Public Employee Pension Plans Under Fire

by Charles Nash and Eric Hays

For reasons that appear to be infinitely more political than fiscal, Governor Schwarzenegger and the Howard Jarvis Taxpayers Association have joined forces with the expressed intent of changing the structure of all public employee pension plans, including UCRS, from defined benefit plans to defined contribution plans for all employees hired on or after July 1, 2007.  They propose to do that by means of a Constitutional Amendment that they threaten to put to a vote of the people either via an act of the legislature or by collecting signatures in the parking lots of shopping malls.

In the legislative arena Assemblymember Keith Richman (R, Northridge) has introduced two measures ACA X1 and ACA 5 that have yet to go anywhere, and as a practical matter were effectively dead on arrival in their current form. That is because it takes a 2/3 majority vote in both houses for the legislature to put a Legislative Constitutional Amendment on the ballot, and the current legislature has a huge Democrat majority in both houses. What Richman has done, however, is insert benefits funding near the front end of a long list of budgetary matters that the legislature must now consider.

Legislative Committees have just started holding informational hearings on the structural features of the two types of retirement plans and the fiscal health of some specific public-employee plans in California. On February 15 the CEO of CalPERS, the CEO of CalSTRS, the Chair of the Legislative Committee of the State Association of County Retirement Systems, and Judy Boyette (UC’s Associate Vice President, Human Resources) discussed public pension plans at a hearing on the “Budget Implications of the Privatization of Public Pensions: Defined Benefit vs. Defined Contribution” held by Subcommittee #4 of the Senate Budget and Fiscal Review Committee.

On the surface, the debate would seem to be over the economics of defined benefit plans vs.defined contribution plans, so at this point it is worth describing their salient features.  In brief, a defined benefit plan pools contributions from employees and employers and upon retirement pays a guaranteed monthly annuity to the employee or the employee’s dependent spouse for life. (UCRS is such a plan.)  A defined benefit plan is administered entirely by the employer. Because the annuity amount is guaranteed, the plan must be fiscally sound (by actuarial standards) at all times. Typically, California public employees make contractually-fixed contributions to the system and if there is “underfunding” after that, the employer bears full responsibility for maintaining the soundness of the plan.

A defined contribution plan creates individual retirement accounts to which both the employer and employee contribute.  The employee invests these funds in one or more externally-managed investment vehicles, which are often contracted for by the employer. At retirement the account balance is paid to the employee (in most plans as a lump sum, but it can also be paid as an annuity over the life of just the retiree). With this type of plan there can be no such thing as “underfunding.”  The financial risks and rewards are born entirely by the employee. A more detailed comparison of the two types of plans is given in the table below.

Proponents of the Amendment assert that changing all the public retirement systems to defined contribution plans would save the taxpayers money, and to date the general public seems to believe that fable    In an Op-Ed piece in the Sacramento Bee Assemblymember Richman asserted that “…public employee pensions are devastating government budgets throughout California, threatening priorities such as education, transportation, public safety and health care.” He noted that a “Public Policy Research Institute of California poll showed seven in ten California voters believe public pensions are a problem for state and local government.” His punch line was “Fortunately, a fiscally responsible solution is available—defined contribution plans—that would help eliminate deficits, lower costs and improve budget predictability.”

What he knows, but did not say in that piece, is that it will take at least ten, and probably more like twenty years for taxpayers to realize any savings whatever.  Public employees earn vested rights to benefits for the performance of their services.  Under the contract clauses of both the US and California Constitutions these rights cannot be impaired.  Pension system staff and the Legislative Counsel hold that the benefits of existing plan members, including the right to accrue benefits from future service and compensation, cannot be reduced for current members without an offsetting benefit.

As a practical matter, therefore, anyone currently employed by a public agency, or anyone hired on or before June 30, 2007, will be entitled to collect benefits equal to or better than those currently offered by the defined benefit plan in which they are enrolled as of the date of hire. An Assistant Professor, Step I, whose employment begins on July 1, 2006, must be able to retire some 35 years later with a benefits package (adjusted for inflation etc.) identical to the one provided to a departing high-step Full Professor who retires effective that same date.

If the Jarvis/Schwarzenegger forces are successful, it is virtually a given that public employers will be required to administer two different retirement plans for almost four decades.  To contradict an old saw: two (retirement plans) CANNOT live (be administered) as cheaply as one.

It is abundantly clear that the Governor is determined to get rid of defined benefit plans.  He summarily revoked the appointments of four of the five individuals (two Republicans and two Democrats) he had named to the board of the State Teachers’ Retirement System because they were part of a 10-2 majority that voted to oppose ACA 5.  (The law allows a Board appointee to serve for one year without Senate confirmation.  These individuals were in that grace period.). On February 16 the CalPERS Board also opposed changing to a defined contribution plan by a vote of 9-3.  The Sacramento Bee’s report on this outcome quoted a spokesman for the Governor as saying “the vote signals that PERS prefers to be a spectator instead of a participant (in discussions).  While we wish that isn’t the case, the debate on reforming the state public employee pension system will move forward.”

As the legislative hearings progress, the debate will surely be highly partisan.  In the Senate Subcommittee hearing mentioned above a Republican Senator attacked CalPERS for what he judged to be highly inappropriate meddling in corporate affairs. (Both CalPers and CalSTRS have blocks of stock that are large enough to give them a significant voice in annual stockholder meetings.)  After the CalPERS Board meeting on February 16 the newly-elected Board President, Rob Feckner, said that the $183 billion fund’s corporate governance agenda, including trying to rein in executive pay and health care costs would not change.  “One thing should be abundantly clear to the corporate wrongdoers: We will not retreat from our fiduciary duty to protect our shareowner interests.”