Great year for CalSTRS won't alter need for big increase in contributions

The Assembly committee that will decide how to fix the multibillion-dollar funding shortfall for teacher and administrator pensions will get good – and some sobering – news when it holds its first hearing on the issue this week.

First, the good news: New figures indicate that impressive return on investments by the California State Teachers Retirement System for the fiscal year ending June 30, 2013, would shave about $550 million from the additional dollars that teachers, school districts and the state will have to pay annually for the next 30 years to erase CalSTRS’ $71 billion deficit, according to CalSTRS.

Now, the sobering news: Even with that great one-year stock market return of 13.8 percent – nearly twice as high as the assumed return of 7.5 percent – contributions from teachers, school districts and the state combined would need to increase at least $4.2 billion annually, starting July 1, 2015. And if, as is more likely, the additional contributions are phased in gradually over four or five years, that figure will rise to about $4.8 billion per year, diverting more money to pension contributions that would have gone to teachers’ take-home pay and to increasing programs and services for California’s students.

The cost of delay: Postponing implementation of the increase needed to bring the Defined Benefit Program to full funding would add hundreds of millions of dollars in contributions from employees, school district and the state. Source: CalSTRS memo to its board of directors, Feb. 2014.

The cost of delay: Postponing implementation of the increase needed to bring the Defined Benefit Program to full funding would add hundreds of millions of dollars in contributions from employees, school districts and the state. Source: CalSTRS memo to its board of directors, Feb. 2014.

The conclusion from CalSTRS’ staff in a memo to the CalSTRS board: “No matter how it is measured, the risk associated with excessive delays in implementing the funding solution for the (defined benefit pension) program shortfall is that the cost of that solution … would have a major impact on the budgets of those who pay those contributions.”

On Wednesday, the Assembly Public Employees, Retirement and Social Security Committee will begin work toward what Chairman Rob Bonta, D-Oakland, hopes will be a solution effective in the next fiscal year. That’s not saying higher contributions into the fund would start July 1: Bonta’s making no commitment at this point. But an agreement would lay the path to financial security for the nation’s second-largest pension fund, with about 860,000 members. ­(The largest is CalPERS, the pension program for most state and local public employees, along with school employees who aren’t teachers and administrators.)

CalSTRS’ pension program guarantees administrators and teachers a percentage of their final years’ pay on retirement (60 percent at age 62 for those who work 30 years). It is funded by a combination of yearly returns on investments and yearly contributions by employees, employers and the state. CalSTRS members do not receive Social Security benefits.

As with CalPERS, CalSTRS’ problem is that a modest increase in benefits, granted by the Legislature during the dot-com years, was followed by a 40 percent plunge in the value of its assets when the stock market tanked in 2007-08. CalSTRS’ investment portfolio is now back to where it was at the peak in 2007. But it lost billions in predicted returns in the interim, leaving it with an unfunded liability – the amount needed to meet pension obligations to current employees – of $71 billion. Unlike pension benefits for other California public employees, which can be negotiated with employees, only the Legislature can set contribution rates for CalSTRS.

Annual contributions are calculated as a percentage of pay. Employees currently contribute 8 percent; school districts 8.25 percent; and the state next year will contribute 3.3 percent for a total of 19.55 percent. (An additional 2.5 percent from the state goes to a separate fund that ensures retirees’ benefits don’t erode with inflation.)

Eliminating the unfunded liability won’t come cheap. Updated figures that Ed Derman, CalSTRS deputy chief executive officer, will present indicate that for the contributions to reach 100 percent funding of the pension fund in 30 years, current contributions would have to go from 19.55 percent of pay to 33.75 percent (a 14.2 percent increase). That’s the $4.2 billion increase, split among employees, districts and the state, that benefits from the 13.8 percent rate of return last year. It assumes that the entire increase will go into effect in July 2015 – an unlikely scenario, since it could devour most, if not all, spending increases for schools.

But delaying the start of the increases or phasing them in a few percentage points per year also raises the cost.

  • Postponing the start of the increases until 2017 would raise contributions by $300 million per year, to 15.08 percent;
  • Phasing in the contributions by 3 percentage points per year, starting in July 2015, would lead to an increase of contributions of $600 million per year, an increase of 16 percent of pay.

Derman said that each percentage increase adds about $290 million in annual contributions.

The goal of the first hearing will be to establish the size of the gap to reach full funding of the pension fund. Future hearings will determine the more contentious issue of how the increase will be divided among teachers and administrators, school districts and the state. The Legislature must decide that. Another option, stretching out the implementation period beyond 30 years to 35 or 40 years – another way to lower the yearly increase while putting future ratepayers and taxpayers on the hook for more years – will also be discussed at some point, Bonta said last month.

The hearing on Wednesday, Feb. 19 will begin at 10:30 a.m. Check here to see whether the hearing will be broadcast live.

John Fensterwald covers education policy. Contact him and follow him on Twitter @jfensterSign up here for a no-cost online subscription to EdSource Today for reports from the largest education reporting team in California.

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3 Responses to “Great year for CalSTRS won't alter need for big increase in contributions”

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  1. Paul Muench on Feb 18, 2014 at 8:41 pm02/18/2014 8:41 pm

    • 000

    I keep wondering what can be learned from this situation. What is the investment policy of CalSTRS? How much extra risk did CalSTRS have to assume to provide the extra benefits promised during the dot com bubble? Did this guarantee that any serious disruption in the market would result in largely unrecoverable losses?


    • Paul on Feb 19, 2014 at 12:31 am02/19/2014 12:31 am

      • 000

      Paul, you are looking squarely at the effect of the recession. CalSTRS was more disciplined than the other two retirement systems.

      Unlike UCRS, which declared a “holiday” on employer and employee contributions in the 1990s, and unlike transit agencies, many of which have been paying both the employer and employee share of PERS for decades (e.g. BART, AC Transit, Santa Clara VTA), STRS never wavered from normal employer and employee contributions. The total contribution rate was equal to the normal, pre-recession cost of the STRS pension.

      Unlike police and firefighters, almost all of whom won a 3% at 50 formula (pension = 3% of highest year’s salary x years of service, with retirement at age 50) from their local municipal employers in the years following September 11th, STRS kept the 2% at 60 formula.

      Though summer school earnings and extra hours became pensionable to full-time teachers for a brief time, teachers never had material opportunities to “spike” their pensions by racking up overtime in the last year of work. Principals and administrators often did engineer promotions for themselves — spiking, lite, since a promotion ostensibly entails extra responsibility — but real spiking abuses were only possible in the types of jobs covered by PERS.

      AB 340 pension reform has lowered the cost of the STRS pension for teachers who begin work after 2012 to 16% of pay, which is less that *current* contributions (8% employee, 8.25% district, 2% state). Pensions for teachers who started pre-2013 cost 18.5% of pay, and the unfunded liability caused by the recession is of course attributable only to the pre-2013 set.

      Sadly, public debate doesn’t admit the nuances mentioned above.

  2. Eric Premack on Feb 18, 2014 at 1:38 pm02/18/2014 1:38 pm

    • 000

    Great update John.

    It’s also worth noting at least a few other points:

    1) CalPERS is also under-funded, with some estimating that the employer contribution rate might need to increase to 18+ percent of salary from the current 11.4 percent level. Recent investment gains may have tempered this a bit. The pre-LCFF “Revenue Limit” school funding formula used to absorb much of the increase in school employers’ PERS contributions via the so-called “PERS reducation” adjustment. This feature is not present in LCFF, so districts will feel the pain immediately where they used to enjoy a cushion.

    2) Both STRS and PERS seem to be basing their long-term actuarial projections on an assumed 7.5 percent average annual investment return. While both have bested this in the prior year, many smart folks question whether 7.5 percent isn’t way too optimistic. If so, contribution rates might need to climb much higher. If they can guarantee 7.5 percent, I’d be happy to have them manage my own personal funds.

    3) These cost pressures, combined with pressures from restoring instructional days, ever-climbing costs of health and other welfare benefits, and cost-of-living adjustments, presumably will place very strong pressure on districts’ budgets. This, in turn, speaks directly to whether districts will be able to target increased funding under the new funding formula for the benefit of high-need students–versus the more likely scenario of bailing-out district-wide salary, health/welfare, and retirement costs.

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