Archive for the ‘Funding gap’ Category

CalSTRS rate hike: a start, full phase-in or delay?

March 24, 2014

The total spending increase needed to get CalSTRS, brought low by mismanagement, back to full funding may be the biggest-dollar scenarios ever presented to a California legislative committee.

Legislators were told last week an additional $181.7 billion would be needed for full funding in 20 years. If payments are spread out to ease the budget bite, the additional amount needed to reach full funding in 60 years is a staggering $618 billion.

The point made by comparing the large numbers: Delaying a funding increase drives up the total cost, not to mention forcing future generations to pay for the services of workers received by the current generation.

The California State Teachers Retirement System could project full funding over 30 years with an annual contribution increase of about $4.2 billion, a major rate shock for schools, teachers and the state that contributed a combined $5.7 billion last year.

To allow time for planning and budget adjustments, the funding scenarios prepared by CalSTRS staff phase in rate increases over several years, some not reaching the maximum until fiscal 2020.

A built-in problem for pension funds, which expect to get roughly two-thirds of revenue from investment earnings, is that they need a rate hike when employers are least able to afford one, during an economic downturn that hits tax revenue and investments.

The state budget has a surplus now after a decade of deficits. But there is fierce competition to restore deep recession-era cuts in schools, health, welfare, prisons and courts. Gov. Brown, meanwhile, wants to build a reserve to cushion future downturns.

Jason Sisney of the nonpartisan Legislative Analyst’s Office offered some perspective last week as he concluded his remarks to a joint hearing of the Assembly and Senate public retirement committees, the second in a series on CalSTRS funding.

“I think for many people, who are dealing with this in the Legislature and the executive branch right now, this may be one of the most difficult issues you ever face during your careers in public service,” Sisney said. “It’s not going to get easier.”

CalSTRS is projected to run out of money in about 30 years even if average investment earnings hit the current target, 7.5 percent a year, which critics say is too optimistic.

Some worry that another economic downturn like the last one, the deepest since the Great Depression, could drop the funding level, 67 percent last year, so low that full funding becomes impractical, requiring rate hikes too costly for employers to bear.

Part of the management problem is that CalSTRS, unlike other public pension systems, can’t raise employer rates, needing legislation instead. Dealing with deficits, the Legislature ignored repeated CalSTRS pleas for a rate hike, and the funding gap grew.

The CalSTRS investment portfolio, like most pension funds, tanked during the recession and stock market crash in 2008. The portfolio only recently climbed back to the 2007 pre-crash peak, $180 billion, after dropping to $112 billion in 2009.

CalSTRS had funding surplus in 2000 (Milliman actuaries chart)

CalSTRS had funding surplus in 2000 (Milliman actuaries chart)

Another management problem: As soaring investment earnings during a high-tech boom created a brief funding surplus around 2000, CalSTRS cut contributions and increased pension benefits.

After a slow climb from the 1970s, when CalSTRS only had 30 percent of the projected assets needed to pay for future pension obligations, a funding level of more than 100 percent was treated as a windfall to be split between employers and employees.

(The larger California Public Employees Retirement System did much the same, notably by sponsoring the retroactive SB 400 pension increase in 1999, while some employer contributions dropped to near zero.)

The state CalSTRS contribution was cut by more than 2 percent of pay. For 10 years, a quarter of the teacher contribution, 2 percent of pay, was diverted from the pension fund to a new individual investment plan for teachers.

A half dozen small CalSTRS benefit increases were enacted around 2000, including a longevity bonus that expired three years ago. CalSTRS has done something CalPERS has not done: calculate the impact of the benefit increases on solvency.

An annual actuarial report from Milliman last April said that if CalSTRS were still operating under the 1990 benefit structure, the plan would be 88 percent funded instead of 67 percent funded.

The CalSTRS pension (reduced by a reform for teachers hired after Jan. 1 last year) is lower than most CalPERS pension formulas. On average, for teachers retiring at age 62 with 25 years of service the pension is said to replace 54 percent of final pay.

A past CalSTRS estimate was that many retirees had about 70 percent of final pay replaced when supplemental retirement funds are included. CalSTRS members do not receive Social Security, and most do not receive employer-paid retiree health care.

At the hearing last week, the chairman of the Assembly retirement committee, Rob Bonta, D-Oakland, mentioned increasing the state CalSTRS contribution to the rate in 1997 before the cut, boosting the annual payment about $260 million.

“Maybe we should do something more aggressive this year,” he said, “but it’s something to consider as at least a floor for contributions from the state.”

Bonta asked the CalSTRS chief deputy executive officer, Ed Derman, for his view of the minimum step to “move the ball forward” on funding. Derman said a one-time cash fusion, though helpful, might cause lawmakers to think the issue has been addressed.

“It’s OK if the contributions don’t come in for a period of time,” Derman said. “I think what’s important is to get the (comprehensive funding) plan established.”

Sen. Mimi Walters, R-Irvine, introduced a bill last week, SB 984, that would provide $1 billion in emergency funding for CalSTRS and another $1 billion next fiscal year if a revised forecast in May shows enough unanticipated revenue.

Here’s a CalSTRS scenario for reaching full funding in 30 years, total cost $236 billion:

Teachers — Contributions, now 8 percent of pay, would increase to 10.83 percent of pay by fiscal 2017, costing the average teacher hired before 2013 an additional $2,150 a year.

Lawyers have told CalSTRS that under a series of state court decisions the pension offered teachers on the date of hire becomes a “vested right” that cannot be cut, unless offset by a new benefit of comparable value.

CalSTRS thinks that guaranteeing an annual cost-of-living adjustment of 2 percent, now a routine practice that could be suspended, would be the offset for a rate increase of 2.83 percent.

State — Contributions to the CalSTRS pension fund that were cut to 2 percent of pay are, under an old law, increasing in steps to 3.5 percent of pay. They would be boosted this year to 4.6 percent of pay, the rate paid in 1997 before the cut.

A separate contribution of 2.5 percent of pay goes to the CalSTRS Supplemental Benefit Maintenance Account that keeps pensions from falling below 85 percent of original purchasing power.

Several years ago the SBMA was spending $270 million a year but had a large reserve of $7 billion. The inflation-protection payment is said to be a “vested right,” which means the state cannot reduce its SBMA contribution.

Employers — School districts and community colleges, now contributing 8.25 percent of pay, would get a 12.8 percent increase phased in over several years, bringing the total to 21.05 percent in 2020.

The state general fund provides most of the money for schools. An issue that would need to be resolved: Would imposing a CalSTRS rate hike on schools increase the Proposition 98 school-funding guarantee?

Reporter Ed Mendel covered the Capitol in Sacramento for nearly three decades, most recently for the San Diego Union-Tribune. More stories are at Calpensions.com. Posted 24 Mar 14


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