It's the Pensions, Not the Funding.

(Full disclosure: The author is a retired public employee from California who receives a pension through the California Public Employees Retirement System [CalPERS])

As recently reported in the Sacramento Bee, California State Assembly Speaker John A. Pérez is suggesting some fixes to the California State Teachers Retirement System (CalSTRS).

In September 2012, the California State Controller's Office reported that:

"CalSTRS is the largest teachers’ retirement fund in the United States. As of October 31, 2011, it had more than 852,000 members..." 

The Controller's Office was reporting on an audit of CalSTRS pension controls and mechanisms between 2009 and 2011. The office found several discrepancies and examples of poor pension fund management and recommended several improvements, among them that CalSTRS make greater efforts to audit itself, particularly in the area of "pension spiking".

"Pension spiking" occurs when employees are allowed to artificially increase their reportable income just prior to retirement so that they can receive a higher monthly pension benefit after they leave. 

The Challenge

Depending upon who you ask, CalSTRS is currently underfunded to the tune of between $71 and $81.4 billion dollars, "with costs rising by $22 million a day...", according to CalSTRS Chief Executive Officer Jack Ehnes.

This level of debt liability was apparently enough to finally get the attention of the Democrat-controlled California legislature. Assembly Democrats have now come up with a novel approach to try to address it: Increase the money in the fund.

Wow. Profound right? Why didn't anyone else think of that?

The Promise

In all seriousness, of course if CalSTRS is underfunded, the immediate response should certainly be to find ways to increase the funding. These pensions are a part of every public school teacher's total compensation as legally bargained for with their respective school district employers. These pensions are, in effect, a promise offered by elected school board trustees on behalf of the voters in their jurisdictions.

As such, existing public school teacher pensions should be fully honored and, so, fully funded.

However, I think there is a bigger picture to be addressed here. A greater challenge than just underfunded public pensions. A bigger picture and a greater challenge which Sacramento Democrats do not appear the least bit interested in either seeing or addressing.

The greater challenge is the nature of these pensions themselves.

Defined Benefit Pensions

Defined benefit pensions like those provided through CalSTRS and other public retirement systems in California (like CalPERS, of which I am a part) will always be a net drain on State funding. These pension accounts are not likely to ever be fully-funded because far more public employees retire and start collecting benefits each year than pass away and stop collecting them.

Because of this, the systems' annual outlays will virtually always exceed their incomes.

These sorts of pensions guarantee all recipients a set minimum monthly payment, regardless of whether or not the available funding can support those payments. When available funding does not support the payments, the net result is a fund deficit like that which currently faces CalSTRS. 

To be fair, teacher pensions are not funded solely through contributions from members, school districts, and state taxpayers. They are also largely funded by returns on various market investments made by fund administrators. Because market returns fluctuate, however, this funding source can be extremely volatile and unpredictable, particularly in the current economy.

In boom years, public pension fund market investments can do so well that these pension programs are actually "super-funded", meaning that the state can actually suspend the requirement for individual and employer contributions altogether. This only happens very rarely, however.

Most often, especially lately, the market is far more of a bust and, during those times, pension fund investment returns shrink and that's when the severe deficits occur and deepen. As fund deficits increase to the levels identified here, this can begin to directly harm the overall fiscal health of the state which, in turn, adversely impacts state residents and businesses in many ways. 

So what's the solution?

California should immediately stop offering defined benefit pensions to its future public employees. Despite that these types of pensions are common in the public sector, they have become all but non-existent in the private sector.

The private sector -which has always been far more responsive and adherent to the basic principles of market economics- used to offer defined benefit pensions but abandoned this practice long ago and for the very same reason that the public sector should also do so: Defined benefit pension systems are a net financial detriment to the providing organization.

Instead, the private sector has largely adopted programs in which employees are responsible for their own retirement planning. Sometimes this takes the form of profit sharing options, sometimes it takes the form of offering one or more 401K plans in which employees make their own choices on how much of their pre-tax income (if any) to voluntarily invest and in what sorts of portfolios.

There are plans for all investor tastes and preferences, from low risk-low yield plans that are essentially just savings accounts that offer slightly better interest rates, to high risk-high return plans that are more speculative but also potentially more lucrative in nature. Regardless of the type of plan chosen, it remains the employee's choice, funded with a portion of the employee's income.  

This type of approach to public employee retirement planning makes far more sense to me. In this way the public employee, rather than the employer, assumes more of the responsibility and, more importantly, all of the funding risk. This is only appropriate since it is also the public employee, rather than the taxpayer, who receives all of the reward in the form of his or her monthly pension payments.

Regardless of the sort of pension program public employers transition into, transition they must, and soon. Otherwise state-managed pension programs like CalSTRS are going to collapse under their own weight and the taxpayers who currently underwrite them will be left with nothing but the bill.



John B. Greet is a Long Beach native and retired LBPD sergeant, currently living in the Pacific Northwest.