Pension Funding Should Be a PriorityCategories: California Developments
Public Retirement Journal, by Amy Brown, May/June 2014
Funding retirement and OPEB liabilities should be among the State’s highest priorities, according to a recent report by the Legislative Analyst’s Office (LAO) titled Addressing California’s Key Liabilities. The LAO says the State has $340 billion in key liabilities, debt that will impact the State’s future health. Over $200 billion is attributable to retirement benefits.
Among all of these key liabilities, the LAO says over $140 billion is being effectively addressed. For example, the State is meeting debt service obligations on its 30-year bonds financing infrastructure projects. The LAO also cites the recent actions by the PERS board to ensure its unfunded liabilities are fully funded in about 30 years. The State’s remaining obligations, however, require legislative attention. –
How much is $340 billion? It equals roughly 2.5 times the amount of the State’s general fund and special fund spending combined in 2013/14. Or, another way, it equates to over $8,500 per California resident. The State doesn’t have the money to address the remaining $200 billion in key liabilities, so it must prioritize. The LAO says the Legislature should prioritize based on the growth rate of the liability, and then looking at other factors such as the benefit to employers, individuals, and local governments. Public confidence in government should also be considered; for example, previous expense deferrals have been perceived as accounting gimmicks. A systemized approach to dealing with the State’s liabilities may also lead to higher confidence among credit rating agencies, hopefully translating to a higher credit rating.
The LAO says because of massive unfunded liabilities and a relatively fast growth rate, STRS funding should be a top priority. Over the past three years, STRS has earned an average of over 12 percent per year on its investments, but over that same period, unfunded liabilities have grown by 14 percent primarily due to the underfunding of the system.
Absent additional contributions, STRS estimates it will exhaust its assets in 2046. The LAO says assuming a gradual ramp-up of contributions, the amount necessary to fully fund STRS within 30 years would be about the same as the State’s general fund total spending on the UC and CSU combined.
Although Governor Brown’s initial budget proposal released in January bumped the STRS funding problem another year, legislative leaders made it clear that they intend to wrestle with the STRS funding shortfall with or without the Governor’s involvement. Low and behold, STRS funding was added to the Governor’s revised budget submitted to the Legislature in May (an official process known as the May revise).
The Governor’s proposal plans to address STRS’ $74 billion unfunded liability over 30 years, calling on schools to pay 70 percent of the tab, the State picking up 20 percent, and teachers paying 10 percent through higher member contributions. This is largely similar to STRS’ proposed solution. The State’s share for FY 2014/15 equates to $73.2 million.
School districts receive half of their funding from the State. The State doesn’t believe a STRS rate hike would trigger a matching increase under the Prop 98 school funding guarantee, so a higher pension contribution would mean less money available to restore previous school cuts. Schools currently pay 8.25 percent of pay for teachers’ pension benefits, which would gradually increase to 19.1 percent of pay. (Teachers do not participate in Social Security.)
While school districts may get little empathy from local governments, this still translates into a potential budget strain for school districts that hadn’t anticipated this extra cost. For one school district, San Francisco, an additional $34 million per year will be required to supplement its existing $25.8 million pension spending. For FY 2014/15, the district will need an additional $4 million. (To be fair, school districts are being given ridiculously little notice if they’re truly expected to pony up more starting on June 1st.)
The Legislature seems primed to pass the proposal to shore up STRS funding, which is currently under consideration by the Budget Committees.
The LAO says among all the State’s other liabilities, retiree health obligations for State employees “present a difficult challenge.” Prefunding over 30 years would have cost the State an additional $1.8 billion in FY 2013/14, but through prefunding, investment earnings will dramatically reduce State costs over the long-term. Thus, after STRS, prefunding retiree health should be a key priority. The State provides health coverage for 277,000 retirees and dependents.
Other Retirement Issues
Other than STRS, retiree health for State employees, PERS (which is already being addressed), what’s left? All told, “other” retirement issues total another $30 billion in unfunded liabilities. The State contributes toward the independent UC Retirement System, which faces its own funding shortfalls. There is also the prefunding of health benefits promised to UC retirees.
And there are two retirement systems for judges (administered by PERS). The phased-out system known as JRS I has been a pay-as-you-go system for many years, which we all know is the least prudent mechanism for providing pension benefits. JRS I has 2,300 members, with only 328 active employees. The system has a $3.3 billion unfunded liability and is less than 2 percent funded. Just like STRS, PERS has been asking the Legislature for years to pay attention to this issue and provide the funds necessary to provide adequate funding.
The LAO says that addressing these issues will reduce money available for other priorities, including building budget reserves and paying down the Governor’s “wall of debt,” but STRS and OPEB obligations have higher interest rates than these other liabilities. Failing to prioritize retirement obligations will increase the State’s budgetary risk in the long run. With State revenues outpacing budget estimates – by $1.4 billion as of April, the Governor and the Legislature have a unique opportunity to put our State on stronger footing.
Published by Amy Brown, the Public Retirement Journal provides a very timely source of valuable information and insight into public retirement, health care and related benefits. The Journal seeks out, and interviews, those people shaping public retirement policy and helps our readers understand just what they have planned in this field.
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