Four years after the state Legislature passed a bailout of the California State Teachers’ Retirement System that will nearly double annual direct contributions to the giant pension fund, a newly released internal report raises the prospect that the infusion of extra dollars may not protect CalSTRS from future disaster.

The 2014 changes in funding required districts to more than double their CalSTRS contributions, phasing in an increase from 8.25 percent of teacher pay in 2013-14 to 19.1 percent in 2020-21. Individual teachers and the state government also were required to pay more. But about 70 percent of the new funding – which will push total annual contributions from nearly $6 billion in 2013-14 to $11 billion in 2021 – is coming from districts.

The assumption in 2014 was that this extra funding was so significant that CalSTRS’ long-term viability was assured. The nonpartisan Legislative Analyst’s Office billed the hikes as a “major state accomplishment.”

On Nov. 8, however, the CalSTRS board was presented with a “risk report” that included both upbeat and gloomy scenarios. As Ed Mendel reported on the Calpensions website, the report found that if investment returns met their 7 percent target, CalSTRS’ retirement liabilities would be 100 percent funded by 2046 – a vast improvement on the present 70 percent.

50% chance fund hits point of no return threshold

But whether a 7 percent projected annual return is reasonable isn’t just questioned by pension watchdogs like Stanford professor Joe Nation and former Schwarzenegger policy adviser David Crane. CalSTRS’ number crunchers concluded that “even with the new rate increases, there is still a 50 percent probability that the CalSTRS funding level will drop below 50 percent in the next 30 years, according to 5,000 simulations based on the current asset allocation,” Mendel reported. Going below the 50 percent threshold is considered by many pension experts the point of no return, with little prospect that stricken retirement funds could ever rebound.

The problem for CalSTRS isn’t just consistently hitting or surpassing the 7 percent annual return goal. It’s that as few as one or two bad years of returns have a compound effect on long-term liabilities. The weak performances by CalSTRS and the California Public Employees’ Retirement System when the Great Recession hit more than a decade ago still haunt the funds, which are the two largest government pension agencies in the U.S. CalSTRS went from being 100 percent funded in October 2007 to 60 percent funded in March 2009, according to a Calpensions report.

CalSTRS’ and CalPERS’ grim numbers are a big reason why state Democrats are pushing for major changes in Proposition 13, the state’s landmark 1978 measure capping property tax increases at 2 percent a year. An initiative ending the protection for commercial and industrial properties will be on the 2020 state ballot and has the potential to generate $11 billion in new revenue a year.

School districts growing desperate over budgets

It may be a tough sell in an era in which the state has run surpluses for several years – including a $15.8 billion windfall expected in fiscal 2019-2020. But the “split roll” change sought for Proposition 13 reflects in many ways the deep concerns in the education establishment that the cost of the 2014 CalSTRS bailout is making it increasingly difficult for school districts to craft balanced budgets.

As CalWatchdog reported Oct. 1, one reason that the Legislature adopted new rules on permissible levels of lead in school drinking water that some health experts thought didn’t go nearly far enough was that the California School Boards Association worried that tougher standards would have been far more costly. The new standards for state schools were seen as still leaving students at risk of developing the severe cognitive and behavioral problems associated with children and adolescents being exposed to lead.

As of July, CalSTRS had $224 billion in assets. It would need to have $320 billion in hand to be considered fully funded.

Tens of thousands of state employees have exceeded the official limit of 80 banked vacation days, leaving the state on the hook for hundreds of millions of dollars.

What are the names of the workers at the top of the list? The State Controller’s Office, which collects the information and generally prides itself on transparency, wouldn’t say.

Rick Chivaro, the controller’s top lawyer, said he considered the information confidential, even though his office routinely discloses salaries of state workers by name.

It turns out that one of the two top vacation troves belongs to Chivaro himself. By June of last year, he had saved up 498 days of vacation, more than six times the limit. If he retired with that much time off, Chivaro could cash out $317,000 ­­– nearly two years of pay.

The Center for Investigative Reporting was able to identify a few of the state’s biggest vacation misers by their pay rates and job titles, information provided by Chivaro in response to a public records request. …

Two and a half years ago, the controller’s office criticized the California Lottery Commission for failing to enforce the state vacation cap among its employees. Yet the controller’s office employs 48 individuals with at least twice the maximum vacation days, the data shows. Seven of them, including its chief of human resources, had more vacation on the books than anyone at the Lottery Commission.

Who is overseeing the overseers?

As Cal Watchdog has pointed out repeatedly, a fundamental problem in trying to rein in the cost of government pensions and perks is that the officials who should be cracking down on the abuses have a financial incentive to look the other way or to downplay problems. The CIR report touched on this angle:

“Wow. That’s just wrong,” said Joe Nation, professor of the practice of public policy at Stanford University. “Anyone on the inside or the outside (of government) knows that that’s wrong.”

Nation, a former state lawmaker and municipal water board president, said it’s especially inappropriate for senior managers in salaried positions to “be able to take advantage of and abuse rules like this.”

What would a more reasonable policy look like? The CIR offers some larger context, than points to another big state:

Workers across the country make do with a finite amount of vacation. Many companies, and some states, have use-it-or-lose-it policies that keep employees from carrying over endless amounts of vacation.

In New York, for example, state workers can’t roll over more than 40 days and get paid out for up to 30 days if they quit or retire. At the stingy end of the spectrum, many employers don’t let workers save any unused time off at all, according to a survey by the Society for Human Resource Management.

As for unlimited stockpiling of vacation, “I’ve never seen it in the private sector,” said Bruce Elliott, manager of compensation and benefits for the Virginia-based organization. “It’s crazy to do that if you don’t expect a big expense.”

By Chris Reed

The aura of self-congratulation surrounding the governor’s office is particularly intense when it comes to the pension reform measure that Jerry Brown got through the Legislature in September.

But I’m not like some other Cal Watchdog contributors who consider the measure a feeble joke. Its provision requiring that public employees eventually must foot half the bill for their pensions — unless it is repealed — will someday lead to public employees asking for smaller pensions so they can have more take-home pay.

That said, I too thought the governor oversold the sweep of his reform measure and was crazy to depict it as anything but the first step of several to address the pension tsunami. Now California Common Sense has come forward with a study that shows the law hasn’t changed the trajectory of California’s pension crisis at all.

“California Common Sense, a nonprofit and nonpartisan watchdog group, recently released a study pointing out that despite glowing reviews for Brown’s 2013-2014 budget — which predicts a $1.7 billion general fund surplus — the state’s unfunded retirement liability has increased 5 percent since February.

“According to the study, California’s major retirement systems now have $222.2 billion in unfunded pensions, up from $211.4 billion five months ago. The report says that number was $110 billion in 2007-2008, meaning the state’s unfunded pensions have doubled in six years.”

Officials numbers grossly understate liabilities

That’s from the Sacramento Business Journal — which also had the good sense to note the official estimates of unfunded liabilities may well be little more than happy talk.

“In January, Sacramento Bee columnist Dan Walters used figures from a Moody’s to estimate that California ‘could have unfunded pension debt approaching $300 billion, plus another $100 billion for retiree health care.’ In 2010, Gov. Arnold Schwarzenegger’s administration claimed the pension overhang for California State Teachers’ Retirement System, California Public Employees’ Retirement System and theUniversity of California Retirement System was $500 billion, a number they based on a study by a group of Stanford University students, according to the Los Angeles Times. A Stanford professor later claimed that local government retirement pensions are short by $200 billion.“

That Stanford professor was Joe Nation, a former Democratic state senator. His candor got him called names by Bill Lockyer, who for all his reputation for outspokeness and contrarianism is an abject CalPERS apologist.

Here’s a link to my whining the day that Lockyer joined Team Maviglio.

Here’s a link to the California Common Sense study.

By John Seiler

As the smoke and the rhetoric have settled, you know pension reform is weak when: a) It’s criticized by an analysis in the Los Angeles Times. c) Ridiculed by the paper’s liberal columnist George Skelton. And c) praised by the California Public Employees Pension System.

The plan was crafted by Gov. Jerry Brown and Democratic lawmakers in the state Legislature and announced Tuesday. The main aspect of it is that there’s no move — at all — toward 401(k)-style pensions for public employees. Brown’s original 12-point proposal, from October 2011, called for a “hybrid” plan for non-safety employees that would be half continuing the current system, called “defined benefit,” in which benefits are guaranteed by taxpayers; and half a 401(k)-style plan called “defined contribution,” because it would guarantee a certain payment into the plan, but payouts would depend on market performance.

Without such a reform — or, better yet, a 100 percent “defined contribution” plan — any reform is a Band-Aid on a knife wound through the heart.

The Brown-Legislature “reform” does contain some minor good elements, reported the Bee, including “higher contributions from existing employees and imposes pension caps and raises the retirement age for new workers.”

The main problem is that it would save, at most, $60 billion. Yet the state’s unfunded pension liability is $500 billion, according to a Stanford University study headed by Joe Nation, the former liberal Democratic assemblyman but an honest man good with numbers. So the “reform” would fill just 12 percent of the pension black hole, leaving 88 percent unfilled.

Reform 2043

“This should more accurately be called the ‘Public Employees Pension Reform Act of 2043,’ since it will be at least three decades before it even begins to have any effect on state or local finances,” Jack Dean told me; he publishes PensionTsunami.com, which reports on national public pension news.

“I printed out a hard copy of the first summary I received by email and then circled every instance of phrases like ‘for new employees’ and ‘going forward’ — because all of those items fail to address the huge unfunded liability that has already started to drown local governments. Unfortunately, one of those phrases appeared in just about every item on the list.

“Banning retroactive pension increases is a sound move but doesn’t help, either, since most unions have already gotten the maximum increases they sought — all of them retroactive.

“And finally, the University of California system with its huge unfunded liability isn’t even included in the legislation.

“If I were to grade this legislation I’d give it an A for creativity and a D for lack of substantive content.”

Times analysis

The Los Angeles Times’ sober analysis of the “reform” found:

“SACRAMENTO — Even by the most ambitious forecasts, the plan Gov. Jerry Brown and fellow Democrats are championing to contain government worker pensions in California could leave state taxpayers awash in debt to public employees.

“The governor’s plan, announced Tuesday, is unlikely to save cities on the brink of bankruptcy. The relief his proposal would provide to the strained state budget is modest.

“Analysts who study the issue say far more aggressive action — including reduction of benefits for hundreds of thousands of current employees left untouched by Brown’s proposal — will be needed to get runaway retirement costs under control.

“Taxpayers still face the prospect of major bailouts to cover retirement promises made to public employees whether lawmakers pass the plan as expected Friday or not.”

Aug. 27, 2012

By Troy Anderson

During Vallejo’s bankruptcy, which began in 2008, the city cut the number of police in half rather than deal with the “pension problem.”

Now, a somewhat similar scenario is playing out in Stockton, a city of 292,000 east of San Francisco that recently displaced Vallejo as the nation’s largest city to declare bankruptcy.

Rather than trim generous pension benefits, the city is proposing to fully fund its pension system while defaulting on $124 million in pension bonds floated in 2007.

Assured Guaranty Ltd., a Bermuda-based bond insurance company, says Chapter 9 bankruptcy is not intended to be used as a “sword to prefer one class of similarly situated creditor over another.” In a prepared statement, the company described Stockton’s attempt to default on the bonds as “unprecedented, a contortion of the bankruptcy process and will foreclose Stockton’s access to the capital markets for the foreseeable future.”

As a growing number of cities in California are contemplating or filing bankruptcy, some pension experts say they are disappointed that the cities are choosing to default on their debts and cut public services instead of dealing with the exploding costs of public pensions.

“They won’t touch pensions,” says Joe Nation, a professor of the practice of public policy at Stanford University. “In the case of Vallejo, they literally reduced the number of police officers by about one-half. It’s horrible. They don’t want to even take modest steps to deal with the pension problem.”

To be fair, Nation says Vallejo officials contemplated the possibility of attempting to scale back generous pension benefits as part of the bankruptcy, but backed off under pressure from the California Public Employee Retirement system.

“CalPERS made it clear that if they tried to reduce those pension benefits that it would litigate,” Nation says. “These cities know CalPERS has deep pockets and is politically strong. Instead of taking on CalPERS, they took on a much easier target — their own citizens.”

CalPERS spokesman Brad Pacheco says CalPERS did not make any threat to the city of Vallejo.

“We did inform the city that any attempt to reduce pension benefits in the bankruptcy case would go to the core of CalPERS’ mission and that CalPERS would respond accordingly,” Pacheco says. “However, the city of Vallejo never seriously contemplated cutting benefits and it quickly affirmed its contract with CalPERS.”

Bankrupt cities

In recent months, Stockton, San Bernardino and Mammoth Lakes have filed bankruptcy, raising questions of whether local governments can reduce pension benefits as part of the bankruptcy process. Compton could be next. City officials say they are on pace to run out of funds by the end of summer. These bankruptcies occurred just months after Vallejo completed its three-year Chapter 9 process.

The filings come as public pensions are consuming a growing proportion of public payrolls throughout the state and nation. Last year, the Little Hoover Commission called on the governor and Legislature to freeze pension benefits for current workers and enact other reforms, noting city councils, county supervisors and school boards face the prospect of increasing contributions into pension funds by “40 to 80 percent of their payroll costs for decades to come.”

These skyrocketing costs follow decades in which public officials bestowed generous pension and retiree health benefits upon public servants. As a result, taxpayers are now on the hook for trillions of dollars in unfunded liabilities.

In California alone, Nation estimates the liabilities range from $265 billion to $737 billion. In a June report, the Pew Center on the States found the shortfall has grown to at least $1.38 trillion nationwide, up 9 percent over last year.

But a July report by the American Enterprise Institute found the true state of public sector pension funding is far worse.  The so-called “fair market valuation” reveals the average public employee pension plan in the United States is only 41 percent funded and unfunded liabilities total $4.6 trillion.

National reforms

In response, elected officials throughout the nation have undertaken pension reforms to reduce the costs, though most reforms have been incremental, such as increasing contributions or retirement ages. The most significant changes have been aimed only at newly hired employees, wrote Andrew G. Biggs, a resident scholar at the AEI, in the report.

“Unfortunately, these reforms won’t come close to restoring plans to true full funding, because current accounting conventions systematically understate pensions’ benefit liabilities and thereby overstate their financial health,” Biggs wrote.

Last October, Gov. Jerry Brown unveiled a 12-point pension reform plan for state and local pension systems designed to end “system-wide abuses and reduce taxpayer costs by billions of dollars over the long term.” Voters in San Diego and San Jose recently approved ballot measures to reduce pension benefits for current employees, although public employee unions are challenging the initiatives in court.

Jon Coupal, president of the Howard Jarvis Taxpayers Association, recently wrote:

“Compounding the problem, of course, is the fact that any suggestion that government employees help out and pay their fair share toward their own guaranteed pensions is rejected out of hand by the union brass who are accustomed — because of their ability to distribute campaign cash and  deliver members’ votes to favored candidates — to being the de facto bosses of the California Democratic Party, the Legislature, and, with their chosen candidate elected governor, the entire state. 

“Now, partially to meet this mammoth pension burden, Jerry Brown wants to increase sales and income taxes. And, in an attempt to show the public that the state deserves more money, he has proposed some reforms to deal with the radically out-of-balance pension system. But proposing is one thing, actually expanding political capital to see it through is another.”          

Modify existing pensions?

As this battle intensifies, a growing number of public officials are asking whether governments can modify existing pension plans. Once a taboo topic, some legal experts say public agencies may have far more latitude to change retirement benefits than once commonly believed.

The recent spate of bankruptcies in California has only magnified this debate.

“Modifying pensions for these cities may be part of the solution,” says Lisa Hill Fenning, a Los Angeles attorney and former U.S. bankruptcy court judge. “If you look at the movable pieces in any bankruptcy case, you have to consider that from an economic standpoint.

“The problem in California is the uncertainty of the degree to which pensions can be modified. The case law has been scattered over the years. It’s most developed in state court, not bankruptcy court. We are just going to see how that body of case law is interpreted in the bankruptcy context.”

In a new report, “Local Government Bankruptcy in California: Questions and Answers,” Brian Uhler, a fiscal and policy analyst in the Legislative Analyst’s Office, addresses common questions about the Chapter 9 process for local governments, including what types of obligations can be changed or eliminated through bankruptcy.

In its case, Vallejo became the first and so far only California city to use a plan of adjustment to significantly reduce health benefits for its retirees by decreasing its payments to a flat rate of $300 per month, Uhler wrote. So far, no city has used Chapter 9 to change pension benefits for current retirees. However, pension benefits were changed in a case in Central Falls, Rhode Island.

Due to the lack of case law regarding the treatment of retiree benefits in Chapter 9, it is not clear if and under what circumstances local governments would be permitted to reduce retiree benefits in future filings, Uhler wrote.

“So, the upshot is that it’s still pretty unclear right now — especially with pensions — because no city in California has tried to modify pensions,” Uhler says. “There is only one city nationwide that has successfully modified pensions, but because of differing state laws and differing pension systems, we just don’t know how applicable that is to California.

“But, in theory, pension agreements are a contract and are just like other obligations that can be restructured or rejected through the Chapter 9 process. So, it’s fair to say that there is at least some reason to believe pensions could be considered — that they are not completely protected from the Chapter 9 process. It’s just that no city has tried it yet.”

In a prepared response to the report, Pacheco wrote CalPERS remains committed to safeguarding the constitutionally protected pension benefits of public employees and retirees.

“The obligations owed to public workers have priority over those of general unsecured creditors including bondholders,” Pacheco wrote. “We don’t agree with all of the characterizations and explanations of Chapter 9 proceedings in the LAO report.”

Taking on pensions

John Moorlach, chairman of the Orange County Board of Supervisors, says elected officials in California are waiting for a city or county “to take on pensions to find out if we can in fact make dramatic changes in pension contracts.”

“When that happens, the city councils in this state are going to have to rally around that city and give CalPERS a good punch in the nose,” Moorlach says. “We have to do something with current employees. That’s the only solution to this mess.”

Former Los Angeles Mayor Richard Riordan and Alexander Rubalcava, president of Rubalcava Capital Management, an investment advisory firm in Los Angeles, warned as early as 2006 that rising pension costs would result in government bankruptcies, massive cuts in public services and calls for a taxpayer bailout.

As a result, Stockton’s attempt to default on its pension bonds is “entirely predictable,” Rubalcava says.

“California cities have been and continue to be run for their employees, not for the people who invest in or live in them,” Rubalcava says. “Whether they can get away with that, whether they can ring-fence pensions and cut everything else to the bone, including bondholders, remains to be seen and only the courts will be able to decide that.”

If local governments won’t attempt to reduce pension benefits as part of the bankruptcy process and agencies like CalPERS maintain unrealistic discount rates, Rubalcava says this first wave of municipal bankruptcies is only the beginning.

Last month, CalPERS reported a 1 percent annual return on its $233 billion portfolio — well below the fund’s discount rate of 7.5 percent. CalPERS’ 20-year investment return is 7.7 percent.

“Some of the world’s smartest investors like Warren Buffett of Berkshire Hathaway and Larry Fink of BlackRock, which is the world’s largest asset management firm, have said they will be lucky to make 5-6 percent going forward,” Rubalcava says.

“If that’s the case, the handful of bankruptcies we’ve had in 2012 will be just a taste of what’s to come. There will be dozens or hundreds of municipalities in California filing Chapter 9 in the decades to come.”