SIEPR Report Calls For Reform to Calif. Pension System

The report, which is authored by Stanford Professor Joe Nation with the assistance of California Common Sense (CACS) researcher and Stanford junior Evan Storms, covers the California Public Employees’ Retirement System (CalPERS), California State Teachers’ Retirement System (CalSTRS) and the University of California Retirement Plan (UCRP).

During a press call, Nation said his graduate students conducted research, and they first looked at the unfunded liabilities today. “Perhaps, surprisingly, the numbers are worse than they were a few years ago,” said Nation. “Things are worse off depending on which scenario you use – 15%-20% worse than they were two years ago.”

Research for the report found:
•  Contribution rates, the share of payroll that state government sponsors of pension plans pay each year, are likely to double or perhaps triple, crowding out education and social services spending. At the state level, barring new revenues, pension spending is likely to rise from its current 5.7% share of General Fund spending to more than 17%.
•  Delaying reform is increasing the costs to the state of California and other governments facing pension shortfalls. “Every day we delay a solution it costs $3.4 million. Over the next year $1.2 billion. That’s money that is not going someplace else in the budget,” said Nation.
•  The June 2011 funded ratio, the measure of assets to liabilities, is only 74% for CalPERS, using a high rate of return on its investments. At a more realistic 6.2% rate of return, the CalPERS funded ratio falls to 58%. Private plans with a funded status below 80% are required to freeze benefits and face other restrictions.
•  Using the same 6.2% assumption, the June 2011 funded status for CalSTRS is 60%. For UCRP, the funded status is 72%.
•  The total unfunded liability for CalPERS, CalSTRS and UCRP is nearly $300 billion, assuming future investment rates of return of 6.2%. Even if the three systems earn 7.75% (CalPERS, CalSTRS) and 7.5% (UCRP) per year, the shortfall is $142.6 billion, or nearly $12,000 per California household.
•  Using a “risk-free” or low-risk discount rate, the total unfunded liability for CalPERS, CalSTRS and UCRP is $498 billion, 17% higher than the $425 billion shortfall estimated in April 2010.  

It is highly unlikely that California’s pension systems will invest their way out of their funding problems. CalPERS must earn an annual average rate of return of 12.5% for 16 years to ensure that its assets are sufficient to cover its liabilities, according to the research.  The magnitude of the problem is sufficiently large that prospective benefit reductions for current employees should be examined, despite legal hurdles.

The report authors conclude that California Governor Jerry Brown’s reform plan is a needed step in the right direction, more than doubling previous savings from reforms, but it appears likely to reduce the unfunded shortfall by a small amount. During the press call, Nation mentioned Brown’s savings plan would save the state $6.2 billion over a 10-year period. “His plan is not exactly clear,” said Nation. “To some people that is a small number, and it certainly is. But he does need to at least more than double the savings to date than previous reforms. I don’t think you can resolve this problem unless you put benefits on the table for employees. There is no way to solve this problem unless that is there." 

Nation added, “My hope is that policy makers and leaders will step up and they will actually decide to address this problem. That means we will have to contribute more to these pension systems now, but that means we will save more in the long run.” 

In addition to the statewide report, SIEPR and CACS are releasing a report on the financial well-being of 63 local or independent public pension systems and a report on San Jose’s two public pension systems later this week.

The studies will be available on the SIEPR website at siepr.stanford.edu.