State Worker Pensions: The Sky Is Not Falling (Part I)

The CBP prides itself on bringing facts to what are oftentimes fact-free policy debates, and we’ve decided to weigh in on an issue we don’t typically cover – state worker retirement benefits – because of the abundance of recent myths about public pensions. In this post, the first in a series on the California Public Employees’ Retirement System (CalPERS) – the nation’s largest public retirement system, responsible for administering health and retirement benefits for more than 1.6 million workers and retirees, and their families – we highlight three facts that tend to get lost in the current debate.

But first, here’s some brief background: CalPERS, like public retirement systems across the US, took a serious hit as the housing bust and financial crisis plunged the nation into the longest and deepest recession the post-World War II era. The subsequent collapse in the housing and stock markets resulted in a roughly 40 percent drop in the value of investments managed by CalPERS – the largest decline in the system’s history. Consequently, the Public Employees’ Retirement Fund (PERF) – the largest “defined benefit” pension fund administered by CalPERS – now faces a substantial long-term funding shortfall. However:

The sky is not falling. The PERF’s shortfall does not pose an immediate crisis. Even if nothing were done to address the shortfall, the PERF has enough funds on hand to pay pension benefits for anywhere from 25 to 53 more years, depending on the fund’s level of investment earnings over time, according to the Center for Retirement Research (CRR) at Boston College. Even if the PERF were closed to new employees and existing workers could no longer earn benefits in that fund, the PERF would be able to provide the benefits already promised for 15 to 18 more years. Moreover, because a large share of the benefits promised to state workers won’t need to be paid for decades – many state workers are years away from retirement – California has time to address the shortfall. Under standards developed by the Governmental Accounting Standards Board, which establishes governmental accounting best practices, states could gradually rebuild their trust funds over as much as a 30-year period.

Significant strides have been made to address the PERF’s long-term shortfall. Changes made largely through the collective bargaining process – a collaborative process involving workers and employers, which in our view is the most appropriate way to address public pension policies – increased state worker contributions to retirement and scaled back retirement benefits for new hires. Existing and new state workers now contribute between 8 and 11 percent of their monthly earnings to retirement – an increase of 2 to 5 percentage points. Increased worker contributions will save the state approximately $200 million in 2011-12, according to CalPERS. (When workers contribute more, the state can contribute less.) In addition, the retirement benefits for new hires were generally rolled back to levels in place more than a decade ago. And benefits for all new hires will now be based on workers’ highest annual pay averaged across three consecutive years rather than on the highest pay workers received in a single year – a change that will not only reduce workers’ pension benefits, but also reduce the likelihood that former state workers will go back to work for the state at the end of their careers for the sole purpose of “spiking” their pensions.

CalPERS is in better shape than some public retirement systems because California has avoided serious mistakes made by other state and local governments. Experts argue that “the best way to maintain the fiscal health of a pension fund is to make regular contributions at the full required level.” State and local governments that failed to do so were more likely to have pension fund shortfalls going into the downturn and now face even greater shortfalls due to recent investment declines. Other state and local governments issued pension obligation bonds (POBs) to finance contributions to their retirement systems, incurring decades worth of debt to avoid an annual operating expense – a highly risky policy. “After the recent financial crisis, most POBs issued since 1992 are in the red,” according to a CRR report. The good news is that California never gambled with POBs (an attempt to do so during the Schwarzenegger Administration was blocked by the courts) and the state “has a long-term record of solidly funding its pension system,” which means the PERF had a solid foundation before the stock market tanked.

—Alissa Anderson