Is Governor Brown’s pension reform “just right?” Unions claim it’s too hot. Some reformers claim it’s too cold.
I’m with Goldilocks; the measure represents real progress considering the tightly constrained legal and political environment within which the Governor had to work. It’s a sure-footed “second step” (the “first step” being Gov. Schwarzenegger’s 2010 collective bargaining agreements that set in motion these union give-backs).
Ignore crocodile tears from the union bosses. They dodged a bullet when the Governor dropped his bid for a defined contribution element as part of a hybrid pension plan. But while fighting successfully on that front, unions gave up ground on several important principles:
- A new second tier retirement plan for all new state and local employees. Never before has the state tried to encompass reforms that apply to nearly all state and local government workers. New employees will face pension caps, higher retirement ages, and lower benefit accrual rates.
- All new employees and, over time, nearly all existing employees will pay one-half of the normal costs (i.e., not the unfunded liabilities) of their pension benefits.
- To eliminate abusive pension spiking, retirement benefits for new employees will be based on regular salary only, and then averaged over three years rather than the highest single year.
- Both public agencies and employees must pay their full share of pension costs – no more “holidays” at taxpayer expense or risk.
According to the chief actuary of the California Public Employees Retirement System, these changes will reduce costs (and the unfunded actuarial liabilities) by $40 billion to $60 billion over 30 years.
True, this is merely a down payment on the large unfunded liabilities facing state and local pension systems, which are probably much larger than advertised, given optimistic investment scenarios used by pension fund managers. But the value of very short-term increases in contribution rates by employees, compounded over many years, will materially increase the health of the pension funds and reduce pressure for even higher taxpayer contributions.
What was left undone? Clearly, the really hard stuff – both politically and legally.
- A hybrid pension package with an integral defined contribution (i.e., 401(k)) element. As it stands now, only top management will likely be subject to a hybrid system since their pension benefits are capped. A true hybrid plan for all new employees would require an even lower defined benefit component to justify a DC element. San Diego achieved this – via voter initiative. But remember – a hybrid system with a DC component does not reduce employer costs as much as it reduces employer (and taxpayer) risk and exposure to poor investment choices or overly optimistic investment return assumptions.
- Employees sharing the costs of the unfunded actuarial liabilities. The Governor proposes equal sharing of “normal” costs, but employers (taxpayers) are on the hook to pay off the unfunded liabilities that have accrued from poor investment choices and investments that have underperformed the system’s projected rate of return. Depending on how one calculates a reasonable or conservative rate of return, the unfunded liabilities could range from the low hundreds of billions to half a trillion dollars. While new contributions from employees would be a major new source of funding to chip away at these liabilities, asking new or recently-hired employees to foot the bill for liabilities accrued for long-time employees may raise questions of equity. But San Jose voters have enacted just such a plan. There, employees may choose either to pay a higher rate to cover the unfunded liability, or enroll in a new defined benefit plan that provides lower benefits. Unions are challenging this new option in court. The outcome of this litigation may be profoundly influential on whether and how future benefits of current workers may be constrained.
- Changing pension system governance to make it more responsive and accountable to employers and taxpayers who foot much of the bill. Unfortunately, governance of the California PERS system is constitutionally protected from legislative change (a union-sponsored measure to that effect passed in 1992). The only way to effectively change the PERS board to improve transparency and accountability would be with a subsequent ballot measure.
- Modifying future, unaccrued benefits of existing employees. Unlike the federal Social Security system, which can change the benefit formulas and retirement ages for the current workforce, and unlike private employers who can even close down a defined benefit plan in favor of a defined contribution plan (while accounting for and remitting already-accrued benefits), once an individual takes a job with a state or local government agency, the benefit system in place at that moment is the benefit that must be delivered once the employee vests and then retires. No changes (to the negative) are allowed for any incumbent employee, no matter if he was on the job, say, just three days before the new benefit took effect for new employees. Obviously, changing future benefits for the mass of existing employees would create the quickest and largest amount of savings – and would do so most equitably. But until the jurisprudence of California pension benefits changes, this option is also off the table.
The good news is that bold jurisdictions like San Jose, San Diego and Orange County are testing the boundaries on hybrid, defined contribution plans and benefit changes for existing employees. This makes sense since local government budgets comprise a higher percentage (say, 75% to 80%) of compensation costs than the state budget. They need to fix these problems locally or they go bankrupt.
This is where the Governor can take reform to the next level. Should he accomplish his productive “second step,” he should leverage that success with the successes of the vanguard of cities and counties to lead a ballot measure to not only enshrine progress so far, but also to address the unfinished business that is constrained by the daunting political, legal and constitutional barriers that the Legislature is incapable of addressing.
Follow Loren on Twitter at @KayeLoren.