The CalPERS board approved a major rate hike yesterday, $459 million, to replenish state worker pension funds that remain low, even though the stock market has rebounded from a post-crash low five years ago.
The first of three rate hikes to cover the expected longer lives of retirees (2 years added for men, 1½ years for women) will push the state payment to CalPERS to an estimated $4.3 billion in the new fiscal year beginning next July.
As the rest of the rate hike is phased in over the following two years, the total state payment to CalPERS will be boosted to about $5 billion in 2016. Rates could go even higher when new actuarial methods are adopted next year.
CalPERS has been using an unusual “smoothing” method that spreads gains and losses over 15 years and a “rolling amortization” that refinances debt each year. The new “direct” actuarial method is intended to reach full funding in 30 years.
The giant California Public Employees Retirement System serves three groups: state workers, non-teaching school employees and 1,581 local governments, ranging from large cities like Long Beach to small special districts with a handful of employees.
Most of the public attention is on state workers, the largest group with powerful public employee unions engaged with the Legislature and the governor on pay and retirement benefits funded by the state budget.
It’s been a political battleground.
Former Gov. Pete Wilson cut pensions and used “surplus” CalPERS funds to help balance the budget. Unions called it a “raid,” prevailed in court and backed an initiative, Proposition 162 in 1992, giving the CalPERS board sole control of pension funds.
Former Gov. Gray Davis signed landmark legislation, SB 400 in 1999, that restored the Wilson pension cuts and increased benefits (notably for the trend-setting California Highway Patrol) to a level that critics say are “unsustainable.”
As former Gov. Arnold Schwarzenegger in 2005 briefly backed a proposal to switch new hires from pensions to 401(k)-style plans, citing steep hikes in pension rates, CalPERS adopted the radical smoothing policy to avoid future rate “shocks.”
This kind of manipulation may be one reason the CalPERS state worker funds on average have only 66 percent of the projected assets needed to reach full funding in the next 30 years.
That’s slightly lower than the troubled California State Teachers Retirement System, which was 67 percent funded in a new actuarial report this month. CalSTRS lacks the power to set employer rates, requiring hard-to-get legislation instead.
CalSTRS needs a rate increase of about $4 billion a year to project full funding in 30 years. Without a rate increase of some kind, actuaries expect CalSTRS to run out of money in about 30 years, even if investment earnings hit the target of 7.5 percent a year.
CalPERS board members, who can set employer rates, have publicly worried about another stock market crash. Some experts think that if funding drops below 40 percent, getting to 100 percent becomes impossible. Rate hikes would be too onerous.
Two-thirds of the money needed to pay CalPERS pensions in the future is expected to come from investment earnings. The CalPERS pension fund peaked at $260 billion in 2007, dropped to $160 billion in March 2009 and was at $286 billion this week.
Half of the CalPERS investment portfolio is in global stocks. The Standard & Poor’s 500, which dropped to 677 in March 2009, had by this week more than doubled to 1,862. But the big runup in stocks did little for the average state worker funding level.
While the state worker funding level went from just 58 to 64 percent during the last four years, the funding level for non-teaching school employees went from 65 percent to 81 percent, traditionally regarded as adequate.
The CalPERS board yesterday set a rate hike of $55 million for the school pool, bringing the total payment for the new fiscal year to $1.2 billion. The big longevity rate hike for schools does not begin until 2016, and then will be phased in over five years.
At the urging of Gov. Brown, the CalPERS board in February adopted the new longevity projection for state workers immediately with a shorter three-year phase in of the resulting rate increase.
Brown said the CalPERS policy (a two-year delay followed by a five-year phase in) would cost the state $3.7 billion more over 20 years. The CalPERS board deferred to the governor on state workers, but followed its policy on schools and local governments.
Asked about the difference between the state worker and school funding level, David Lamoureux, CalPERS deputy chief actuary, said the school funding level has been higher for decades for a number of reasons.
For example, he said, the CalPERS board agreed to extend the amortization or payment period for state worker plans debt or “unfunded liability” to 40 years in the early 1990s to ease the strain on the state budget.
He said more recently the retirement rate has exceeded projections among state peace officers and firefighters and the Highway Patrol. Retirements did not drop as expected with the end of a Highway Patrol incentive, an 8 percent benefit increase.
“Schools are a much bigger group,” Lamoureux said. “A lot of them tend to work part-time. They tend to have earlier retirement ages. We see less swing for schools on a year-to-year basis, and that makes it easier to predict.”
The board took several actions under Brown-backed legislation, AB 340, that created the Public Employees Pension Reform Act on Jan. 1 last year.
New hires covered by the reform in the Legislature and CSU peace officer and firefighter plans will contribute an additional 0.5 percent of pay to CalPERS, bringing the total to 11 percent of pay.
The reform made similar small pension contribution increases for members of current state workers in several plans. The state savings from the higher contributions, expected to be nearly $100 million, will be used to help pay off CalPERS debt.
A decade ago CalPERS put about 1,400 small plans, each with less than 100 active members, into 10 “risk pools” to protect small employers from a big rate increase caused by an industrial disability or other event.
By requiring lower pensions for new hires, the pension reform forced CalPERS to temporarily create two large risk pools for miscellaneous and safety workers. Now staff is proposing a change that would cause some employers to pay more and others less.
But the new plan would give local governments something many have asked for but could not do under the old pools: pay down their pension debt or unfunded liability if they choose to do so.
At the request of the chief actuary, Alan Milligan, the board delayed action on the plan to allow time for a CalPERS webinar with the League of California Cities to explain the proposed changes to local governments, an attempt to build support.
Originally posted at CalPensions.