Later this week the board of the California State Teachers Retirement System, or CalSTRS, will forward to the Legislature a report laying out options for raising higher contributions into the pension system to ensure its long-term viability.
The Legislature has avoided action for a decade, and Gov. Jerry Brown’s budget forecast for education, with healthy projections for revenue, doesn’t take into account the daunting cost of teachers’ pensions on the expense side of the ledger.
Funding ratio of CalSTRS’ defined benefit program for the past 35 years, through 2011. After being fully funded by 2000, the Legislature expanded benefits. Values fell, recovered, then plummeted in 2008. (Click for a clearer image)
The remedies won’t come cheap. The choice that CalSTRS financial analysts recommend would boost payments, currently about $6 billion, by $4.5 billion per year, starting next year. That amount, a whopping 75 percent increase per year – would be borne mostly by the state and by K-12 and community college districts, as employers and not by current employees. If adopted by the Legislature, that option – diverting billions of dollars from the classroom into pensions – could dampen, if not dash, districts’ hopes for replenishing their own depleted budgets. Yet that option, which CalSTRS CEO Jack Ehnes is expected to recommend in a cover letter to the report, is the only one that would restore CalSTRS’ defined benefit program to full funding in 30 years, consistent with federal government accounting standards.
Anticipating that lawmakers would want to dodge that bullet, however, the 26-page report presents seven other, cheaper alternatives that would fall well short of that 30-year, 100 percent funding goal – by delaying the start of higher contributions by a few years, phasing in increases gradually or aiming for only 80 percent funding. Setting a target of 80 percent of funding over 30 years would lower the contribution increases from 15.1 percent to 12.1 percent, requiring $3.6 billion in annual increases, about $1 billion less, split among districts and the state.
Another option is to stretch out the goal of full funding to 75 years. But even that target would still cost $2.9 billion more in yearly payments into the pension system while leaving CalSTRS only 62 percent funded after 30 years. That option also would saddle additional generations of state taxpayers and teachers with decades more of higher payments.
One alternative not presented is to do nothing. CalSTRS would then gradually deplete its assets and go broke in 2046. At that point, it would convert to a pay-as-you-go pension system, requiring contributions equaling 50 percent of an employee’s pay, according to the report.
Next to CalPERS, which serves other state and local public employees, CalSTRS is the state’s second largest pension system. It’s still recovering from the 2008 plunge in real estate values and the stock market slide that wiped out 25 percent of the value of the portfolio for CalSTRS’ defined benefit program and has left it only 69 percent funded to meet its long-term obligations; liabilities to current and future retirees exceeded assets by $64 billion.
That was as of June 30, 2011, the most recent year that the CalSTRS board has to act on. Reflecting recent gains in the stock market, however, CalSTRS had an impressive 13.5 percent rate of return for the year ending Dec. 31, 2012. The value of its assets – $157.8 billion on Dec. 31 – edged closer to its high point of $172 billion in 2007.
Two different options for CalSTRS’ recovery. Under this scenario, the $64 billion deficit would be wiped out in 30 years by raising contributions, as a percentage of an employee’s pay, 17.2 percentage points, by increments of 3 percent annually, starting next year. The value of assets would actually continue to fall for the first few years, then steadily rise. Source: CalSTRS. (Click for a clearer image)
However, recent gains don’t make up for years of lost earnings. Had the target annual return on assets of 7.5 percent been met since 2000, CalSTRS would be more than fully funded. Instead, the report notes, it would now take five straight years with a 17 percent return on assets, followed by 25 years of hitting the earnings goal of 7.5 percent annually, to reach full funding without the need for additional payments into the system – an implausible scenario. Last year, at Brown’s urging, the Legislature passed a package of public employee pension reforms. But because reduced pension benefits will affect only employees hired after Jan. 1, 2013, nearly all of the savings to the system won’t be felt for decades, and won’t reduce the need to deal now with CalSTRS’ deficit.
Under this option, which CalSTRS actuaries would discourage the Legislature from adopting, the goal would be only 80 percent fully funding the pension program in 75 years, not 100 percent funding in 30 years, by adding incremental contributions of only 1.5 percent of an employee’s pay per year, leveling out at 11.3 percent more. But at the end of 30 years, the program would be only 55 percent funded, leaving it more vulnerable to stock market swings. Source: CalSTRS (Click for a clearer image).
CalSTRS has relied on gains in investments to meet 58 percent of the obligations paid out to retirees and on contributions from teachers, K-12 and community college districts and the state for the other 42 percent. Unlike the CalPERS board, which can adjust the amount that government employers have to pay into the system – and already has ratcheted rates upward – CalSTRS must rely on the Legislature to set contribution levels.
Payments into the system currently total 21.45 percent of a teacher’s or administrator’s pay, split three ways.
- The employee pays 8 percent (a level that’s been constant since 1972);
- The district as employer pays 8.25 percent;
- The state pays 5.2 percent.
To reach full funding in 30 years would require additional contributions of 15.1 percent of pay by some combination of the employee, the school district and the state, bringing in $4.5 billion to the system, as of July 1, 2014. But here’s the rub: The Legislature could make new school employees share the increase, but courts have ruled that the Legislature can’t increase the contribution rates of current school employees without giving them a benefit equal to the value of their increased contribution, like higher pay. The result: The state, through the General Fund, and districts will have to absorb most of any increase in contribution levels. The report suggests that there may be a way, by deft legal maneuvering, to increase employee contributions by a maximum 2.6 percentage points.
One important, unresolved question is whether higher CalSTRS contributions by districts would require the Legislature to increase Proposition 98 funding for K-12 and community colleges by an equal amount. A 2006 opinion by the Attorney General’s office said no; the Legislative Counsel disagreed, according to the report. Without an increase in Proposition 98 funding, districts would have to absorb higher pension costs within their existing budgets. Each percentage point increase in contributions would cost the General Fund or districts about $300 million, according to the report.
There is no easy solution
During their discussion of the report last Friday, some board members expressed reluctance to even offer options that clearly would not get CalSTRS to full funding, like the 75 year payback period or raising contributions less than a percentage point per year or just enough to push back insolvency a few years.
“It is human nature; legislators will look for the cheapest way out,” said California’s Chief Deputy Superintendent Richard Zeiger. “We need to say that some of the options will not meet the fundamental requirement.”
Regardless of what the Legislature does now, it will have to adjust CalSTRS’ contributions periodically, because there will be years when the system exceeds its projected rate of return, and years, like 2008, when it falls drastically short.
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