Raising Contributions not the Solution to CA’s Pension Funding Crisis

October 19, 2010 (PLANSPONSOR.com) – A new study suggests that raising employee contributions alone will not solve California’s growing pension funding crisis.

The report put out by the economic think tank The Milken Institute projects that, if no corrective actions are taken, the combined liability of the three major state pension funds – the California Public Employees’ Retirement System (CalPERS), the California State Teachers’ Retirement System (CalSTRS), and the University of California Retirement System (UCRS) – will be more than 5.5 times as large as total state tax revenue around 2012–2013. Moreover, the combined liability per each working-age adult in California is projected to more than triple, from $3,000+ in 2009 to over $10,000 in 2014.  

The researchers suggest making adjustments to the traditional defined benefit plan by concurrently raising the retirement age and increasing employee contributions, or in order to achieve a more lasting and effective pension overhaul, shifting to a risk-sharing retirement plan. Generally, this type of plan, similar to a defined benefit plan, guarantees a basic pension benefit or a minimum rate of return to pension contributions that are risk-free to the employees, but asks the employees to bear the investment risks for part of their future benefit in the same fashion as a defined contribution plan, such as a 401(k).  

The paper provides examples from Utah, which offers new hires a choice between a hybrid plan that has a lower guaranteed benefit rate or a defined contribution plan, and Nevada, which offers a cash balance plan with an interest credit rate on employees’ pension account balances instead of guaranteeing a fixed annual benefit.  

While recent investment losses have prompted concerns about the state funds’ investment strategies and risk management, and many reports and studies question the funds’ accounting practices, the Milken study says there are also important structural factors at work, mostly related to demographics. From 2000 to 2050, the aging of California’s population will accelerate. The size of the senior population is expected to more than triple, from 3.6 million in 2000 to 11.6 million in 2050. At the same time, the report says the working-age population will increase steadily in terms of its size, but its share of the total population will shrink from around 60% to 54%.  

Improved longevity will result in more benefit-receiving years than pension-contributing years for state employees. “If the average retirement age remains unchanged, pension liabilities will proliferate without commensurate increases in the pension contributions that prefund future benefit payments,” the report states. “If state pensions remain underfunded or if there are future shortfalls, raising employee contributions alone will have a less and less mitigating eect.”  

The Milken Institute report is here. A free registration is required.