When Gov. Jerry Brown talks about paying down the state’s “wall of debt,” he doesn’t mention the state teachers’ retirement system. And yet the towering $73 billion unfunded shortfall in the state pension fund for teachers and administrators, the California State Teachers’ Retirement System, makes Brown’s wall, at about $30 billion, look like a picket fence.
On Wednesday, at a joint legislative information hearing, speakers from CalSTRS, groups representing educators, and the Legislative Analyst’s Office urged the Legislature to act now to address the outstanding liability. If nothing is done, CalSTRS won’t have enough money to cover the retirement benefits it promised to the teachers and administrators who will one day be drawing it down. Fully restoring the financial health of the pension fund will be tremendously expensive – requiring $4.5 billion to $5 billion annually in additional contributions, primarily by school districts and the state.
That amount is almost as much as the state expects to bring in from annual revenue from Prop. 30; it is more than what the state spends now for the UC and CSU systems combined. But the alternative is worse, said the speakers. Each day of failing to act to replenish the defined benefit fund increases the liability by $17 million and moves a step closer to 2044, when the pension fund would run out of money.
The dilemma, of course, is how to come up with that magnitude of dollars when the state and school districts are recovering from cuts in education and state services, and when Gov. Jerry Brown has ambitious plans, assuming additional revenue, for reforming the state’s school finance system. There will also be the challenge of how to divide the burden of higher contributions among the state, school districts that contribute as employers, and, to a lesser extent, teachers.
Even if Brown and the Legislature decide to delay or phase in additional money, it’s important that legislators commit formally to action, said Ed Derman, deputy chief executive of CalSTRS. A secondary benefit is that bond rating agencies would recognize that districts and the state have a plan to remove a liability hanging over them.
“There is a big benefit of making a decision now,” agreed Assemblymember Bob Wieckowski, D-Fremont, a first-term legislator who also is a bankruptcy attorney.
Legislative Analyst’s Office analyst Ryan Miller suggested that the Legislature make contributions to CalSTRS a higher priority than repayment of other state bonds, which have fixed interest rates or grow more slowly than CalSTRS’ unfunded liability.
Digging out of its hole
CalSTRS’ defined benefit fund lost about a quarter of its value when the market plunged in 2008. Though it has largely recovered to where it was in 2008 – the market value was $161.5 billion on Feb. 28 – it lost five years of compound growth, leaving it only 66 percent funded to pay long-term obligations as of February. To meet its commitments to retirees and current employees, CalSTRS relies 60 percent on the growth in investments and 40 percent on contributions. CalSTRS assumes a return of 7.5 percent on investments – a rate that some analysts already consider too optimistic. Investment returns would have to average 10 percent annually for 30 years to wipe out the shortfall without raising contributions.
In a report to the Legislature, CalSTRS’ board of directors outlined eight options for restoring the fund, seven of which would either set a target at less than full funding or a goal of full funding in 75 years. The preference of the CalSTRS board, the non-partisan LAO and outside actuaries, as the most prudent option, is full funding in 30 years. It is also the most expensive. The other choices, Miller said, shift the responsibility for current commitments to future generations. And a lower repayment, with a goal of 80 percent funding, would leave the fund more vulnerable to another plunge in market values, the analyst said.
But a goal of 80 percent funding in 30 years would also reduce the need for additional contributions by nearly $1 billion a year, to $3.6 billion, down from $4.5 billion. “The solution becomes more doable,” Assemblymember Rob Bonta, D-Oakland, who led the hearing, said in an interview Thursday. Bonta, who chairs the Assembly Public Employees, Retirement and Social Security Committee and will eventually introduce a bill on the issue, said that he believes, from discussions with employee and employer groups, that they could accept a target of less than full funding. Any action would not take effect until July 1, 2014 at the earliest, he said.
Contributions to the fund currently total $5.7 billion. School districts’ share is 8.25 percent of teachers’ and administrators’ pay, for $2.2 billion; teachers contributed 8 percent of their pay, $2.1 billion; and the state currently pays 2.7 percent of pay, $1.4 billion. The state also pays an additional 2.5 percent into a separate inflation protection account for members.
Implementing full funding immediately would require upping the contributions by $4.5 billion. But phasing in additional contributions over several years would raise the eventual annual increases by an additional $500 million, to more than $5 billion.
Dividing the increase proportionally or even-steven won’t work, because courts have ruled that current employees have a vested right to their present benefits, and new employees won’t be contributing enough to make a difference quickly – if the burden for the shortfall were shifted to them. The CalSTRS board did conclude that, with some complicated legal moves, the Legislature could raise the teachers’ contributions a few percentage points of pay. But even that would only be about one-seventh of what’s needed for full funding.
Districts will also have a legal case against making them shoulder the burden within their existing budgets. Daniel Vandekoolwyk, deputy legislative counsel for the Office of the Legislative Counsel, which provides legal advice to state government, told the committee that Proposition 98, the voter-approved funding guarantee for schools, protects districts from the state adding responsibilities without providing money for them. So the Legislature would have to fund any increases it mandates to employers’ share of contributions.
With the state’s General Fund then carrying the burden of the $4.5 billion in increases, lawmakers face hard choices.
Sal Villaseñor, legislative advocate for the Association of California School Administrators, while urging legislatures to commit to full funding in 30 years, said changes in contribution rates should be incremental. He also said that the contribution formula should be reexamined every decade to see whether it should be adjusted up or down.
Bonta agreed that additional increases should be phases in “to avoid sticker shock.” If current forecasts for several billion dollars in unexpected state revenue this year prove accurate, he said, it would be smart to channel a portion to pay down the CalSTRS shortfall. The sooner the Legislature acts, the less the state will owe in the long run, he said.