California’s pension cliff

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Governor Arnold Schwarzenegger penned an op-ed for the Wall Street Journal last week that lays out the stark reality of California’s budget crisis. Bluntly stated, without significant public pension reform, the state budget is shot all to heck – leading to its inevitable demise.  “Here’s the plain truth,” says Schwarzenegger. “California simply cannot solve its budgetary problems without addressing government-employee compensation and benefits.”

Right now, 80 cents out of every government dollar is being spent on public employee compensation and benefits. The costs over the last decade rose THREE TIMES faster than revenues. There must be trade-offs, so on the chopping block has been higher ed, state parks and even one of California’s sacred cows – environmental protection.

It gets worse. According to the governor, “much bigger increases in employee costs are on the horizon.” He continues:

Thanks to huge unfunded pension and retirement health-care promises granted by past governments, and also to deceptive pension-fund accounting that understated liabilities and overstated future investment returns, California is now saddled with $550 billion of retirement debt.

The cost of servicing that debt has grown at a rate of more than 15% annually over the last decade. This year, retirement benefits—more than $6 billion—will exceed what the state is spending on higher education. Next year, retirement costs will rise another 15%. In fact, they are destined to grow so much faster than state revenues that they threaten to suck up the money for every other program in the state budget.

Over the last TWO years, the private sector has seen the loss of almost 1.2 MILLION jobs in California. The public sector? Virtually none. 401K’s have declined 20% nationally since 2007. Public sector? Up in value, to the point that in California public employees who retire at age 55 can look forward to a million bucks for their retirement.

Before he signs a state budget, Governor Schwarzenegger insists that the Democrat-controlled California assembly:
#1: Reverse the massive and RETROACTIVE increase in pension formulas enacted 11 years ago.
#2: Prohibit “spiking” – the practice of giving someone a big raise in his last year of work so his pension is boosted.
#3: Require public pension funds to make truthful financial disclosures to the public.
#4: Require public pension funds to use REALISTIC projected rates of return.
#5: End the “annuity give-away” they passed in 2003.
#6: Require employees to up their contributions.
#7: End the immoral practice of pension fund board members accepting gifts or even campaign contributions from lobbyists, salesmen, unions and other special interests.
#8: Establish a rainy day fund.

So far, his demands are falling on deaf ears. The Washington Examiner published a piece two days before the Guv’s op-ed titled “California rejects even modest pension reform.” In fact, recent California legislation allows government employees to PAD their pensions during their last year on the job. “We should be taking away the candy, not adding more,” Marcia Fritz of the California Foundation for Fiscal Responsibility complained to the Los Angeles Times.

There is one state, though, that has addressed the pension black hole. Any guesses? Yep – it’s Utah. In March, the state legislature became the first in the nation to pass a major overhaul of the state’s defined benefit pension system after it lost 30 percent of its assets ($4 billion) in the stock market. All current employees are “held harmless” and will continue in the current system. All new workers hired after July 1, 2011 can choose to enroll in either a 401(k) or a hybrid pension system that caps state contributions at 10 percent of employees’ salaries – no matter what the stock market does.

I admit – this one flew under my radar during the last session. I went to a couple of committee meetings where it was discussed and heard blah, blah, blah, actuarial tables, blah, blah. I did understand Representative John Dougall who said something like this on the House floor: “Without these changes, pensions blow a HUGE hole in the state budget and we go bankrupt.” (Dougall didn’t think Utah’s changes went far enough, by the way.)

According to the Washington Examiner,

Utah state Senator Dan Liljenquist, who sponsored the legislation, said it was the only way to honor current pension commitments and also keep unfunded pension liabilities from bankrupting his state.

Other states have tried increasing retirement age, scaling back retiree benefits, freezing cost of living increases and requiring employees to start contributing to their pension plans, but hybrid plans like Utah’s are increasingly viewed as the best way to keep government promises to current employees while scaling them back to sustainable levels for future workers.

We’ve completely eliminated the pension-related bankruptcy risk. This is exactly what California needs to do,” Liljenquist told The Examiner, adding that all the public unions in Utah were initially opposed to the idea. “But they eventually realized that we preserved benefits for current employees, and if we go bankrupt, all pensioners will be out of luck.”

Contrast that with California’s irrational ability to make even minor adjustments to its unsustainable pension system, virtually guaranteeing its own demise.

I still don’t fully understand all the ins and outs of pension systems – but I do recognize a broken, unsustainable system when I see one. I don’t buy for one second the line that “California is too big to fail” (nor do the companies leaving CA and flocking to Utah, apparently). I wish Governor Schwarzenegger luck in pulling his state back from the brink.

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7 Responses to “California’s pension cliff”

  1. Pops Says:

    Regarding a video on this subject a few spots down, the following comment was made:

    The video isn’t to [sic] bad as a point making video (even if its [sic] wrong). However the source of the video is intellectually bankrupt, reason.tv loves to ignore facts, use statistics out of context, or as in this video ignore the wider context of a particular problem.

    So is “The Governator” wrong, too?

  2. Ronald D. Hunt Says:

    Holly,

    Use the rule of 70 when looking claims made about growth problems such as how long it takes for an investment to double in size, That is divide 70 by the interest that something is paid, or the rate at which some quantity grows. Medical inflation rises at 6%, so 70 / 6 % = 11.6 years. Most pension funds should be able to pull off around 9% so 70 / 9 % = 7.7years. And Remember this numbers of only approximations, as technically the equation is the natural logarithm of the growth multiple divided by interest/growth rate. that is log(e)2 / 0.06 or ln2 /0.06.

    I know that isn’t a huge help when you have to figure in withdrawals from the account over time as well after a person retires, but its not hard to figure out that many pension reformers are using some pretty funny numbers.

    One other note, What is it with republicans reporting liability and debt as tho it where the same thing lately? “$550 billion of retirement debt.”. Does Arnold think we are stupid?

    Pops,

    California is a bit of a special case, they have an epically broken legislative process for passing budgets. In California it’s not just a 2/3rd vote requirement for new taxes its a 2/3rd vote requirement for the yearly budget. And against popular belief their not a 1 party state like Utah. Both sides of thee aisle their would like to fix the problem but neither will compromise at all with the other sides proposals, and the Republicans there hold just enough seats to prevent Democrats from obtaining a 2/3 majority(This may change after the next election).

    That said yes “The Governator” is using some funny numbers. That also said I don’t disagree that they need reform in that state.

  3. Ronald D. Hunt Says:

    I have heard rumblings about some California Democrats pushing the creation of a State Bank similar to Nebraska’s State Bank. As this would also solve the University endowment, and pension fund manager corruption problems their would end up being a pretty good idea.

    And don’t be shocked in California uses their single payer health bill next year as part of their budget solution. They already passed the thing twice and Arnold vetoed it twice, once they get rid of the Governator, replacing him with Brown(again?! Odd but whatever).

  4. Pops Says:

    What is it with republicans reporting liability and debt as tho it where the same thing lately?

    It isn’t a Republican thing. Most corporations treat unfunded liability essentially the same as debt, and have taken pro-active steps to limit unfunded liability.

    Why? Because at the end of the day it is the same as debt – it’s a promise to pay real money at some real future date. The difference is only in how the obligation was incurred.

  5. Ronald D. Hunt Says:

    Not exactly, Arnold like Utah is using return rates that are unrealistically low from the pension to inflate the number, liabilities only convert to debt if you don’t change something to either reduce or pay for them, and you don’t pay interest on a liability as you would with a debt.

    Further projecting out liabilities 40-50-60-70 years into the future using current inflation(very low), with current return rates(very low) and current tax revenues(very low), etc. Will only further skew the number in a very negative looking fashion. This is just more intellectual dishonesty designed to exploit peoples misunderstandings of math.

  6. Pops Says:

    To most people that’s a rather fine point. A lot of the factors have high risk of change. Inflation may be low today, but what about tomorrow, given the financial corner Congress has painted itself into? Current returns are low, but what about tomorrow? What if a pension fund is in stocks and the market tanks?

    Can you provide specific details of what the Utah reformers did wrong? Are there generally accepted ranges for the future unknowns? Has risk been factored into those unknowns?

    Isn’t it a little harsh to say someone is dishonest because they’re more conservative in their projections than your are? Wouldn’t it be more reasonable to point out specific things you would have done differently? Or are you just trying to throw mud?

  7. Ronald D. Hunt Says:

    “What if a pension fund is in stocks and the market tanks?”

    Pension funds are guaranteed by the Federal government. However The Pension benefit guarantee corporation can not pay the full pension amount on a bankrupt pension, the payout can be as little as 1/3. This entity has been abused horrendously sense bankruptcy rules where changed in the 1980′s by Reagan to allow bankruptcy loans to have “super priority” over all other obligations, this rule change mostly created so that corps could attack unions more easily but has also been used to threaten bond holders and other non “super priority” debts and obligations.

    “Can you provide specific details of what the Utah reformers did wrong? “

    For one the state does not pay the same into the new 401K program as they did to the pension plan, indicating to me this is about cutting employee costs outside of the pension plan as well. The pension plan never dropped below the 80% funded barrier, its not uncommon for the plans to float around a bit on the funded metric just because of the market. They didn’t really put in place any new funding source to pay for the difference the state will have to make for current pensioners, making me wonder if they really have any plans todo so.

    “Wouldn’t it be more reasonable to point out specific things you would have done differently?”

    I would have paid for the difference that was missing to meet the obligation for current pensioners, Second I wouldn’t have dropped people into the 401K blackhole I would have been looking at what options the state has for creating a new form of retirement account that provides for a partial benefit guarantee while freeing the state from much of the liability to loses in that account, like when i talked about bridge gaping subsides for indexed annuities.

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