At a time when most public employee retirement funds have huge debts, a court decision has resulted in a $7 billion reserve for a CalSTRS inflation-protection account expected to spend $269 million this fiscal year.
The Supplemental Benefit Maintenance Account makes payments needed to keep the pensions of CalSTRS retirees from falling below 85 percent of their original purchasing power.
The California State Teachers Retirement System gives retirees an annual 2 percent increase, based on the original pension payment and not compounded. But the cost-of-living adjustment has not kept pace with inflation in recent decades.
This fiscal year 24 percent of CalSTRS benefit recipients (59,996 persons who generally began receiving pensions in 1990 or earlier) are expected to receive a total of $269 million to keep their pensions at 85 percent of the original purchasing power.
The special fund that makes the inflation-protection payment not only has a $7 billion reserve now, but money continues to pour into the Supplemental Benefit Maintenance Account, rapidly increasing the size of the reserve.
The special account gets about half of the $1.3 billion state contribution to CalSTRS this fiscal year. The other half goes to the seriously underfunded CalSTRS pension fund, which has a $56 billion long-term debt or unfunded liability.
Moreover, the interest earned by the $7 billion reserve, $489 million last fiscal year, is nearly twice the amount needed for the annual inflation-protection payment. The interest is growing at a pace that may soon surpass the state contribution to the account.
How did this happen?
A secondary provision in a pension-boosting bill, AB 1102 in 1998, made the state contribution to the special account, 2.5 percent of teacher pay, a “vested” right protected by contract law.
That means the state must continue to make an annual payment equal to 2.5 percent of teacher pay, now more than $600 million, into a special account with a reserve far in excess of the amount needed for its annual expenses.
As lawmakers learned the hard way, the courts have been ruling that “vested” pension rights are protected by contract law and not easily cut.
During a budget crunch in 2003, the state cut $500 million from its payment to the inflation-protection account when the reserve was $1.6 billion. The CalSTRS board filed a lawsuit and won repayment.
The state made an initial repayment of $500 million to the special account in September 2007. Now the state is paying off the remaining principal and interest with $70 million annual installments, the last one scheduled next fiscal year.
Meanwhile, the unvested state contribution to the CalSTRS pension fund, which was 4.3 percent of teacher pay in 1998, was cut by legislation and dropped to 2 percent of teacher pay.
Most of the CalSTRS contributions come from teachers, 8 percent of pay, and school districts and other employers, 8.25 percent of pay.
An actuarial report showed that as of June 30 last year, the CalSTRS pension fund was 61 percent funded. An additional annual contribution of 14 percent of pay, nearly $4 billion, would be needed for 100 percent funding over the next 30 years.
The CalSTRS investment fund, recently worth $154 billion, had strong earnings in the fiscal year ending last month, up 22 percent. But the fund, which plunged to $112 billion in March 2009, is still short of its $180 billion peak in October 2007.
Unlike most California public pension systems, the CalSTRS board lacks the power to set the annual contribution rate that must be paid by employers, needing legislation instead.
Two key points in the CalSTRS message to lawmakers: 1) Investment earnings will not close the funding gap. 2) The amount of the contribution increase needed for full funding grows with delay.
So, would the $7 billion in the special-account reserve, and the $600 million annual state contribution to the account, be better spent if much of the money was shifted to the troubled CalSTRS pension fund?
Or during this era of deep state budget cuts, when school spending has been slashed, why not tap the unused $7 billion reserve for a multi-billion dollar loan that could ease some of the painful reductions in education or health and welfare programs?
The provision in the 1998 bill vesting the state contribution to the special account at 2.5 percent of pay can look like a blunder, at best a drafting error.
The bill could have protected retirees by guaranteeing that pensions would not drop to less than 75 percent of their original purchasing power (later increased to 85 percent, the current minimum).
Lawmakers would have retained budget flexibility, the ability to respond to changing circumstances. The state would have avoided the apparent absurdity, not to mention inequity, of pouring money into a giant unused reserve during hard times.
But the vesting bill was enacted during good times, part of a legislative package in 1998 that increased teacher pension benefits, while cutting state contributions to the pension fund.
The CalSTRS funding level, about 30 percent in the 1970s, was nearing 100 percent. Legislation a decade earlier had increased contributions to the system, and investment earnings soared during a high-tech boom.
Lawmakers wanted to use the apparent new wealth to increase the pensions for teachers, which were said to be lagging other public retirement systems, and give teachers with long service and experience an incentive to work longer.
Top billing in the vesting bill went to provisions that boosted pensions. Unused sick leave was allowed to be counted as service credit. The pension formula was increased for teachers with 30 or more years of service.
The vesting bill and another pension-boosting bill were linked to a third bill that a legislative analysis said “contains the funding component of the package.“ AB 2804 lowered the state CalSTRS contribution, saving $1.4 billion over seven years.
Now some CalSTRS officials regard the ironclad inflation-protection account as one of the good things that emerged from the good times more than a decade ago.
In their view, the big reserve is not excessive because the billions could be used up fairly quickly if inflation increases, particularly to the double-digit level of the late 1970s.
The funding stream from the state general fund into the inflation-protection account is indeed vested. But inflation-protection payments to retirees are not vested if the account does not have enough money to make the payments.
Therefore, at a time when most public retirement systems are seriously underfunded, including the CalSTRS pension fund, the inflation-protection account is a welcome exception with a healthy cushion to protect retirees in the future.
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 13 Jul 11