Pension dilemma: cut benefits or contributions

As an historic stock market crash continues its downward spiral, local pension fund officials are talking about two very different responses — cut benefits to retirees or delay putting more money into bleeding investment funds and hope the market recovers.

Generous state and local government pension benefits, some of which allow retirement at age 50 or 55 with up to 90 percent of the final salary, were expected to be paid not by taxpayers but mainly by returns on long-term investments.

That worked when a long bull stock market yielded big returns for investment portfolios, often above the 8 percent annual return assumed in the long-term forecasts of many pension funds.

A national report issued last week said that between 1990 and 2006 state and local government pension funds received 69.6 percent of their money from investment earnings. Employers (taxpayers) contributed 19.6 percent and employees 10.8 percent.

“Earnings on investments — not taxpayer contributions — then have historically made up the bulk of pension fund receipts,” said the report by the National Institute on Retirement Security, a nonprofit group in Washington, D.C.

When the stock market soars, the taxpayer contribution to the pension funds can drop, sometimes all the way to zero. Regents voted last month to restart contributions to the University of California retirement system next year after a two-decade “holiday.”

But when the stock market falls, an increase in taxpayer contributions is the standard way to fill the hole in the pension fund, providing the money that forecasters say will be needed to pay for future pension obligations.

Now the stock market crash is turning up the pressure for more taxpayer contributions to pension funds. Needless to say, it’s bad timing as a faltering economy produces less tax revenue and other government programs face cuts.

Many state pension funds had lost 30 percent of their value by the end of last year, the Retirement Research Center at Boston College estimated. The stock market plunge has continued since then, punching even bigger holes in pension funds.

It’s a dilemma for local officials who have the dual responsibility of maintaining the health of pension systems while also trying to avoid deep spending cuts in other government programs.

In San Diego, Supervisor Dianne Jacob said in her State of the County address last month that a 30 percent loss had erased a “staggering” $2.5 billion from the county pension fund.

“Even if the market bounces back, the required contribution by the county is expected to triple over the next five years,” said Jacob. “The hard reality is this: current benefits are not sustainable. Many governments are considering drastic changes.

“From returning to a two-tiered pension system, to increasing the retirement age, to asking employees to shoulder more of their contribution, all of these ideas should be on the table to keep the fund healthy.

“I believe our employees and our labor unions understand the gravity of our economic situation. A government that cannot stay afloat helps no one. There are really only two choices here: pick up an oar and row, or watch as we take on water.”

A “two-tiered” system would reduce pension benefits for new employees, without changing benefits for current employees obtained through collective bargaining contracts protected by law.

But there have been notable examples of two-tier pension systems that were adopted during hard times, then abandoned when the stock market took off again.

Former Gov. Pete Wilson, a Republican, obtained legislation creating a two-tier system for state workers during a state budget crunch in the early 1990s. Former Gov. Gray Davis, a Democrat, signed legislation in 1999 undermining the two-tier system.

In the San Francisco retirement system, where pension benefit increases must be approved by voters, a two-tier system was imposed in 1976. Then it was erased, retroactively, by a series of votes from 1996 to 2000.

Seeking more than a lower tier of benefits for new employees, the City of Vallejo declared bankruptcy last year and is asking a federal court to overturn labor contracts providing retirement benefits for current employees.

U.S. Bankruptcy Court Judge Michael McManus concluded a hearing Feb. 10 and is expected to rule soon in the widely watched case. Labor unions, challenging the bankruptcy in a separate suit, are expected to appeal if McManus overturns the contracts.

In another test case, Los Angeles County Superior Court Judge Helen Bendix tossed a lawsuit last week filed by Orange County supervisors to overturn an agreement with deputy sheriffs in 2001 that boosted their pension benefits by about a third.

Supervisor John Moorlach argued that the retroactive benefit increase is a gift of public funds for work already performed and will cost $187 million in the decades ahead, exceeding a debt limit. The suit may be amended or the judge’s ruling appealed.

In Los Angeles last week, a report on the big hole punched in the city’s two pension funds by stock market losses talked about ways to cut contribution rate increases, not retirement benefits.

A staff report said the city’s pension contribution could increase by more than $1 billion during the next several years — up $458 million in fiscal 2010-11 and $663 million in fiscal 2011-12, an estimate that could change with investment returns.

“Furthermore, we are exploring different funding methodologies to help mitigate these impacts,” said the report by Raymond Ciranna, interim city administrative officer.

According to actuarial consultants, said the report, contribution increases might be reduced in the short run by “extending the smoothing or amortization periods, or modifying the existing market value corridor policy.”

The strategies would delay recognition of the pension fund’s stock market losses. But that could result in higher contribution rates in the future — unless a bigger-than-expected market rebound lowered future contribution rates.

“The advisability of lowering short-term contribution rates relies on the assumption that either these higher contribution rates will be more affordable when the economy turns around and/or that a market rebound will generate investment gains in excess of actuarial assumptions, reducing later contribution rates,” the report said.

“Given the current market volatility, there are many unknowns.”

Reporter Ed Mendel covered the Capitol in Sacramento for nearly three decades, most recently for the San Diego Union-Tribune. More stories are at https://calpensions.com/ Posted 3 March 09

3 Responses to “Pension dilemma: cut benefits or contributions”

  1. Jim Reilley Says:

    They should cut services or raise taxes and meet their obligations to existing employees. Defining EXACTLY what your compensation is going to be on the front-end is only fair. Cut pensions for newly-hireds who know what they are getting and can choose to be hired on the new terms or go elsewhere. But to induce people with a promise (moral or legal) of a certain pension level and then change it after people have relied on it, many times after decades of employment, is unacceptable. This crisis is the politicians’ fault not the employees. If they had implemented proper tax & budgetary policies they would not be in this mess.

  2. Rich Rifkin Says:

    Ed,

    I read your blog all the time and appreciate your work. I have a suggestion for a story you might consider: What is going on in Pacific Grove. Last November, the citizens of that city voted to divorce from CalPERS. I don’t know how far along the divorce is or what it will mean for the future. I’d love to see you take a look at this, and see how PG’s new retirement program will compare with what they would have faced, had they remained in the CalPERS fold.

  3. ian Says:

    There really should be a cap on how much someone can receive – I have a hard time believing that anyone actually NEEDS $200k/yr. I don’t care if it was promised, it is wrong.

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