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California Association of Private Postsecondary Schools

LAO recommends $4.5 billion CalSTRS rate hike

03/21/2013

CALPENSIONS. MARCH 21, 2013.  The nonpartisan Legislative Analyst’s Office yesterday recommended that the Legislature adopt a plan to fully fund CalSTRS in 30 years — an estimated cost of $4.5 billion a year, a hefty addition to current annual contributions totaling $5.7 billion.

That’s not likely to happen as the state, with a budget back in the black from an improving economy and a voter-approved tax increase last fall, faces demands to restore what some say were $20 billion in classroom cuts during five years of deep deficits.

But after years of ignoring a growing CalSTRS debt or “unfunded liability,” the Assembly and Senate public employee retirement committees held a joint hearing yesterday on proposed solutions requested by a Senate resolution last year.

Ryan Miller of the Legislative Analyst’s Office told the committee that the unfunded liability of the California StateTeachers Retirement System, a century old this year, “may be the state’s most difficult fiscal challenge.”

The analyst said the CalSTRS unfunded liability is twice the size of what Gov. Brown calls “the wall of debt” from years of budgetary borrowing. The governor’s proposed budget spends $56 billion on K-12 funding under the Proposition 98 guarantee.

A lobbyist for teacher unions, Jennifer Baker, told the committee a “huge” issue is whether an increase in contributions to CalSTRS would count as part of the Proposition 98 guarantee or be additional funding for schools.

The Legislative Counsel told the committee that requiring school districts and other employers to contribute more to CalSTRS would trigger an offsetting increase in the Proposition 98 guarantee.

An opinion from the state attorney general disagrees. A lobbyist for school administrators, Sal Villasenor, said the Proposition 98 issue should be resolved “sooner rather than later.”

The lobbyists for teachers and administrators both urged the legislators to boost the state contribution to the CalSTRS pension fund, now about 2.5 percent of pay, back to the 4.6 percent rate cut in the late 1990s.

“We would stress the need for the state’s rate adjustment to take place prior to seeing any other rate increases,” said Villasenor.

“Prior to increases in educator members and school district and community college (contributions) the state needs to return to its previous level of funding,” said Baker.

The state currently contributes 2.5 percent of pay to the CalSTRS pension fund and another 2.5 percent of pay to a separate inflation-protection fund for long-time members, a total of $1.4 billion.

Teachers contribute 8 percent of pay to the CalSTRS pension fund, $2.1 billion. School districts and other employers contribute 8.25 percent, $2.2 billion. The total contributions, $5.7 billion, are exceeded by pension payments to retirees, more than $10 billion.

Unlike the California Public Employees Retirement System and most public pension funds in California, the CalSTRS board lacks the power to set annual rates that must be paid by employers, needing legislation instead.

Villasenor told the committee the teacher contribution hasn’t changed since 1972, and the school district contribution hasn’t changed since 1990. He said the state paid a rate of 4.6 percent in 1997 when the contribution cut began.

“The somewhat ironic nature of this situation is the fact that CalSTRS members and the school districts did not have pension ‘holidays,’” Baker said, using the term for a contribution cut she said saved the state more than $3 billion.

But during a 10-year period that ended in January 2011, a quarter of the teacher pension contribution, 2 percent of pay, diverted $4.9 billion into an individual investment fund for teachers with guaranteed minimum earnings based on 30-year U.S. bonds.

The Defined Benefit Supplement (AB 1509 in 2000) was one of severalbenefit increases enacted with the state contribution cut as investment earnings soared during the “dot-com boom,” briefly giving CalSTRS a surplus.

CalSTRS has had an unfunded liability for most of its history since the founding in 1913. In the 1970s the pension fund only had about 30 percent of the assets needed to pay for its future obligations.

The Legislative Analyst report said an appellate court decision in 1984, CTA vs. Cory, made it clear the state has contractual obligations to fund CalSTRS. A 1990 bill aimed for full funding in 40 years, but CalSTRS got there by 1998 with the market boom.

Now CalSTRS is about 66 percent funded with an unfunded liability of $73 billion. Ed Derman, CalSTRS deputy chief executive, told the committee the unfunded liability is growing at the rate of about $17 million a day.

“In the future, we advise policymakers to avoid changing pension contributions or benefits based on any short period of strong investment gains,” said the Legislative Analyst’s report to the committee.

The CalSTRS investment fund, valued at $161.5 billion on Feb. 28, is projected to run out of money by about 2044. If CalSTRS reverts to pay-as-you go at that point, the contributions needed to pay pension obligations are estimated to be 50 percent of pay.

The Legislative Analyst said increasing pension contributions now makes less money available for programs and tax relief, but will significantly lower costs in the long run.

CalSTRS expects to get about 60 percent of its money from investment earnings. Pension contributions made now will have time to yield investment earnings, an amount that compounds over time.

“The state’s retirement obligations generally grow faster than infrastructure and budgetary obligations,” said the analyst. “Left unaddressed, CalSTRS’ unfunded liabilities, for example, tend to grow at something like the system’s assumed annual rate of investment return — currently 7.5 percent.”

CalSTRS investment earnings averaged about 7.5 percent over the last two decades. But critics think that 7.5 percent in the future is overly optimistic. CalSTRS earnings would have to average 10 percent over 30 years to reach full funding.

The Senate committee chairman, Jim Beall, D-San Jose, asked for “probability” data on hitting the earnings target. He said developing a funding plan is “not going to happen overnight.”

A CalSTRS report to the committee lists “six key decisions,” including when rate increases would begin and how they are allocated, and four “financial outcomes,” ranging from full funding to delaying the date the investment fund runs out.

“Hi, Mom,” Beall said to a television camera, drawing a laugh. He said his mother, who retired from teaching four years ago, was probably watching.

“So, I really care about teachers, obviously,” Beall said, “and I wanted to express my confidence that we will come up with a strategy, working together with all legislators and the governor and the CalSTRS board. We are going to be partners in this journey.”