New California Governor Aims to Cut CalPERS, CalSTRS Debt

Gavin Newsom’s plan for the two largest US pension plans allocates more than $7 billion to reduce their unfunded liability and help California school districts with their contributions to pension costs.

California’s new governor, Gavin Newsom, proposes giving an extra $4.1 billion in his budget to reduce the almost $250 billion combined unfunded liability of the two largest US pension plans, the California Public Employees’ Retirement System (CalPERS) and the California State Teachers’ Retirement System (CalSTRS).

In addition, Newsom put in the budget that would start July 1 an additional $3 billion to school districts to reduce the money they pay to fund CalSTRS, the educators’ pension system.

Newsom’s first state budget gives directly to CalPERS an extra $3 billion on top of the state’s $6.2 billion required contribution for the 2019-2020 budget year, and CalSTRS an extra $1.1 billion above the state’s required $3.3 billion contribution.

“We are investing an historic amount and doing what no previous governor has done on PERS and STRS,” Newsom said at a news conference on January 11.

Both officials of CalPERS and CalSTRS praised Newsom’s plan, which uses part of California’s more than $20 billion budget surplus to pay off the unfunded liability. In reality, however, it will only make a small dent without additional action.

A confidential CalPERS memo, obtained by CIO, shows that the pension system estimates that the additional $3 billion from the state will reduce the pension system’s overall unfunded liability by 0.5% to 0.8%. CalPERS is estimated to be 71% funded. Its unfunded liabilities were calculated at $138.8 billion as of June 30, 2017.

The California state portion of that unfunded liability amounts to $58.7 billion. The confidential memo does show that the additional dollars from Newsom’s budget will mean the state’s portion of the unfunded liability would be reduced by a larger 1.5%.

The state’s extra payment won’t impact the more than $70 billion unfunded liability combined for school districts, cities, towns, counties, special districts, and other public agencies whose employees receive their pension benefits from CalPERS, the largest US pension plan.

The number of public agencies covered by CalPERS is staggering, including 451 cities and towns, 37 counties, and 1,029 special districts.

“While we applaud Gov. Newsom for recognizing there is a challenge and paying down the state’s portion of the CalPERS debt, it does nothing to help the fiscal sustainability of California cities,” Dane Hutchings, legislative representative/ federal policy liaison of the California League of Cities, told CIO.

Hutchings said many California municipalities will be facing layoffs, which would result in a reduction of services, to meet increasing CalPERS bills to cover pension benefits.

A California League of Cities study in January 2018 said rising costs to pay CalPERS would require cities over the next seven years to nearly double the contributions from their general fund to the pension system. “For many cities, pension costs will dramatically increase to unsustainable levels,” it said.

For some California cities, 50% of their payroll costs for public safety officers are already going to CalPERS to pay for pension benefits for those employees.

CalPERS never fully recovered from massive losses during the financial crisis, which saw its portfolio drop in value by around 25%, but a new wrinkle is that the pension plan has dropped its expected rate of return to 7% from 7.5%. This means that municipalities must pay more in contributions to make up for the increase in unfunded liabilities from the new investment assumptions.

Furthermore, CalPERS’s own investment consultants have concluded that the pension plan on average can only make slightly above 6% a year for the next decade, meaning that the system’s unfunded liability could get even worse in the next few years.

The CalPERS rate increases for cities and towns start in July.

School districts fare better under the Newsom plan; they get a direct break from their CalSTRS bills because the  $3 billion would go directly to them.

The districts would see $700 million to reduce their payments to CalSTRS in the next two budget years that would be applied to buy down their rising payments to the teachers’ pension system. For the next budget starting July 1, the governor’s office estimates that school districts would pay 17.1% of each teacher’s wage toward pension costs instead of 18.13%. In the 2020-2021 budget year, the new rate would be 18.1% instead of 19.1%

The rest of the $2.3 billion would be used to pay down school districts’ payments to CalSTRS by 0.5% in budget years 2021-2022 and beyond, saving school systems $6.9 billion over 30 years, according to a state department of finance estimate.

CalSTRS’s June 30, 2017, actuarial valuation, released in May 2018, said the pension plan was 62.6% funded with an unfunded liability of $107.3 billion. CalSTRS is the second-largest US pension plan.

School district contributions to CalSTRS have more than doubled since 2015 after state lawmakers approved a bailout plan. The pension system had been expected to run out of money by 2046. The increased payments by school districts are part of  the plan to bring CalSTRS to 100% funding, also by 2046.

Under the CalSTRS funding plan, school districts’ payment for pension costs per teacher cannot exceed 20.25% of payroll.

Derick Lennox, legislative counsel to the Small School Districts Association, said the Newsom plan was a first step in the right direction.

“Basically, the governor is tackling in his very first budget, the No. 1 cost driver for schools, which are pension cost increases,” Lennox said. “He deserves a lot of credit for taking on one of California’s unsexy issues.”

Lennox said school districts still have long-term issues, however, with rising pension costs, issues they hope to raise with the governor.

Newsom’s plan also makes a $1.1 billion extra contribution to reduce the state’s own $35.3 billion unfunded liability to CalSTRS in the coming budget year. It also proposes that extra contributions totaling another $1.8 billion be made in the next three budget years, assuming the availability of funds.

The budget still needs to be approved by state lawmakers, but it is not anticipated that the Democratic governor will have an issue in getting his plan passed by the state Assembly and the state Senate, both of which are controlled by Democrats. The new budget would run from July 1, 2018, through June 30, 2019.

Stanford Professor Joe Nation, the project director of the university’s pension tracker project, said the governor’s plan to cut the unfunded liabilities of CalPERS and CalSTRS, is “very smart politically.”

Nation said there was concern that Newsom was going to spend aggressively with funding for new programs, but he has instead put 60% of the surplus towards reducing pension and other state debt, showing that he is taking a long view to responsible management of the state’s finances.

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