A Tale Of Two Public Pension Plans

Same recession, same stock market, different outcomes.

Two public pension plans started off in the same spot before the Global Financial Crisis and went through the same investment markets since then but ended up in very different spots.

The plans — let’s call them “O“ and “C” for now — reported nearly equivalent “funding ratios” (the ratio of pension assets set aside to meet pension liabilities; the higher, the better) before the crisis, both lost big in the crisis, and both participated in the subsequent stock market boom. But their funding ratios diverged, with B’s plummeting 16 percent and O’s improving 10 percent as of their most recent published annual reports. The difference arises largely from two factors:

  1. Before the crisis C chose to employ a much higher discount rate — 50 percent higher! — that allowed it to hide the true size of pension obligations and to inadequately pre-fund those obligations, as explained here. C continues to employ a much higher rate than O.
  2. O requires employees to equally share pension costs with citizens and after the crisis made changes to un-accrued future benefits for retirees whereas C imposes most of the pension cost burden on citizens and made no changes to un-accrued future benefits.

Plan O is Ontario Teachers’ Pension Plan and Plan C is CalPERS, California’s public employee retirement system.

A similar example is found in the private sector. Like Ontario and CalPERS, Berkshire Hathaway’s pension plan had a healthy funding ratio before the crisis, lost in the crisis and participated in the subsequent stock market rise. And like Ontario — but unlike CalPERS — Berkshire’s plan has a healthy funding ratio now (and that’s even at a low discount rate about half CalPERS’s). Private sector defined benefit plans like Berkshire’s are governed by ERISA, a federal law that requires the use of a truthful discount rate and, like Ontario, allows changes to un-accrued future benefits.

California’s pension cost wounds are self-inflicted. For now, California’s governor and legislature impose all the negative consequences on citizens. That must change.

Despite a long-term bull market that has more than tripled stocks since the bottom of the Great Financial Crisis and a $6 billion partial bailout from the state earlier this year, CalPERS’s self-inflicted low funding ratio is crowding out public services because unlike Ontario and ERISA, California’s governor and legislature continue to impose all the burdens of pension underfunding on citizens. The rapid run-up in pension costs has led to recent headlines such as these:

“Pension costs could run school districts out of business.”

“Pension costs crowding out spending on parks, schools and social services.”

“California cities get next year’s pension bill. ‘It’s not sustainable,’ Sacramento official says.”

By not acting, California’s governor and legislature are also threatening the retirement security of local government employees, who don’t have the same protections as state employees.

California’s pension problem was easy to address a decade ago but its officials chose otherwise. More difficult actions are required now. Fast rising pension costs will continue to crowd out public services, force tax and fee increases and threaten local government employee retirement security until the governor and state legislature enact reforms such as those allowed in Ontario and legislated in states like Rhode Island.

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