California's Pension Predicament

Fixing the state's retirement finances is like untangling a Gordian knot.
May 6, 2010 AT 3:00 AM
Gordian knot
Girard Miller
By Girard Miller  |  Finance Columnist
The finance columnist for Governing.

Last month, I testified in Sacramento before a bipartisan commission of the California state legislature, a commission that was founded in 1962 to focus on government reform and efficiency. The members are studying public pension and retirement-plan finance statewide, and will likely conduct another hearing and continue to study the issue. A full copy of my prepared remarks is viewable on their website along with the other testimony, or you can click here.

Overall, I estimated the combined actuarial real-time deficiency of state and local government retirement plans -- including both pensions and retiree medical plans -- at roughly $325 billion. That's almost equal to the total bonded indebtedness of the state and all public agencies in California. One key difference, of course, is that the voters never approved the retirement deficits. They just grew like weeds in an untended field where the sprinklers were left on by neglectful groundskeepers.

The causes of these actuarial deficits are many and varied, as my testimony explained. One of the largest problems I cited was the statewide policy error made between 1998 and 2000 of awarding irreversible and constitutionally protected retroactive benefits increases to public employees. The belief, at the time, was that the then-skyrocketing stock market would continue to grow from the moon to Mars. The implicit assumption back then was that, to pay for these benefits increases, the stock market would magically grow to a 2010 level of 28,000 on the Dow Jones Industrials Average. There are other factors as well, and I urge those who want a complete picture to view all 10 causes I identified.

The constitutional conundrum. In California, as with other states identified in the informative study of professor Amy Monahan of Minnesota, the state constitution's explicit pension protections and some ensuing court cases have been interpreted by many to protect the rights of public employees to an entitlement to receive the same benefits their entire lifetime. With that legal precedent, it becomes virtually impossible to reduce incumbents' benefits prospectively or to change the retirement ages for incumbent employees. Although there are some lawyers in California who argue against that interpretation, few if any public employers are willing to be the guinea pig to test that constitutional issue. Hence, we are stuck in California with a view that the only meaningful change that can legally be made to incumbents' pension or retirement benefits is the contribution level. Thus, retirement reform in the "Golden State for Incumbents" is mostly focused on "new tiers" of reduced benefits for new employees.

If that's the case, then the only really viable long-term solution to California's whopping retirement finance quagmire is to amend the state's constitution. Realizing full well how difficult that path would be, it may be the only real long-term solution to a dysfunctional system with an asymmetrical payoff structure for public employees. I proposed that the Commission explore three such provisions. One would amend the state constitution by raising the retirement age systematically to conform civilian pension ages more closely with Social Security age requirements for younger workers and retiree medical ages with federal Medicare eligibility. For older workers, the amendment could provide for legislative transitional language that makes reasonable upward adjustments in retirement ages without imposing unfair financial hardships. Second, the fundamental laws must be changed to permit the people's elected representatives to bargain with employees to modify the terms of their retirement plans with respect to future service, and to freeze an existing plan or transfer it to an employee-run beneficiary association to liquidate the employer's obligation, as is done in the private sector. Third, California needs to allow local voters to approve a tax increase to fulfill these obligations while maintaining service levels. Otherwise, we have no other alternative to chronic layoffs, hiring freezes and municipal bankruptcy proceedings.

Statutory options. Other suggestions in my testimony could be accomplished by statutory reform. Each is explained in greater detail in the full text:

o Public employees must pay half of the cost of their retirement benefits.

o Public employers must make their actuarially required contributions on a timely basis.

o No retirement benefits increase may be awarded for prior service unless fully funded or approved by a majority of voters.

o A majority of the members of a retirement plan's governing board must be independent trustees. (My testimony also provided a full page of recommendations on governance; I will discuss these in a future column.)

o Labor arbitrators must systematically consider total compensation and prevailing retirement benefits levels offered in the private sector.

o For new employees, the pension formula should be reduced to sustainable and sufficient levels. Employers with the financial capacity to provide additional retirement benefits can add-on a supplemental defined contribution plan without having to fear that they can never turn back.

o No cost-of-living or inflationary increase may be awarded to retirees unless the retirement plan is properly funded or approved by a majority of voters. Pension plans must retain a reserve for adverse markets before they increase benefits in the future.

o CalPERS, the state pension fund, must offer participating agencies greater flexibility in plan designs to provide sustainable and affordable benefits levels.

o Before it increases retirement benefits, the governing body of a public employer must review in public a multi-year fiscal sustainability analysis.

o Newly hired public employees should have the option to participate in a defined contribution retirement program instead of a defined benefit program.

o Finally, the Commission should look into disability pensions, which have been persistently abused in some jurisdictions.

Public officials seeking to reform retirement benefits in other states may find this testimony, and the work of the California commission, of interest and a potential source of ideas and policy language. As the list above suggests, we have a long way to go to make significant headway in achieving sustainable financial plans for public employees' retirement.

Girard Miller
Girard Miller | Finance Columnist |