An official analysis of two public pension reform initiatives last week raised an issue quickly seized by opponents — a potential cost increase of $1 billion or more a year for state and local governments during the next two or three decades.
Much of the focus in the pension debate has been on court rulings widely believed to mean that pensions promised state and local government workers on the date of hire can’t be cut, not even for future service as is allowed in private-sector pensions.
Now the analysis of the two proposed initiatives makes the point that switching new hires to cheaper retirement plans can drive up costs, mainly by cutting the cash flow used to help pay pensions under the old plan.
To replace the cash from new hires the old plans would have to switch some investments to yield cash not capital gains, lowering expected earnings. And a lower earnings forecast can increase employer contributions to the old plans and long-term debt.
The nonpartisan Legislative Analyst’s Office review of two versions of an initiative proposed by California Pension Reform, led by Dan Pellissier, said putting new state and local government hires in cheaper retirement plans could trigger major costs.
The analyst said an initiative giving new hires 401(k)-style investment plans could increase employer costs for two or three decades by “up to several billion dollars more per year (in current dollars) to cover pension costs of current and past employees.”
Over a similar period, the analyst said an initiative giving new hires a “hybrid” retirement plan combining a smaller pension with a 401(k)-style plan could cost employers “$1 billion more per year (in current dollars).”
But the initiatives also would cap employer contributions, raise the contributions of current employees to help pay off pension debt and make other cost-cutting changes virtually certain to be challenged in court by public employee unions.
The analyst’s summary of the fiscal effect of the 401(k) initiative, similar to the hybrid summary, reflects the uncertainty and concludes that government costs could go up or down:
“Over the next two or three decades, potentially significant increased annual costs or some savings in state and local government personnel costs, depending on how this measure is interpreted and administered.”
The analyst’s summary is more certain about what happens under the 401(k) initiative, and potentially under the hybrid plan depending on its structure, when most workers are in the cheaper retirement plan.
“In the long run (several decades from now), annual savings in state and local government personnel costs of billions of dollars per year (in current dollars), offset to some extent by increases in other employee compensation costs.”
The analyst thinks that if retirement benefits are cut by the initiative, pay or compensation for government jobs is likely to be increased to keep them competitive in the labor market.
A labor coalition, Californians for Retirement Security, issued a news release about the Legislative Analyst’s Office review of the initiatives that emphasizes the potential cost increase.
“LAO: GOP Pension-Slashing Measures Would Mean ‘Large Uncertainty’ and $1 Billion a Year in New Costs for at Least 30 Years,” said the headline on the labor news release. “Legislature’s Fiscal Watchdog Says Proposals Threaten Massive Legal Challenges, Reduced Returns and Would Hurt CalPERS and CalSTRS.”
The author of the initiatives, Pellissier, a former aide to a Republican governor and legislator, said part of the potential increased cost of the initiative would be covered by increased employee contributions.
Pellissier said he had expected a more detailed analysis, perhaps using data available from the 20 largest public pension plans that cover about 90 percent of the state and local government employees.
For example, he said, the initiatives would save employers money by more quickly paying off pension debt or unfunded liabilities. He said the analysis is “more of a discussion of the concepts” than an evaluation based on assumptions and work sheets.
Pellissier said the group will use the title and summary of the initiatives, expected from the attorney general later this month, in polling to determine which version of the initiative to place on the November ballot by gathering voter signatures.
“We have hired fundraisers in all the major markets,” he said. “We are seeing enough money to do what we need to do.”
In San Diego, a pension official said an initiative on the June ballot that would give all new city hires except police a 401(k)-style plan instead of a pension could increase costs by about $90 million over the first six years.
If the pension plan is closed to new hires, said Mark Hovey, the pension system’s chief executive, government accounting rules require the $2.1 billion pension deficit to be paid off more quickly.
Gov. Brown fired back last month when the California Public Employees Retirement System said the hybrid plan for new hires in his 12-point pension reform plan could increase employer costs.
“As a matter of fact when I read the PERS analysis they say if you close the system of defined benefit (pensions) and don’t let any more people in, then the system would become shaky,” Brown told a legislative hearing.
“Well, that tells you you’ve got a Ponzi scheme,” the governor said.
“Because if you have to keep bringing in new members then the current system itself is not in a sustainable position,” he said. “So I don’t accept that, and we don’t need to close it off, anyway. But we do have to make sure that this system is sustainable over the long term.”
In a Ponzi investment fraud, recently made famous by convicted swindler Bernie Madoff, money used to pay investors if they cash out their account comes not from earnings but from new investors.
The CalPERS chief actuary, Alan Milligan, told the legislators he does not think carrying out the governor’s plan requires closing the current pension systems to new hires.
“However, that is one possible way of accomplishing the governor’s proposal, so it’s important to understand what it means when that happens,” he said.
After explaining how less cash flow from new hires can lower investment earnings, Milligan said it’s also important to know that the “same effect” can result from giving new hires lower pensions.
He said it’s not clear that the “significant” reduction of pensions for new hires in the governor’s plan would trigger lower earnings. But if it did, that would not happen for many years.
“So this is a concern,” Milligan told the legislators. “This is something that you want to think about. But this is not a boogeyman in the night that means you should be scared away from any particular course of action.”
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 Jan 12