Is There is a Public Pension Problem? Then Why Aren't We Solving It?

Joe Nation, Ph.D. Professor of the Practice of Public Policy Stanford University Feb. 24, 2012

Project Summary

Sponsored by California Forward, Irvine Foundation Focus on financial problems, solutions at state and local levels Deliverables (reports)

Statewide San Jose Independent

Outline
Statewide findings Independents Conclusions/Recommendations

Statewide findings Independent systems Conclusions/recommendations

CalPERS Funded Status Has Improved, but Remains Poor, Even at 7.75% Assumption
Statewide findings Independents Conclusions/Recommendations

June 2009 June 2010 June 2011 Dec. 2011

Funded ratio

60.1%

72.7%

73.5%

67.0%

Unfunded liability

$118.9B

$84.7B

$85.5B

$108.6B

Based on 7.75% annual arithmetic rate of return and market value of assets. Dec. 2011 assumes $221.0B market value, $329.6 billion actuarial liabilities.

Unfunded Liability for Three State Systems Tops $142B at 7.75% Return Assumption
Statewide findings Independents Conclusions/Recommendations

CalPERS

CalSTRS

UCRP

Total

Unfunded liability

$85.5B

$50.6

$6.5

$142.6

Unfunded liability per householda

aAssumes

$7,018

$4,152

$533

$11,703

12,187,191 households statewide. U.S. Bureau of the Census, State and County QuickFacts, http://quickfacts.census.gov/qfd/states/06000.html, retrieved Oct. 26, 2011.

Funded Status Poor Using Most Rate of Return Assumptions

Statewide findings Independents Conclusions/Recommendations

Investment Probability of Rate of Return Meeting or Exceeding Rate 9.50% 7.75%a 7.10% 6.20% 4.5%b 21.7% 42.1% 50.7% 62.6% 80.9%

CalPERS

CalSTRS

UCRP

95.1 73.5 66.7 58.3 45.1

95.9 75.3 68.8 60.6 47.6

114.0 86.5 81.8 72.0 60.8

Source: Authors calculations. CalPERS and CalSTRS June 2011 liabilities are estimated based on reported 2009 figures, adjusted for recent annual growth less 50 percent. UCRP June 2011 liabilities are based on 2010 figures, adjusted for recent annual growth less 50 percent. If liabilities are higher, funded ratios will decline. a 7.5 percent for UCRP. b Low is based on the assumed rate of inflation and recent, hypothetical 16-year Treasury Inflation Protected Security (TIPS) equivalent rate (Oct. 17, 2011). The low-risk rate for CalPERS and CalSTRS is 4.504 percent; for UCRP, it is 5.004.

Low Probability of CalPERS Meeting Obligations, Even With 7.75% Assumption

Statewide findings Independents Conclusions/Recommendations

Source: Authors calculations based on June 2011 MVA, 7.75 percent annual rate of return, standard deviation of 12 percent. 16-year duration. 10,000 simulations.

CalPERS Earnings Assumptions Likely Too Optimistic

Statewide findings Independents Conclusions/Recommendations

CalPERS boasts 1990-2011 annual rate of about 8

percent

But a 20th century portfolio with 72% equities,

28% fixed income instruments earned 6-6.5%

Overstating returns results in trouble very quickly

Accounting Rules, Assumptions, and Methods Matter

Statewide findings Independents Conclusions/Recommendations

Discount, investment rates most important Ex post vs. ex ante assumptions

Private sector earns return, then modifies benefits, contribution rates based on market experience Public sectors awards benefits, then expects to earn enough to pay them

Long amortization periods cushion current hit,

increase chances of sustained higher costs
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State Retirement Spending Up Sharply, Likely to Continue Steep Climb

Statewide findings Independents Conclusions/Recommendations

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Scenarios Show Sharp Increases In CalPERS Retirement Spending

Statewide findings Independents Conclusions/Recommendations

Investment Rate of Return 7.1%

Annual Pension Expendituresa $10.0B

Increase Above 2011-2012 Amount $1.6B

6.2%

$16.3B

$7.8B

4.5%
a Based

$25.6B

$17.2B

on covered state and public agency payroll of $47.915 billion.

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Independent Systems Often Overlooked

Statewide findings Independents Conclusions/Recommendations

Non-CalPERS city, county, special districts $156.7 billion in current assets 320,000 active members Significant impact on lives of residents Examined top 24 in 20 jurisdictions Summary findings

53.6% funded ratio collectively $135.7 billion in unfunded liabilities

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Independent System Pension Expenditures Growing at High Rate

Statewide findings Independents Conclusions/Recommendations

Pension share of member government spending

4.1% in 1999 9.6% in 2011

Pension spending growth, 11.4%, faster than other spending

Education 5.6% Public assistance 4.5% Public protection (safety) 5.3% Health & sanitation 4.2% Public ways & facilities 10.4% Recreation & cultural 5.3%

With low investment returns, pension expenditure growth rates actually understate that necessary

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Pension Share of Total Expenditures for All Systems Rises (Potentially) to 16-20%
Statewide findings Independents Conclusions/Recommendations

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San Mateo County Pension Share of Total Expenditures Shows Relatively Steady Climb
Statewide findings Independents Conclusions/Recommendations

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San Jose Pension Share of Total Expenditures Began Steep Climb After 2010
Statewide findings Independents Conclusions/Recommendations

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Funded Ratios Average 53%

Statewide findings Independents Conclusions/Recommendations

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San Jose Benefit Levels At or Near Top

Statewide findings Independents Conclusions/Recommendations

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So Why Arent We Solving the Problem?

Statewide findings Independents Conclusions/Recommendations

Public has not yet caught on Sacramento frozen by politics Dishonest title/summary for proposed initiative Not most pressing problem

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Gov. Browns Reforms Have Positive, But Modest And/Or Long-Term Effects
Statewide findings Independents Conclusions/Recommendations

Reform measure Benefit reductions

New employees

All employees

Requires hybrid plan Increases retirement age Requires three-year salary

basis to avoid spiking Limits final salary to base rate, i.e., base salary only

Felons forfeit pensions, if related

to official business Prohibition on retroactive pension increases Prohibition of service credit purchases Limits post-retirement employment

Contributions

NA

Requires employees to

Governance/other

NA

contribute at least 50 percent of normal costs Prohibits pension holidays Adds public members to CalPERS
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Source: Office of Governor Jerry Brown, Twelve-Point Pension Reform Plan, Oct. 27, 2011, http://gov.ca.gov/docs/Twelve_Point_Pension_Reform_10.27.11.pdf, retrieved Oct. 27, 2011.

Climbing Out at the Local Level: The Easy Part?

Statewide findings Independents Conclusions/Recommendations

Support Gov. Browns 12 Point Plan Add operational flexibility

Via initiative

Educate stakeholders Litigate

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The Hard Part: Reducing Costs

Statewide findings Independents Conclusions/Recommendations

Employee compensation

Decrease compensation costs through collective bargaining (if/ when contracts are open) Require employees to pay a larger share of contributions (e.g., for enhanced benefits) 2nd tier for new employees, e.g., do not include optional benefit upgrades, such as COLAs, final year compensation basis, etc. Ensure wide cafeteria of health care plans offered to active members; will reduce retiree health care costs

Retiree health care

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Contact Information

Joe Nation, Ph.D. SIEPR Stanford University 650-724-9532 jnation@stanford.edu

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