASB and Moody’s, and watch that $71 billion double. And you don’t need to be a certified pension actuary to know that paying $1.1 billion a year on a $71 billion liability will NEVER get you out of the hole.

Apparently, however, the public sector union machine that runs California wants to believe this party can go on forever. And backing them up are the pension bankers; the Wall Street speculators, the hedge funds, the private equity funds, the high frequency traders, the currency speculators – the entire corrupt apparatus of casino capitalism – addicted to $350 billion (or more) per year of taxpayers money pouring through U.S. government employee pension funds and into their firms to invest.

Public sector pensions are headed for a catastrophic clash with taxpayers. Because California’s taxpayers don’t have another $10 billion per year to rescue public sector worker pensions – and that’s the minimum, if they hit their numbers year after year.

To save CalSTRS, and the other defined benefit plans, the initiative proposed by San Jose Mayor Chuck Reed (ref. Pension Reform Act of 2014) is a good start. It will allow cities and counties to reduce pension benefits that haven’t yet been earned. But even that modest reform is being fought behind the scenes. Unions are putting contributors and businesses on notice – don’t support this initiative – or else.

Here’s what union spokesperson Steve Maviglio has to say about Mayor Reed in his recent essay “Reed’s Anti-Pension Drive Enrages Labor:”

“Perhaps Reed’s biggest dilemma is that the only money behind the measure is likely to come from right-wing ideologues.  The state’s business community has little interest in changing the pensions of public employees.”

These unions are making a tragic mistake. Because if they don’t recognize the problem and start working with reformers, their plans could collapse entirely.

Saving defined benefits, using CalSTRS as an example, might require the following:

(1) Recognize that pension bankers are peddling the same sort of misleading, overly optimistic financial hogwash that lead to the housing bubble and great recession. Stop carrying their water.

(2) Reduce all pension benefits to the levels in place before the benefit enhancements began back around 1999. Do this retroactively and apply this to all active and retired participants.

(3) Establish a floor on pension benefits for participants so nobody collects less than they would have if they’d been enrolled in the Social Security system instead of CalSTRS.

(4) Establish a ceiling on pension benefits equivalent to twice the maximum Social Security benefit.

(5) For retirees and active employees with significant vested benefits, phase in the preceding benefit reductions by abolishing cost-of-living increases to pensions until the purchasing power of their benefits erodes to the specified levels.

(6) Establish one pension multiplier from now on, instead of awarding teachers escalating multipliers if they stay in the profession longer. Back-loaded multipliers keep bad teachers teaching, and discourage good prospects from entering the teaching profession at mid-career.

(7) Enroll ALL public employees in the Social Security system and adjust pension benefits further downwards accordingly.

It may come as a surprise to pension reactionaries that not all reformers are libertarian brutes, or “right wing ideologues,” who hope to someday reduce every citizen to island status in a Darwinian ocean. Social Security is a successful safety net that can be rendered permanently solvent with relatively minor adjustments. Similarly, defined benefit pensions can be saved if the benefits are reduced and the assets are invested in lower yielding, but far less risky assets.

Maviglio suggests that “the smart money in the state sees it [pension reform] as a sure loser.” Maviglio may be right that nobody in their right mind dares to fight California’s unionized government. But he is wrong regarding the facts about pensions. Absent major reform, CalSTRS, CalPERS, and nearly every other government employee pension plan in California is headed for shoals. When they run aground, they are going to wipe out public sector solvency, and, ironically, foster a wave of privatization in response.

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