Joe Nation Presentation Feb 24, 2012

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Is There is a Public PensionProblem?

Then Why Aren't We Solving It?

Joe Nation, Ph.D.Professor of the Practice of Public Policy

Stanford UniversityFeb. 24, 2012



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• Sponsored by California Forward, Irvine Foundation

• Focus on financial problems, solutions at state and locallevels

• Deliverables (reports)

- Statewide

- San Jose

- Independent

Project Summary



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• Statewide findings

• Independent systems

• Conclusions/recommendations

Outline

Statewide findings Conclusions/RecommendationsIndependents



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CalPERS Funded Status Has Improved, butRemains Poor, Even at 7.75% Assumption

Statewide findings

June 2009 June 2010 June 2011 Dec. 2011

Fundedratio

60.1% 72.7% 73.5% 67.0%

Unfundedliability

$118.9B $84.7B $85.5B $108.6B

Based on 7.75% annual arithmetic rate of return and market value of assets.Dec. 2011 assumes $221.0B market value, $329.6 billion actuarial liabilities.

Conclusions/RecommendationsIndependents



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Unfunded Liability for Three State SystemsTops $142B at 7.75% Return Assumption

Statewide findings

CalPERS CalSTRS UCRP Total

Unfundedliability

$85.5B $50.6 $6.5 $142.6

Unfundedliability per householda

$7,018 $4,152 $533 $11,703


a Assumes 12,187,191 households statewide. U.S. Bureau of the Census, “State and County QuickFacts,” http://quickfacts.census.gov/qfd/states/06000.html, retrieved Oct. 26, 2011.



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Funded Status Poor Using MostRate of Return Assumptions


InvestmentRate of Return

9.50%

7.75%a

7.10%

6.20%

4.5%b

Probability of Meeting or Exceeding

Rate

CalPERS CalSTRS UCRP

21.7% 95.1 95.9 114.0

42.1% 73.5 75.3 86.5

50.7% 66.7 68.8 81.8

62.6% 58.3 60.6 72.0

80.9% 45.1 47.6 60.8

Source: Author’s calculations. CalPERS and CalSTRS June 2011 liabilities are estimated based on reported 2009 figures, adjusted for recent annual growth less 50 percent. UCRPJune 2011 liabilities are based on 2010 figures, adjusted for recent annual growth less 50 percent. If liabilities are higher, funded ratios will decline.a

7.5 percent for UCRP.b Low is based on the assumed rate of inflation and recent, hypothetical 16-year Treasury Inflation Protected Security (TIPS) equivalent rate (Oct. 17, 2011). The low-risk rate for CalPERS and CalSTRS is 4.504 percent; for UCRP, it is 5.004.



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Low Probability of CalPERS MeetingObligations, Even With 7.75% Assumption

Statewide findings

Source: Author’s calculations based on June 2011 MVA, 7.75 percent annual rate of return, standard deviation of 12 percent. 16-year duration. 10,000 simulations.




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• CalPERS boasts 1990-2011 annual rate of about 8percent

• But a 20th century portfolio with 72% equities,28% fixed income instruments earned 6-6.5%

• Overstating returns results in trouble very quickly

CalPERS Earnings AssumptionsLikely Too Optimistic




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• Discount, investment rates most important

• Ex post vs. ex ante assumptions

- Private sector earns return, then modifies benefits,contribution rates based on market experience

- Public sectors awards benefits, then “expects” to earnenough to pay them

• Long amortization periods cushion current hit,increase chances of sustained higher costs

Accounting Rules, Assumptions,and Methods Matter




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State Retirement Spending Up Sharply,Likely to Continue Steep Climb




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Scenarios Show Sharp IncreasesIn CalPERS Retirement Spending

Statewide findings

Investment Rateof Return

Annual PensionExpendituresa

Increase Above2011-2012 Amount

7.1% $10.0B $1.6B

6.2% $16.3B $7.8B

4.5% $25.6B $17.2B

a Based on covered state and public agency payroll of $47.915 billion.




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• Non-CalPERS city, county, special districts

• $156.7 billion in current assets

• 320,000 active members

• Significant impact on lives of residents

• Examined top 24 in 20 jurisdictions

• Summary findings

- 53.6% funded ratio collectively

- $135.7 billion in unfunded liabilities

Independent Systems Often Overlooked




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• Pension share of member government spending

- 4.1% in 1999

- 9.6% in 2011

• Pension spending growth, 11.4%, faster than other spending- Education 5.6%

- Public assistance 4.5%

- Public protection (safety) 5.3%

- Health & sanitation 4.2%

- Public ways & facilities 10.4%

- Recreation & cultural 5.3%

• With low investment returns, pension expenditure growth rates

actually understate that necessary

Independent System Pension ExpendituresGrowing at High Rate




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Pension Share of Total Expenditures for AllSystems Rises (Potentially) to 16-20%




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San Mateo County Pension Share of TotalExpenditures Shows Relatively Steady Climb




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San Jose Pension Share of Total ExpendituresBegan Steep Climb After 2010




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Funded Ratios Average 53%




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San Jose Benefit Levels At or Near Top




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• Public has not yet caught on

• Sacramento frozen by politics

• Dishonest title/summary for proposed initiative

• Not most pressing problem

So Why Aren’t We Solving the Problem?




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Gov. Brown’s Reforms Have Positive,But Modest And/Or Long-Term Effects

Statewide findings

Reform measure New employees All employees

Benefit reductions •Requires hybrid plan

• Increases retirement age

•Requires three-year salary

basis to avoid “spiking”•Limits final salary to base

rate, i.e., base salary only

•Felons forfeit pensions, if relatedto official business

•Prohibition on retroactive

pension increases•Prohibition of service credit

purchases

•Limits post-retirementemployment

Contributions NA

•Requires employees tocontribute at least 50 percent of normal costs

•Prohibits pension holidays

Governance/other NA • Adds public members toCalPERS

Source: Office of Governor Jerry Brown, “Twelve-Point Pension Reform Plan,” Oct. 27, 2011, http://gov.ca.gov/docs/Twelve_Point_Pension_Reform_10.27.11.pdf, retrieved Oct. 27, 2011.




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• Support Gov. Brown’s 12 Point Plan

• Add operational flexibility

- Via initiative

• Educate stakeholders

• Litigate

Climbing Out at the Local Level:The Easy Part?

Statewide findings Independents Conclusions/Recommendations



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• Employee compensation

- Decrease compensation costs through collective bargaining (if/when contracts are open)

- Require employees to pay a larger share of contributions (e.g.,for enhanced benefits)

- 2nd tier for new employees, e.g., do not include optional benefitupgrades, such as COLAs, final year compensation basis, etc.

• Retiree health care- Ensure wide “cafeteria” of health care plans offered to active

members; will reduce retiree health care costs

The Hard Part: Reducing Costs

Statewide findings Independents Conclusions/Recommendations



Joe Nation, Ph.D.

SIEPRStanford University

650-724-9532 [email protected]

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Joe Nation Presentation Feb 24, 2012

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