The #1 rule of defined benefit pension plan management is that plan sponsors should supply enough cash each year to fund the “annual required contribution” (ARC). Failure to pay the ARC produces pension deficits.
The #1 violator of that rule is California.
In 2013, the California teachers pension fund (CalSTRS) received only 44% of its ARC. The skipped contribution — $3.5 billion — was the largest skipped ARC in the country. California has been skipping ARC’s for so long that, on Valentine’s Day last year, CalSTRS asked Governor Jerry Brown and the State Legislature for a $240 billion cash injection over 30 years, starting with $4.5 billion this year.
329 days later, Governor Brown responded: Wait till next year.
His reply was found on pages 141-2 of the Governor’s proposed budget for the 2014-15 fiscal year, which starts July 1. While acknowledging the CalSTRS problem, the Governor offered only to start providing funds the following fiscal year (2015-16).
That’s a very costly delay. Because CalSTRS’s deficit grows $22 million per day, Brown’s proposed 365-day delay translates into more than $8 billion of additional CalSTRS debt. If Brown’s delay is adopted, then at least 867 days will have elapsed between CalSTRS’s request in 2013 and initiation of funding in 2015. That translates into nearly $20 billion of new debt, which is twice as much as the Governor, to his credit, has reduced the state’s debt since he took office in 2011.
In other words, if Governor Brown doesn’t act immediately on CalSTRS, then by the time he runs for re-election this fall, he will have left the state with more debt than he inherited.
CalSTRS’s debt has been the easiest can for Brown and the Legislature to kick down the road. It doesn’t need to be repaid until the fund runs out of money (CalSTRS says that happens in 30 years, financial economists say earlier), the press pays little attention because there are no current consequences, and the can is kicked at innocent people — the next generation — who don’t know they’re being assaulted.
But because the can grows every time it’s kicked, the consequences for that generation are devastating. Each kick attracts interest at 7.5 percent per annum and, more perniciously, that interest is paid invisibly because it’s added to the balance due, just like the accrued-interest mortgages that helped cause the financial crisis. As a result, $20 billion of new debt today becomes a $160 billion balance due when CalSTRS runs out of cash. That’s on top of CalSTRS’s existing debt, which is also invisibly accruing interest at 7.5 percent per annum.
If unaddressed, CalSTRS’s debt will grow to more than $600 billion by the time it runs out of money – i.e., when cans may be kicked no more – and sends the next generation into a crisis unlike any before seen in California. That generation would have to choose between making pension payments to retirees or providing K-12 education and other public services, setting the stage for an intergenerational war.
This is why the Governor – especially this Governor – must not delay any longer. Brown is a popular leader with no serious challengers to his re-election, and he’s the only leader with the standing to pull together the parties who must reach agreement, which include the Legislature, school districts, and the teachers union. He also knows from experience that all too often there’s a wide spread between his words and legislative action. Look no further than his 2011 proposal for pension reform, which at that time he said was the “minimum” that needed to be accomplished. Later he signed a bill that, by his own analysis, fell far short of that minimum.
Crueler still, CalSTRS will in all likelihood need more than $240 billion because that number is based on an assumption that the fund will earn high investment returns. At the lower return Warren Buffett assumes his pension funds will earn, CalSTRS will need closer to $500 billion. Either way, the sooner cash is injected, the lower the cost and burden on the next generation.
Politicians will always look for reasons not to spend money on past debts, but CalSTRS’s unresolved debt threatens the very fabric of civil society for the next generation. Brown should set as his highest priority over the next six months the negotiation of an agreement and commencement of funding on July 1 of this year.
In May 2012, Governor Brown told me that he would address CalSTRS when the budget was stabilized by the temporary tax increase for which he was campaigning at that time. As I write this, that tax increase passed 434 days ago – or, put another way, nearly $10 billion of additional CalSTRS debt ago. Governor Brown should act now on CalSTRS.