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Pension Reform: The Key to California's Budget Problems

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California has been hard hit since the economy took a dive in 2008, with at least one city declaring bankruptcy and others considering it. The state is struggling to find ways to cut expenses. Pension reform tops the list of items that would save both local and state governments money.  

California Gov. Jerry Brown made pension reform a priority. In October of last year, he came up with a 12-point proposal to help solve the pension crisis. The Senate Republican Caucus has taken on the duty of making Brown’s proposals a reality.

“I am committed to pension reform because I believe there is a real problem,” said Brown in his State of the State Address on Jan. 18. “Three times as many people are retiring as are entering the workforce. That arithmetic doesn’t add up. In addition, benefits, contributions and the age of retirement all have to balance. I don’t believe they do today. So we have to take action. And we should do it this year.”

Brown’s proposal would, among other things, stop current and future employee members of all state and local retirement systems from purchasing additional retirement service credits, would prohibit pension holidays and prohibit employers from making employee pension contributions. It also would prohibit retroactive pension increases and pension spiking and any person who commits a felony related to their employment would no longer receive pension benefits.

The state Senate introduced a Senate Constitutional Amendment last June, which was amended in January 2012, that calls for various pension and health reform measures, including the creation of a hybrid plan for new hires.

The California Public Employees’ Retirement System (CalPERS), which is the nation’s largest public pension fund with $245.8 billion in total net assets as of June 30, 2011, conducted an analysis to find out what the impact would be of offering a hybrid plan to new hires beginning Jan. 1, 2013. A hybrid plan would include a defined contribution plan and a reduced defined benefit plan.

 “One key aspect to keep in mind when a hybrid plan is being considered is the fact that lowering the risk for an employer in a hybrid plan does not necessarily mean lowering the cost,” the CalPERS analysis found.

In the hybrid scenario, new hires would have to foot about half the bill of both plans, taking on more risk while the employer sheds risk. The plan would reduce a new hire’s benefits at retirement from what they are today. 

“Even though the total retirement benefits provided to the member by the proposed hybrid plan are lower than those currently in place, the expected savings are generally not significant and for the State plans cost increases for some plans may largely offset cost savings in other plans,” according to CalPERS.

“We’re doing fairly well. We’re estimated to be around 75 percent funded as of June 30, 2011,” said Amy Norris, a spokesperson for CalPERS. “With the adjustment of our discount rate, that might go down a percentage or two, but if a fund is 80 percent funded, that is fairly good for a pension fund and we’re close to that.”

Currently, CalPERS offers a defined benefit plan.

“We stand behind defined benefit plans as an efficient way to deliver a secure pension,” she said. “We just have to wait and see. Funding depends on the markets. We did recently lower our discount rate to increase the stability of the fund. It will increase our unfunded liability, but does make our fund more stable.”

She added that “everybody wants a sustainable pension system that works for members and employers that will be here for the long haul.”

CalPERS isn’t the only California pension that has suffered during the economic downturn. The Stanford Institute for Economic Policy Research and California Common Sense released a report in February showing that California’s local pension systems, that aren’t part of CalPERS, are more than $130 billion in debt.

The study covered the top 24 independent systems across California, including the counties of Alameda, Contra Costa, Fresno, Kern, Los Angeles, Orange, Sacramento, San Diego, San Francisco, San Joaquin, San Mateo, Santa Barbara, Sonoma, Stanislaus and Ventura and in the cities of Fresno, L.A., San Jose and San Diego.

It found that as of June 2011, the funded ratio for the 24 systems was 53.6 percent, based on a discount rate of 5 percent. “This is higher than the 45.1 percent estimated under the same assumptions for CalPERS,” the report stated.

The unfunded liability for the 24 systems is $135.7 billion and none of the systems is at or above 80 percent funded.

The aggregate reported 2011-2012 employer contribution rate is 23.8 percent. About one-half of this rate is due to contributions for unfunded liabilities, the report found. “Aggregated pension costs were 4.1 percent of aggregate municipal spending in 1999; by 2011, that figure had more than doubled. The highest share is 17.7 percent in San Mateo County and the lowest is 6 percent in Los Angeles County.”

It also found that between 1999 and 2010, “pension spending grew at 11.4 percent per year, more than the rate of growth for any other expenditure category.  If the investment rate of return is 6.2 percent annually, which is a typical rate of return for private pension systems, total pension costs would total 17.4 percent of all municipal expenditures by 2012,” according to the report.

Many California municipalities are exploring different ways to rein in their pension costs, like raising the average retirement age, having new hires contribute more to their plans or switching from defined benefit to defined contribution plans.