Within the span of only 11 years, the hole at the bottom of California’s state and local pension funds increased a staggering 3,046 percent.
The monstrous growth of the gap between what public agencies have promised workers upon retirement and what they actually have – from $6.3 billion in 2003 to $198.2 billion in 2013, according to figures gathered by the state controller’s office – matters to all Californians, reformers argue.
If it’s not filled up with meatier investment earnings and heftier contributions from public workers and employers, that hole will continue to expand, and taxpayers must fill it directly.
Why? Because in California, the promises made to public workers on Day One of their employment can never, ever be broken – at least, not outside of federal bankruptcy court. And even in court, officials from Vallejo and Stockton and San Bernardino did not request permission to modify these burdens, fearing they’d have trouble attracting and retaining workers if the city next door offered something better.
This fear of competition, the “keeping up with the Joneses” impulse, or whatever you’d like to call it, also fueled the widespread embrace of super-sweetened, retroactive retirement formulas at public agencies large and small in the early 2000s.
“You can now see why I started screaming back around 2002,” said state Sen. John Moorlach, R-Costa Mesa, long a pension reformer. “As the old tombstone read, ‘I told you I was sick.’”
Public labor unions say the focus on unfunded liabilities “is a little worrisome.” Unfunded liability is not debt and shouldn’t be viewed that way, said a spokesman for Californians for Retirement Security, a coalition of unions trying to protect the current system.
Unfunded liabilities are different because what’s owed is not a hard-and-fast number, as is money borrowed through public bond debt. Instead, pension liability numbers depend on many moving parts and assumptions, including annual returns on investments. When the market booms, returns are great and liabilities get smaller. When the market tanks, liabilities grow.
“That number floats up and down depending on all kinds of factors, and the pension bogeymen make it seem that it’s the number taxpayers should look at to scare them into thinking that’s what they’ll have to make up in taxes,” said spokesman Steven Maviglio. “Few know – we’ve done polling – that their tax dollars are a small percentage of what pays for pensions.”
Such “don’t worry” talk outrages reformers.
“For citizens and taxpayers, unfunded pension liabilities are actually more of a burden than bonded debt,” said David Crane, a research scholar at the Stanford Institute for Economic Policy Research. That’s because they tend to rank higher in priority in bankruptcy proceedings than other kinds of debt and are repaid first. He pointed to New York City’s woes in 1975, when it suspended interest payments on debt but kept paying pension liabilities.
“Put another way, unfunded liabilities are more sacrosanct than conventional debt, and therefore more of a burden for citizens and taxpayers,” Crane said.
Debt, liabilities – call it what you will. These numbers will be subtracted from public agencies’ balance sheets beginning next year.
How did we get here? Critics say the answer lies in that tremendous spike in unfunded liabilities from 2003 to 2004.
In 2003, the hole in California’s 80-plus public pension systems totaled just $6.3 billion. But in 2004 – virtually overnight – it exploded to $50.9 billion.
That was the work of new, more generous, retroactive retirement formulas adopted by one public agency after another in the early 2000s, said Moorlach, a certified public accountant.
Meaning this: Agency A had been socking money away for Police Officer B’s retirement for decades. When Agency A adopted sweetened pension formulas, it suddenly was committed to paying Police Officer B quite a bit more every month for the rest of his life – even though no one had ever set money aside to cover a pension that large.
Officials thought pensions were so super-funded that this retroactive thing would not come back to bite them.
Oops. Add in “pension holidays” (when funds looked so healthy that officials quit putting money into them, sometimes for years), a crippling recession, lengthening life spans, a spike in retirements and reductions in what pension plans expect to earn on investments, and you get a hole $198.2 billion deep.
Or deeper. These official liability totals are computed assuming a 7.5 percent-or-so return on investments, which critics say won’t pan out over the long haul. If one assumes lower return rates – as did Joe Nation of the Stanford Institute for Economic Policy Research – the hole can easily double.
All this was made possible by SB400, passed in 1999 under then-Gov. Gray Davis, which Crane has called “the single greatest issuance of debt in state history.”
SB400 lowered retirement ages for general state workers, from 60 to 55, with pensions paying 2 percent of salary for each year worked. It based pensions on the highest single year’s salary rather than an average over three years. And it gave patrol officers the most generous formulas the Golden State had seen: 3 percent of salary for each year worked, beginning at age 50, vs. the previous 2 percent at 50.
The bill was a creature of its time. The stock market was booming, retirement costs had been dropping for a decade, and the California Public Employees’ Retirement System said it could fund sweeter benefits with a combination of high returns and accounting adjustments.
And the rest, as they say, is history.
The cost of benefits snowballed, particularly for public safety personnel, and the market tanked, wiping out billions. Even with the market recovery of the past six years, unfunded liabilities are high and growing.
“The financial meltdown took place in 2008, and the stock market bottomed in 2009. Since then the market has gone up 2.5 times and reached all-time highs – and yet the controller’s numbers show how the unfunded liability keeps growing,” said Stanford’s Crane.
The result: Public agencies are pumping more money than ever into pension systems to try to fill the hole, which critics say siphons money away from services. CalPERS has hiked annual contribution rates for public agencies 30 percent to 50 percent to erase unfunded liabilities over the coming decades and will keep rates high for the foreseeable future.
CalPERS places the overwhelming majority of blame for increasing costs on the stock market crash and changes in actuarial assumptions (increasing longevity, smaller investment returns), as well as a larger payroll. SB400 and other benefit changes account for less than a quarter of increased costs, officials said.
A Register analysis found that surging tax revenue is easing the bite of these increases – in some cities more than others. But analysts say weak investment returns over the past year put further stress on the system.
CalPERS officially expects a 7.5 percent return per year on its portfolio of stocks, real estate and other investments. In July, it announced preliminary earnings of just 2.4 percent – which will make those unfunded liability numbers grow.
“The weak 2015 investment performance is credit negative for California and most of its local governments because it adds to growing pension funding and demographic challenges,” said rating agency Moody’s Investors Service in its latest Credit Outlook report.
Moody’s noted that, over the past five years, CalPERS has earned an average of 11 percent, exceeding its expectations. But pension plans deal in decades. In November – fresh off a year of stellar returns, which hit 18.4 percent in 2014 – CalPERS actuaries issued this caution:
“(T)here is a significant amount of risk being taken in the funding of the system. The probability that the system will face a period of severe stress is still at a level that may be unacceptable.”