Pensions – The Educated Guess

Buck up, California, and learn from Rhode Island’s big pension reforms

Rhode Island is a tiny state with just over one million people in one thousand square miles. California is 37 times more populous and many times that size. And yet, when it comes to public employee pension reform, the tiny state of Rhode Island is acting both bigger and bolder.

For years, Rhode Island lawmakers watched fearfully as the state’s required pension contributions, the second-fastest-growing line item in its budget, exploded, doubling from 2003 to 2010. Without significant reforms, the liability was on track to double again by 2013. Lawmakers knew that if the pension liability remained unchecked, it would severely limit funding for other budget priorities.

California finds itself on a similarly unsustainable path. Earlier this month, the California Teachers’ Retirement Board announced that the $152 billion pension fund faces a $64.5 billion shortfall over the next three decades, an increase of $8.5 billion from last year. To put this in perspective, California spent $64.4 billion on K-12 education during 2010-11. Unless California acts to make its pension system more sustainable, the K-12 education budget – along with other important government priorities – will likely be carved up to feed the ever-growing pension deficit.

In Rhode Island, despite the growing recognition of the pension problem, the political obstacles to fixing it were high: The state is heavily unionized, and Democrats have held the legislature since World War II. But faced with numbers that threatened to devour the rest of the state’s $8 billion budget, an unlikely alliance between Gov. Lincoln Chafee (elected as an Independent), State Treasurer Gina Raimondo, a Democrat, and legislative leaders who were getting pressure from their home-district unions to avoid making any significant changes to the pension system, proposed and pushed through historic pension reform, saving $4 billion.

While most states just patch over their pension problems by slashing new teacher pensions or trimming minor provisions, Rhode Island made painful but necessary changes to its whole system. The reform law raised the retirement age for most workers and created a hybrid plan that combines a 401(k)-style account with a smaller defined benefit. The law also suspended cost-of-living increases to retirees for five years; after that, retirees will receive increases only if the pension fund is healthy. These changes, crucially, apply to new, current, and retired employees. While the law likely faces a legal challenge, the lawmakers wrote the bill to deflect that. They ensured that the reforms reflected a critical financial situation, used a temporary adjustment, and sought to share the burden across current employees, retirees, and taxpayers – a formula that also worked for similar reform in Minnesota.

California should take Rhode Island’s example to heart. Last fall, Gov. Jerry Brown acknowledged California’s dire financial situation when he released a bold 12-point proposal for pension reform. The proposal includes fundamental fiscal reforms such as raising the retirement age for new employees from 55 to 67, enrolling new employees in a hybrid plan, and increasing employee contributions to one-half of total pension contributions. The Democratic-controlled Legislature, however, continues to punt on substantive reform, focusing instead on relatively insignificant measures like eliminating pensions for convicted felons.

But while the political will is lacking, public will is not. In a nonpartisan poll last December, 83 percent of Californians thought that public pension costs were a problem. Sixty-eight percent of adults and 64 percent of public employees favored switching to a 401(k)-style plan. And earlier this year, in a surprising piece of political one-upmanship, the Republicans in the Legislature announced a package of bills identical to Governor Brown’s proposal.

California’s Democrats are beginning to look dangerously out of touch with budget realities – and with their constituents. Bipartisan support is crucial for pension reform, if only because the bar for implementing the governor’s proposal is high. Since teachers’ pensions are not subject to local collective bargaining, it will take nothing short of an amendment to the state constitution – a high bar indeed.

While California should recognize the serious consequences of pension reform for state employees and retirees, the state must act to secure pensions and protect its budget. Rhode Island is small but played big. California is big, and it needs to stop playing small.

Sarah Rosenberg is a policy analyst at Education Sector. Her research interests include teacher quality, public employee pensions, school improvement, and rural education. Before graduating from Duke University with a master’s degree in public policy, she taught high school English in rural North Carolina as a Teach for America corps member.

CalSTRS down to 69 percent funded

A 23 percent return on investments last year offered welcome relief, but it did not significantly alter this reality: The Legislature and school districts should start paying about $3.25 billion more annually – the sooner the better – to keep the defined benefit pension fund for California teachers and administrators solvent.

This week, the California State Teachers’ Retirement System released the actuary report by the consulting firm Milliman for the year ending June 30, 2011. It showed that the unfunded liability for CalSTRS’ defined benefit program actually increased from $56 billion to $64.5 billion – an obligation that will all but certainly fall on the backs of taxpayers. It jumped even though, with a rebound in the stock market last year, the market value of CalSTRS’ assets grew 19 percent, to $147 billion.

In 2000, the defined benefit program was overfunded. As of last June, it was 69 percent funded. Source: CalSTRS actuarial valuation, June 30, 2011. (Click to enlarge.( — In 2000, the defined benefit program was more than 100 percent funded. As of last June, it was 69 percent funded. Source: CalSTRS actuarial valuation report for the year ending June 30, 2011. (Click to enlarge.)

The defined benefit program is now only 69 percent funded, down from 71.4 percent a year ago. If nothing is done – a cut in future benefits or an increase in contributions – the fund will run out of money in 35 years.

This news – really just another stark reminder for those with cotton in their ears – comes as the Legislature prepares to deal with Gov. Jerry Brown’s proposed 12-point plan for pension reform. It or the lawmakers’ variation may include raising the retirement age for all public workers and capping pension payouts up to a certain salary level, combined with a 401K-type program. But nearly all of the reforms would apply only to future employees, not to current retirees and employees, thus making a minor dent near-term to the $64 billion problem.

CalSTRS serves only certificated employees – teachers and administrators – not hourly or classified employees, who pay into the larger state pension fund, CalPERS. The benefits for CalSTRS’ 253,000 retirees and beneficiaries (9,000 more than a year ago) are financed through a combination of investment income and annual contributions from employees, employers (districts and county offices of education), and the state, through the General Fund. For more than a decade, the CalSTRS board had assumed an 8 percent gain on investments; it lowered that to 7.75 percent two years ago, and earlier this year dropped it another notch to 7.5 percent. But over the past decade, the return averaged only 5.5 percent, creating an unfunded liability – the amount needed to cover pension costs – starting in 2003 and soaring in 2009. That has left contributors holding the bag.

With additional contributions of $3.25 billion per year, the unfunded liability would be paid off in 30 years. If nothing is done, the defined benefit fund would be wiped out in 35 years. Source: CalSTRS actuarial valuation, 6/30/12 (Click to enlarge.) — With additional contributions of $3.25 billion per year, the unfunded liability would be paid off in 30 years. If nothing is done, the defined benefit fund would be wiped out in 35 years. Source: CalSTRS actuarial valuation report for the year ending June 30, 2011. (Click to enlarge.)

“There is a need for additional contributions to fund the program,” Deputy CalSTRS CEO Ed Derman told a press briefing Tuesday. “We cannot invest our way out of the problem.”

CalSTRS contributions currently amount to 18.25 percent of current employees’ $25.6 billion payroll; 8 percent of that comes from employees’ pay, 8.25 percent from districts, and 2.5 percent from the state. (The state must also contribute an additional .25 percent each year until it reaches about 4 percent in 2015.) Actuaries are saying that wiping out the unfunded liability over the next 30 years will take raising the contributions to 32 percent of payroll, an additional 13 percentage points. The “good” news is that it would be 14 percent, were it not for last year’s big gains on investments.

The additional 13 percent equals $3.25 billion per year. CalSTRS isn’t recommending how the increase should be divided among contributors; unlike CalPERS benefits, which are subject to negotiations, only the Legislature can set contribution rates for CalSTRS. However, CalSTRS points to state court rulings that pension benefits are vested rights, which means that unless these decisions are overturned, the contribution rates of current employees are frozen. The Legislature and districts will divert more money to pensions that could have gone to rehire teachers and lower class sizes, restore programs, or buy textbooks.

If no action is taken, the need for extra contributions will grow from an additional 13 percent of payroll to nearly 40 percent by 2026. Source: CalSTRS actuarial valuation, 6/30/2011. (Click to enlarge.) — If no action is taken, the need for extra contributions will grow from an additional 13 percent of payroll to nearly 40 percent by 2026. Source: CalSTRS actuarial valuation report for the year ending June 30, 2011. (Click to enlarge.)

Given the state’s already precarious finances, Brown’s not proposing further contributions in next year’s budget, and the Legislature’s not likely to include any in its reform package. But the actuaries’ report cautions that time is money; the longer the Legislature puts off raising contributions, assuming other variables don’t change, the more costly it will become to stave off insolvency. Initially, add a half percentage point for each year’s delay – about $112 million extra each year, but it will grow. If nothing is done by 2026, contributions will consume 40 percent of payroll costs.

Other points about the valuation report:

The unfunded liability for the year ending June 30 increased even though the market value of assets grew handily because CalSTRS smooths losses and gains over three years. This was the final year that CalSTRS built in the 25 percent drop in market value of its assets in 2008-09.

Don’t expect CalSTRS to have another 23 percent gain this year. With three-quarters of the next fiscal year over, the gain is about 2 percent.

Reflecting teacher layoffs and cutbacks, the number of CalSTRS active members dropped from 441,544 to 429,600, and the total salary pot fell 2.7 percent from $26.3 billion in fiscal year 2010. This has a mixed impact on the pension fund. Fewer members reduce future pension obligations but also generate less in contributions.

Tightening teacher dismissals

It has taken a mess of lewd acts, criminal charges, and threatened lawsuits in Los Angeles Unified to spur calls for reforming the cumbersome process for dismissing teachers for immoral and unprofessional conduct.

Last week, LAUSD board members unanimously passed a resolution sponsored by board member Tamar Galatzan, who’s also a criminal prosecutor, calling for the Legislature to speed up state dismissal procedures (see item 16 of the board’s agenda). Democratic and Republican lawmakers, in turn, have been elbowing one another to be first in line with legislation that has yet to be filed.

Changes in statutes could fix some but not all parts of what has been a systemic failure to act on and follow up on credible evidence over many years.

Three former teachers at one LAUSD elementary school face criminal charges for sexually abusing students. One was fired last month after being charged with committing lewd acts on a 9-year-old in 2009. Another teacher, now a fugitive, was investigated for three cases of sexual misconduct against students before resigning from the district several years ago and being hired by Inglewood Unified, where he is now accused of molesting another young girl.

The most egregious case involved Miramonte Elementary third-grade teacher Mark Berndt, 61, who pleaded not guilty to lewd acts on children (for more explicit details, go here). The district investigated complaints about Berndt dating back two decades but failed to substantiate them. Information about the complaints wasn’t in Berndt’s file, because a clause in the district’s contract with United Teachers Los Angeles, negotiated in the ’90s, requires that misconduct allegations that did not lead to action be removed from a teacher’s file after four years.

Berndt was dismissed after the latest accusations surfaced in January 2011. In June 2011, the district agreed to pay him about $40,000, including legal fees, to drop the appeal of his firing. This type of settlement is common, not just in LAUSD, but in many districts, because appeals of dismissals to a three-person Commission on Professional Competence can take more than a year, during which time teachers continue to be paid, and the district can be liable for attorney’s fees if it loses the case.

For all three teachers, the district failed to notify the state Commission on Teacher Credentialing, which would have had the authority to pull the licenses of the teachers, whether or not they were convicted of a crime.

The resolution passed by the school board calls for changes in state law in cases involving unprofessional, criminal, or immoral conduct that would:

Discontinue paying a teacher during the appeals process;
End the prohibition on introducing personnel information involving charges of misconduct that is more than four years old. (This would preclude districts from negotiating away the right to keep the information confidential, as occurred in Los Angeles Unified, and would allow the state Commission on Teacher Credentialing to consider older information as well.);
Permit dismissal notices to be filed throughout the year (including summer) and shorten the 45- or 90-day grace period before the board could initiate dismissal proceedings;
Withhold pension benefits to any public employee convicted of sex abuse involving a minor;
Make decisions of the appeals board, the Commission on Professional Competence, advisory only, giving a school board final say over dismissals.

The resolution asks Superintendent John Deasy to make recommendations to the board next month on how to proceed. If LAUSD didn’t already have enough to worry about, last month the State Supreme Court ruled unanimously that school districts can be liable for administrators who fail to act to protect children after learning that an employee may be prone to molesting children.

Trustees have cause for frustration. Three years ago, they approved a similar resolution calling for legislative action. While the Legislature failed to enact what the board requested, the issue wasn’t ignored. In 2010, Republican Sen. Bob Huff sponsored SB 955, a sweeping bill calling for changes in teacher evaluations and giving districts more authority to ignore seniority when making layoffs. It also would have given school boards the final say over all teacher dismissal cases, not just those involving personal misconduct and criminal acts. It would have eliminated the positions of two teachers on the three-person Commission on Professional Competence, leaving appeals solely in the hands of an administrative law judge, whose decisions would have been strictly advisory.

Huff’s bill actually passed the Senate Education Committee, 5-4, but the Democratic Senate leaders referred the bill to the Rules Committee, and it was never brought to the full Senate for a vote – an action that rankled Huff.

Two Democratic senators from Los Angeles have said they would introduce bills on dismissals. Kevin de Leon plans to work on banning pension benefits for teachers convicted of abusing children. The bill would apply only to future cases; Berndt and other teachers now facing charges would continue to be entitled to pensions. Alex Padilla says he will introduce a bill on other dismissal issues sought by LAUSD board members. Meanwhile, Republican Assembly and Senate leaders put out a press release stating that “Republicans are standing with Mayor Villaraigosa and Los Angeles Unified to enact reforms to empower local districts and ensure that a Miramonte-like tragedy never happens again.”

It will be interesting to see whether the Republicans will tailor their bill to apply only to misconduct cases, based on the LAUSD board’s resolution, or whether it will apply to all dismissals, including those based on unsatisfactory performance, which comprises the vast majority of cases and was the intent of Huff in SB 955.

In returning to the trustees with recommendations next month, Deasy too must decide whether he favors a narrow or broad bill.

United Teachers Los Angeles and the California Teachers Association didn’t respond to my requests for comment on likely legislation. UTLA President Warren Fletcher has said the union would be open to renegotiating the prohibition on using old information on unproven misconduct complaints.

More CalSTRS pressure

What a difference a quarter of 1 percent makes.

The decision last week by the board of the California State Teachers Retirement System to lower the expected rate of return on investments from 7.75 percent to 7.50 percent equates to an additional $475 million that school districts and the State Legislature must eventually contribute annually to make up for the shortfall and keep the pension fund healthy. That’s on top of the $4 billion extra per year that CalSTRS says contributors should already start paying to compensate for the big hit that investments took when the market tanked in 2008. The Legislature, facing a General Fund shortfall of its own, hasn’t acted on CalSTRS’ recommendation, and it’s also not expected to act this year on the latest change. But the increased liability will add pressure on lawmakers to deal with Gov. Jerry Brown’s proposed reforms to reduce pension costs. Last week, Brown provided a conference committee on pension reform the details that he had promised on his 12-point proposal.

The CalSTRS board’s action marks the second time in a year and a half that it has lowered the investment forecast by a quarter percent – and reflects a new realization that CalSTRS can’t rely on the high annual return that the pension fund has assumed. Certainly the last volatile decade should temper its optimism. In the 2011 calendar year, CalSTRS earned only 2.3 percent on investments. It was 0.7 percent over the last five years, 5.4 percent over the last decade, and 7.2 percent over the last 20 years.

CalSTRS depends on strong returns on its investment portfolio for the bulk of income for the projected pension payouts of its 856,000 teachers and administrators. The rest must come from annual contributions from members, school districts, and the state. If investment income falters, as it has over the past decade, then the difference must come from higher annual contributions.

Critics are saying that CalSTRS’ 7.5 percent return is still too high. (CalPERS, the worlds’s largest public pension fund, serving state and municipal workers, is still projecting 7.75 percent.)

“It’s a step in the right direction, but not enough of a step,” says Joe Nation, a professor of the Practice of Public Policy at Stanford University, leading critic of the state’s public pension funds, and author, in December 2011, of “Pension Math: How California’s Retirement Spending is Squeezing the State Budget” (see press release; the report was too large to link in this post).

Based on projections of savvy investors like Warren Buffett, Nation said a reasonable rate of return on investments, also called a discount rate, would be 6.2 percent. That assumption, in turn, would require districts and the state to ante up about a sobering $2.5 billion per year more – money that otherwise could go to fund classroom programs.

CalSTRS presently collects $5.6 billion in contributions. That works out to 18.25 percent of current payroll, with teachers and administrators kicking in 8 percent of their pay, districts paying 8.25 percent, and the state, through the General Fund, adding 2.01 percent. (The state contributes another 2 percent through a separate fund to minimize the impact of inflation on employees’ pensions.) Because CalSTRS currently has an unfunded liability of $56 billion, CalSTRS staff recommended that the Legislature increase the contribution rate 14 percentage points to 32.25 percent of payroll, requiring collecting an additional $4 billion annually. In addition, they suggested adding an additional 1.8 percent of payroll, to 34 percent, to compensate for the CalSTRS board’s latest decision to lower the investment rate to 7.5 percent.

But here’s the catch: As opposed to laws dealing with private employers’ pension programs, California courts have ruled that public employees’ contributions cannot be unilaterally raised. Teachers and administrators have a vested right to the pension benefits in effect when they were hired. The only way to raise the rates that members pay is to give them a comparable benefit, such as higher pay. As a result, all of the additional liability for investment shortfalls or higher contributions must be borne by school districts and the state, in the case of CalSTRS. Because taxpayers ultimately bear all of the burden, Nation argues that CalSTRS should adopt a more conservative discount rate – under 5 percent – and then adjust contributions or benefits if, as historically has been the case, the investment returns come in higher. The current system is “an asymmetric risk for taxpayers, who must pay the whole freight,” Nation says.

In his reform proposals, Brown would raise the retirement age for most public employees to 67, substantially reducing the payout over time, and convert part of employees’ pensions to a 401 (k) type program, in which employees would bear more of the risk. But, consistent with court decisions, Brown proposes to impose these changes only on new public employees. As a result, the savings in the first decade would be modest.

Renewed call for pension reform

Someone watching State Sen. Joe Simitian’s annual education presentation in Palo Alto from an adjoining room last week passed along a comment. “I’m for more money for schools; I support the governor’s tax initiative,” the person wrote, “but I won’t vote for it unless the Legislature passes pension reform.”

How representative is this not-so-silent minority? Gov. Jerry Brown no doubt has been wondering, too, and increasingly calling on lawmakers to pass his 12-point pension reform plan.

“Please take up the issue and do something real,” he told the Legislature in his annual State of the State address. And Brown has come back to the issue repeatedly during speeches and media appearances around the state.

“The numbers just don’t add up,” Brown told the Los Angeles Area Chamber of Commerce. “Benefits, contributions, and the age of retirement don’t reflect today’s realities, putting taxpayers on the hook for huge costs in the future. The cracks are showing and this dam will burst unless the Legislature gets serious and takes urgent and decisive action.”

Simitian, a Palo Alto Democrat who’s one of six legislators on a conference committee charged with coming up with a solution, didn’t offer much assurance. “It’s not clear to me what the Legislature or the conference committee is prepared to do,” he said.

Then, predicting that voters would take the issue into their own hands if lawmakers don’t act, he said, “We’d better find a common sense answer that is fair, affordable, and sustainable or this gets done for us by those not interested in those three (qualities).” Simitian compared pension reform with Proposition 13, in which “the state was slow to act,” and so voters did. It could happen again, with a result that “would not serve us well.”

That probably won’t happen this year. Two initiatives filed by Californians for Pension Reform haven’t attracted big donors. The proposals would go farther than Brown’s 12-point pension reform plan in cutting costs to taxpayers and shifting the burden to public employees. If the initiatives can’t draw enough signatures in the next two months to make the November ballot, some of the pressure will be off the Legislature to act this year. (I followed up with Simitian after the meeting, asking him why the Legislature might not act. See his answer in the accompanying video. )

But reports last week from the California Public Employees Retirement System (CalPERS), the nation’s largest public pension plan, and the California State Teachers Retirement System (CalSTRS), number two behind CalPERS, should serve as a sober warning to legislators not to run from the issue. CalPERS reported a meager 1.1 percent return on investments in 2011, while CalSTRS reported a tad better at 2.3 percent – far below the 7.75 percent rate of return that both pension funds need to meet payouts to retirees. Though CalSTRS had a spectacular fiscal year that ended June 30, its investment portfolio then fell $7.9 billion in the six months ending Dec. 31, to $144.8 billion.

CalSTRS’ 10-year return was 5.4 percent, and, as writer Ed Mendel noted in his latest post in Calpensions, many financial analysts are predicting another decade of low returns. A failure to make the rate of return will add to both pension systems’ unfunded liability, which is the taxpayers’ burden. For CalSTRS, currently only 71 percent funded, the unfunded liability is $56 billion. Lowering the expected rate of return in line with what experts are predicting would immediately result in higher contributions from the state and school districts, in the case of CalSTRS. Either way, districts and the state face laying out billions more per year in coming decades to keep CalSTRS solvent – money that will be diverted from the classroom. On Thursday, the CalSTRS board will consider a staff recommendation to drop the investment forecast 1/4 percent, to 7.5 percent; the impact would raise contributions by the state and districts by $500 million per year.

Higher retirement age, lower benefits

Brown’s plan would significantly decrease benefits for new public employees, and lower the risk for governments, by raising the retirement age from as early as 55 to 67 for all new public employees except safety workers. It would cap the amount of salary qualifying for a defined benefit, affecting mostly higher paid administrators in the case of CalSTRS, and it would end spiking, the practice of raising salaries and benefits in the last few years to jack up an employee’s pension.

In the biggest change, it would replace a significant portion of a defined benefit plan for new employees with a defined contribution plan similar to a 401(k). At the last hearing of the conference committee this month, CalSTRS’ deputy chief executive officer, Ed Derman, offered a variation of the defined contribution plan that would offer security to employees, while reducing costs and risk for employers. Under a “cash balance plan,” workers would contribute a portion of their earnings, matched by the employer. CalSTRS, not the individual, would manage the investment, and would guarantee only the rate of return equal to a long-term Treasury note, plus the principal. If the rate of return by the time of retirement turns out to be greater, the employee wins. CalSTRS already offers this option as a retirement supplement to members.

A cash balance plan may be more palatable to employees than a straight 401(k), but unions are expected to resist the higher retirement age and switch to a defined benefit program. And this is an election year, when Brown is counting on union support to underwrite the campaign for his tax increase. So far, the conference committee has gotten little done, and three months after introducing his 12-point plan, Brown has yet to flesh out details. That’s expected to come this month.

Compounding the challenge, two-thirds of the Legislature must approve putting an initiative before voters, because it will amend the state Constitution. And, as Simitian noted in the video clip, five out of six members of the conference committee must agree on a package to present to the Legislature.

That’s a tall order for any proposal, and this one will require bipartisan support. Will voters withhold their support for a tax increase for failure of action on pension reform? Legislators may not want to put that question to a test.

LAO: Solve CalSTRS’ $56B burden

The Legislative Analyst’s Office generally praised Gov. Jerry Brown’s 12-point proposal for pension reform in an analysis released Tuesday, save for one gaping omission: CalSTRS’ unfunded liability. A failure to face up to it when suggesting big changes to public pension programs, like raising the retirement age, “doesn’t make sense to us,” wrote LAO analyst Jason Sisney.

What to do about it, though, is far from clear.

CalSTRS, the nation’s largest public pension program for educators, with 852,000 members, hasn’t recovered from a 30 percent drop in its investment portfolio in 2008 that has left it 71 percent funded, with a $56 billion liability in the latest annual report. Brown isn’t recommending cutting benefits of current workers or asking them to pony up more money to make the system whole. On this point, the LAO agrees. Court decisions have made it “very difficult – perhaps impossible” to mandate such changes for current public workers and retirees, the analysis said. So that leaves it to taxpayers to shoulder the burden. (Others have called for challenging past court rulings; California Pension Reform, which is gathering signatures for a November 2012 referendum, would alter benefits and limit defined benefits for current and future public workers.)

The LAO report notes that restoring full funding to CalSTRS would require additional contributions of $3.9 billion per year for at least the next three decades. That alone would equal about an eighth of the $33 billion in the state’s General Fund spending under Proposition 98 for K-12 schools and community colleges this year. In other words, paying off the pension obligations to current teachers and administrators could gobble up new money for education – if there were any around.

Rather than cut school spending further, Brown’s not proposing to immediately increase state contributions to CalSTRS. But the longer the state puts off dealing with the liability, the bigger the $4 billion tab will tend to increase, LAO said.

Unlike other public pension contributions, which can be renegotiated with workers, CalSTRS contribution levels are set in the Education Code and can only be altered by the Legislature. Brown recommends raising the minimum retirement age for new teachers from 60 to 67 and requiring a 401(k) type plan as part a benefits package. That would limit future liability to taxpayers.

Phase out state’s share

As for current obligations, the LAO recommends that the Legislature increase payments in coming years while at the same time pursuing a goal of phasing out the state’s share of CalSTRS payments. Under the current split, the employee pays 8 percent of salary to retirement; districts kick in 8.25 percent, and the state, through two separate funds, adds 4.5 percent. The LAO wants to shift to the employees and districts splitting the normal costs of funding CalSTRS.

Doing so, the LAO said, would reduce the likelihood of future unfunded liabilities.

“In this new structure, we believe that school districts, their employee and retiree groups, and CalSTRS itself would have a much greater incentive to establish prudent, rather than optimistic, investment return assumptions, given that they and they alone will be responsible for keeping the system well-funded for future teachers.”

Pension reformers and financial analysts have criticized CalSTRS for continuing to assume a 7.75 percent rate of return on investments. That keeps employee contributions down, but the state has to make up the difference when investments come up short.

CalSTRS’ troubles notwithstanding, the LAO notes that “several reports have indicated that teachers enrolled in CalSTRS receive less generous benefits than other kinds of public employees in California.” Many local governments continue to offer employees 3 percent at 60, meaning workers can retire at age 60 receiving 3 percent of their final year’s salary times the number of years they worked (3 percent at 55 for public safety workers). For teachers, it’s 2 percent at age 60, rising to 2.4 percent at age 64.

Pension reform’s impact on teachers

Under Gov. Jerry Brown’s plan to rein in pension costs, future teachers would work years longer before they could retire with smaller pensions. Current teachers and administrators would soon pay about 1 percent more out of their paychecks toward their retirement. And both current and future educators would be unable to retire, then turn around and return to the classroom full time.

Brown’s pension reforms would uniformly apply to all public employees, state and local, municipal and school. They would significantly decrease benefits, especially for new workers, and lower the risk for governments, by raising the retirement age from as early as 55 to 67 for all new non-safety employees, and by replacing a significant portion of a defined benefit plan with a defined contribution plan similar to a 401(k).

“This is a decisive step forward,” Brown said at a press conference. “The plan will make the pension system more sustainable and fair to taxpayers and the employee.”

Brown’s plan would reduce the state’s pension costs by billions of dollars over the next 30 years. What it would not do, because it applies primarily to new workers, is solve the current huge unfunded liability facing most pension plans. That includes CalSTRS, the nation’s largest pension fund for educators, which is currently only 71 percent funded and could run out of money in 30 years unless the state pays in hundreds of millions of dollars more per year. Nothing in the plan would address the unfunded liability issue, and Brown indicated he doesn’t intend to do so next year.

Here’s how Brown’s 12-point plan would appear specifically to affect to CalSTRS members. The governor has presented only an outline; details aren’t clear on a lot of important aspects, such as terms of early retirement. Brown also indicated he favors a cap on defined benefits, affecting higher-paid administrators and superintendents, though he didn’t specify what the level would be.

A shift to splitting the contributions of annual normal pension costs between educators and the state/school districts. Current teachers pay 8 percent of their pay toward retirement; districts pay 8.25 percent, and the state 2.017 percent. That adds up to 18.25 percent. (The state pays another 2.5 percent into a cost-of-living fund.) But the key word is normal costs, says Ed Derman, CalSTRS Deputy Chief Executive Officer for Plan Design. That means the annual contributions needed to meet actuaries’ assumptions of pension payouts and revenues not funded by investment returns. That, he says, is currently 17.7 percent. A split of that would be 8.85 percent, so CalSTRS members can expect to pay about 1 percentage point more of their pay, phased in. (Update: School employees who pay into CalPERS– non-classified workers like custodians and secretaries – would be affected more, Sheila Vickers, Vice President of School Services of California, reminds me. They current pay 7 percent of their pay to retirement, while the district contributes 13 percent. Under the 50-50 split, which would be phased in, districts would save money, while employees would pay more.)

However, if the CalSTRS board lowers its expected rate of return on investments, now 7.75 percent, as critics have called for, the contribution rate would increase. Again, this doesn’t take into account the additional payments needed to meet a $56 billion unfunded liability. Based on court decisions, that would be entirely the state’s burden and could raise the state’s contribution by 14 percentage points to 32.25 percent of payroll – a whopping extra burden on taxpayers.

A new hybrid plan for new teachers that introduces a defined contribution component. Because CalSTRS members do not pay into or receive Social Security, the defined benefit plan would cover two-thirds of the pension benefit and the defined contribution would cover a third. The target pension that teachers/administrators would receive would be 75 percent of their salaries after 35 years of work (with a cap for some higher-paying jobs). That would be less than currently received under CalSTRS. Teachers who retire at age 64 with 35 years in now can retire with 84 percent of final pay, with an additional 2.4 percent for every year beyond that.
A higher retirement age for new teachers. Saying, “We have to align retirement ages with actual working years and life expectancy,” Brown’s plan would raise the retirement age to 67, the current age for full benefits under Social Security. Currently, teachers who retire at age 60 after working 35 years receive 70 percent of full salary (2 percent times 35 years). Under Brown’s plan, they could not draw full retirement for another seven years, saving the system $364,000 for a teacher who made $70,000 a year.
Anti-spiking protections for new employees. To avoid perks thrown in during the final year to boost pensions, pensions would be based on the average of an employee’s final three years. Bonuses, unused vacation, and sick pay would no longer count toward compensation.
No more double dipping. Raising the retirement age will discourage a revolving door of having public employees, including teachers and superintendents, retiring one day and returning the next in a new full-time job. Brown would restrict retirees on public pensions to working 960 hours or 120 days per year for a public employer – about two-thirds of a school year.
Bans on retroactive pension increases and the purchase of additional retirement service credit for time not actually worked., known as “airtime.” Districts had offered this as a way of encouraging early retirement.

Hurdles, resistance in Legislature

Brown wants to put the uniform changes on the November 2012 ballot as a constitutional amendment. That would require a two-thirds vote of the Legislature – a formidable hurdle, given expected union opposition to the biggest changes, like raising the retirement age, and to circumventing negotiations via the ballot.

“We simply cannot stand for imposing additional retirement rollbacks on millions of workers without bargaining,” Dave Low, representing a coalition of public employee unions, said. The California Teachers Association, still examining the plan, didn’t issue a statement Thursday.

But Sen. Joe Simitian, D-Palo Alto, one of three senators chosen to serve on a new conference committee to deal with pension reforms, called Brown’s plan “substantive and significant” and credited him with making it comprehensive.

Simitian worked for two years, without success, to get an anti-spiking bill passed, and that should have been the easy piece. Now, he said, “with more moving parts, it will be more difficult to develop consensus.” The two-thirds requirement to get it out of the Legislature will be difficult but doable, he said.

Brown will have to thread the needle to win over Democrats who will side with labor and Republicans who will charge he didn’t go far enough with his reforms. Reacting to the proposed hybrid plan, Senate President pro Tem Darrell Steinberg told the Sacramento Bee, “I believe in defined benefit, because I don’t think that retirement should be based on the ups and downs of what occurs on Wall Street.” (Never mind that when Wall Street tanks, and public pension plans don’t make 7.75 percent returns, taxpayers are left holding the bag.)

But Brown cautioned that voters want pension reform, and implied that a failure to put it on the ballot will hurt chances to pass higher taxes. “Legislators would be well advised to take (pensions) seriously, get it all enacted and get it on the ballot when there are things they will be particularly interested in,” he said.

A labor icon’s thoughts on education

On this Labor Day, in lieu of our regular column, we leave you with some words from Albert Shanker, who served as president of the American Federation of Teachers from 1974 to 1997.

Albert Shanker speaking at the 1968 United Federation of Teachers Delegate Assembly, Local 2, AFT.(Courtesty Walter P. Reuther Library, Wayne State University.)

Professionalization of Teaching: In a speech to the National Press Club on January 29, 1985, Shanker called for a national exam for beginning teachers and a national board to improve the teaching profession.

It would be a group which would spend a period of time studying what is it that a teacher should know before becoming certified, and how do you measure it? And it would seek to have instruments established.

Before someone finally gets the ticket, [there] ought to be an internship program. Teaching is the only profession that I know of where a person begins the first day with the same responsibility that he or she will have the last day – a profession in which practice and performance are certainly as important as intellectual knowledge, but it’s just assumed that you can take someone who’s been to college for four or five years and throw him into a classroom the first day to sink or swim. I know of no major corporation, I know of no law firm – and certainly not the medical profession – that introduces people that way. Any other profession which involves any complexity is quite different.

Unless we make that investment, we will be getting people who don’t know their subject matter. We will be getting people who have no knowledge of what is known in education or how to apply it. And we will not really be giving anyone any help in terms of practical and performance matters. And in a few years we will grant them tenure and they will be with us for a long, long time.

Tuition Tax Credits and Union Power: Shanker spoke against tuition tax credits and explained the necessity of a strong union in his “State of Our Union” address at the August 21, 1978 AFT Convention in Washington, D.C.

Tuition Tax Credits: There is no doubt in my mind that if tuition tax credit passes, it is the end of public education in this country as we know it. Yes, first, it will be the wealthiest children who will take it and move out; and the next year another group will move out. And each year there will be more and more.

When we’re all finished, we will still have some children in the public schools. They will be the difficult to educate. They will be the ones who were not accepted by the private schools. They will be those who were accepted and then were kicked out. So there will always be a public school system, but it will become sort of the “charity ward;” it will become the “clinic, ” it will become the “poor house” of education in the country. It will become a national scandal, as private schools flourish.

Tuition tax credits is not just another bill, it’s not one of those things where, if it doesn’t pass, that’s good, and if it does, well, we don’t like it. It’s not like another $500 million won or lost. Tuition tax credits is the whole ballgame, it’s the whole existence of public education in this country, it’s the existence of the union, it’s the existence of equal opportunity. Do you just count that as one of the pieces of legislation in a long list?

Power of the union: More and more our problems are national, and our problems are political.

And the only way in which we’re going to succeed in defeating the Proposition 13’s, in getting labor law reforms through, in permanently defeating tuition tax credits and vouchers, is to continue making our organization more and more powerful, more and more members within our organization, so that political figures know that when they do something that hurts us or that’s a question to the life or death of public schools, they have a huge group of politically active and sophisticated people who are going to be working against them.

Now, look around this hall. Many of us are from locals that were very small locals five years ago, and 10 and 15 years ago, 20 years ago, very small and struggling. Most of us at one time or another believed that we have joined an organization which was a permanent minority. We belong to the union, and we joined at a time when it was dangerous, and at a time when it was very unpopular. We joined at a time when we were sure that maybe we could have advanced and been promoted in the school system, but joining the union would probably mean that whatever opportunities we had in that direction were considerably reduced if not completely killed.

Most teachers who join the union join because of some little or bit problem that they had in their own pocketbooks or in their own schools. But, you know, the people who founded this union were people who saw beyond that. They had a belief and a dream that some day teachers within our society would not just be fighting for a livelihood at the local level or handling a grievance, but that some day the teachers of this country would be organized and powerful enough to be able to influence national policy and national decisions, because, who knows better than the teachers of this country what’s good for schools?

Charter Schools: Albert Shanker didn’t invent the idea of charter schools, but he helped launch the movement in a landmark speech before the National Press Club in Washington, D.C., on March 31, 1988.

I would like to make a proposal today. The proposal is based on the notion that we have not moved reform fast enough …

How would this work? The school district and the teacher union would develop a procedure that would encourage any group of six or more teachers to submit a proposal to create a new school. Do not think of a school as a building, and you can see how it works. Consider six or seven or twelve teachers in a school who say, “We’ve got an idea. We’ve got a way of doing something very different. We’ve got a way of reaching the kids that are now not being reached by what the school is doing.” That group of teachers could set up a school within that school which ultimately, if the procedure works and it’s accepted, would be a totally autonomous school within that district.

It’s a way of building by example. It’s a way not of shoving things down people’s throats, but enlisting them in a movement and in a cause. I believe that this proposal will take us from the point where the number of real basic reform efforts can be counted on the fingers of two hands to a point where, if we meet here again a few years from now, we’ll be able to talk about thousands and thousands of schools in this country where people are building a new type of school that reaches the over-whelming majority of our students.

Standards and Assessment: Shanker was a champion of high standards and rigorous but appropriate assessments and testified for the need to strengthen both on July 21, 1989 before the House of Representative’s Subcommittee on Oversight and Investigations Committee on Economic and Educational Opportunities.

The subject of what students should know and be able to do is about as basic to education policy and practice as one can get. Every one of the advanced industrial democracies with which we compete has grade-by-grade national or regional curriculum frameworks, and in so doing makes clear its expectations for students, school staff, textbooks and other instructional material, and the professional preparation of prospective teachers. We do not. Every one of these nations also administers student tests that are based on its content standards, that complement curriculum and instruction and that students can study for and have strong incentives to do so; their class and test performance during their school careers will determine whether they go to college and whether they get a good job at good wages. We do none of these things.

Many of Albert Shanker’s papers are available online through the Walter P. Reuther Library at Wayne State University which houses the AFT archives.

No anti-spiking reform this year

There will be no significant pension reform this year.

SB 27, anti-spiking legislation sponsored by Sen. Joe Simitian, never made it out of the Assembly Appropriations Committee on Thursday, the day that Appropriations in the Assembly and the Senate decided the fate of hundreds of bills.

The bill would have imposed a six-month waiting period for retirees eligible for CalSTRS or CalPERS pensions to return to work. It also would have combated spiking – the practice of jacking up public employees’ pay in the final years to qualify them for higher pensions – by limiting how much of a raise could qualify for a defined benefit pension. CalSTRS and the California Teachers Assn. opposed applying the bill to current employees and had proposed alternate controls.

But the bill was not brought up for a committee vote. AB 27 will now become a two-year bill, with the possibility that it might be combined with grander reforms of the system next year. I hope to reach Simitian for his perspective later today.

UPDATE: I did reach Sen. Simitian, who says the future of the bill remains uncertain as of today. It could be turned into a two-year bill and become rolled into a bigger pension reform bill next year, or it still may be brought up for a final vote, which is his preference. Look for some indication soon from Gov. Brown, whom Simitian anticipates will make a statement on pension reform.

Meanwhile, he and CalSTRS did reach a compromise on the language of SB 27. Those following my previous post on the bill will recall the disagreement: SB 27 called for a maximum 25 percent raise in pay during the last five years of work for purposes of calculating the person’s defined benefit pension. The difference beyond that would qualify for the defined benefit supplement program only.

CalSTRS, for simplicity sake, proposed a maximum of $147,000 income per year qualifying for a defined benefit pension.

The compromise reached: A maximum of a 7 percent raise in the final year of employment can be applied toward the defined benefit calculation, according to Simitian. There would be no income ceiling. Most elements of the bill, including new definitions of what sorts of income qualify for defined benefit and which for the supplement, would apply to current and future employees. The 7 percent pay increase for defined benefit calculations would apply only to future employees.

(My preference for the future: Put a ceiling on income for defined benefit purposes as part of a larger reform – and $147,000 is too high.)

State Auditor: CalSTRS is a high risk

State Auditor Elaine Howle has added the teachers’ pension fund, CalSTRS, to the state’s high-risk list, adding urgency to the imperative to reduce taxpayers’ liability for the nation’s largest education pension fund. The release of Howle’s periodic update of financial worries comes on the eve of the final showdown on a significant pension reform before the Legislature, an anti-spiking bill sponsored by Sen. Joe Simitian, a Palo Alto Democrat.

Passage of SB 27 by itself won’t make a huge dent in the problem. But the bill deals with what Simitian calls “low-hanging fruit.” Spiking – the practice of jacking up employees’ pay in their final year with the intent of increasing their annual pensions – is an abuse of the system that harms taxpayers and other pensioners.

“If we (the Legislature) cannot come to grips with pension spiking, then how can we deal with larger reform issues?” Simitian said last night.

Though proposals and voter initiatives for major changes in public pension systems have been floated, none are live now. Gov. Jerry Brown may have come close to reaching a deal with Republicans in the Legislature on pension reform in exchange for a public vote on higher taxes, but Republicans walked away from it, and Brown hasn’t yet said what his ideas are – or when he will offer them.

The clock is ticking. At a time when K-12 schools and higher ed are desperate to restore money that’s been cut, the Legislature faces the prospect of raising additional subsidies of hundreds of millions to several billion dollars per year to make CalSTRS whole. That’s because CalSTRS’ defined benefit program – the primary retirement fund for its 852,000 members – has not recovered from the 30 percent drop in value of its portfolio in 2008, when the stock market tumbled. Though it has had two fine years, with returns of 13 percent and 23 percent, the defined benefit program “is currently funded at 71 percent, well below the 80 percent considered necessary to fund a sound pension program,” Howle’s report said. The formula for funding the program – taking 8 percent of an employee’s salary, matched by 8.25 percent from the district and 4.25 percent from the state and counting on investment returns to make up the difference – hasn’t been changed in 35 years. Unless it’s changed, or the Legislature cuts benefits by extending the retirement age and the payout, taxpayers will get socked. (Correction: The total state match is 4.5 percent of payroll, not 4.25 percent. This consists of two programs, 2 percent directly toward the defined benefit program and 2.5 percent toward a separate inflation adjustment program, the Supplemental Benefit Maintenance Account).

Last stop for SB 27

Simitian’s bill unanimously passed the Senate and the Assembly Committee on Public Employees, Retirement and Social Security. But at a hearing this week before the Assembly Appropriations Committee, the last stop before a full vote in the Assembly, a dozen or so public employee groups testified against either parts of or the full bill.

SB 27 has two primary provisions. One would would ban an employee from returning to work as a contractor or full-time worker for 180 days after retirement. The intent is to thwart double-dipping, receiving a public paycheck and a pension simultaneously immediately on retirement. Unlike private industry, in which executives train their successors before they retire, some districts and municipalities have rehired administrators at their pre-retirement salaries, saddling the public with triple pay: the salaries of the new executive and the previous one, along with the full retirement benefit. The bill wouldn’t prevent rehiring a teacher to be a mentor or sub, but that would have to wait for half a year.

The second provision would redefine what income qualified for determining a defined benefit pension (not car allowances, sick and vacation pay, or district-paid insurance premiums) and would exclude from pension calculations any raise exceeding 25 percent during the final five years of employment. That wouldn’t prevent promoting an administrator to a key position, with a fat pay boost; however, the excess amount wouldn’t count toward inflating a pension. (It, along with other non-qualified compensation, would count toward a supplemental program, which doesn’t involve a state match and is paid out as a lump sum amount – still a sweet deal.)

Simitian’s bill would apply to both current employees and new workers; that’s the only way to start getting real savings. The CalSTRS board and the California Teachers Association are opposing the bill unless it exempts current employees, who, they argue, have a vested right to all current benefits. They also want to replace Simitian’s spiking formula with what they argue is a simpler alternative that’s less expensive to administer: capping income qualifying for a defined benefit pension at $147,000. Remuneration in excess of that would count toward the supplement program only. Most if not all teachers earn less than $147,000.

“Unfortunately, the fact that CalSTRS specified that these amendments apply to future members has caused some to falsely assume that CalSTRS is only interested in protecting the status quo when our position is actually a function of recognizing the legal limitations of what can and cannot be done,” Ed Derman, Deputy Chief Executive Officer for Plan Design and Communication at CalSTRS wrote this week in a column in Capitol Weekly.

Whether any chance in benefits can be imposed by the Legislature on current CalSTRS employees is disputable. SB 27 would provide an early and important test. The bill has been written to continue to apply to new workers, even if a court overturns the application to current workers. That reduces the risk of litigation.

Simitian also said he is not enthusiastic about accepting an amendment that would sanction pension spiking for more modestly paid employees, such as lower salaried administrators and teachers who are rewarded with promotions with big pay in their final year before retirement. The amount may be smaller, but the principle is the same: It’s wrong and potentially expensive.

Derman also argues that a cap would not preclude CalSTRS from imposing additional oversight procedures to root out spiking; the CalSTRS board has ordered further safeguards. But Simitian said that the way to guarantee lasting oversight is through statute.

(Both Simitian and CalSTRS have points, so I say why not amend the bill to include both the cap on defined benefits for new employees and future earnings for current employees as well as the anti-spiking provisions for workers earning under the cap. That would yield the biggest savings.)

SB 27 is now “in suspense” in the Assembly Appropriations Committee, where many good bills die a silent, mysterious death. Whether it gets out and is sent to the Assembly, where it likely would pass, will be decided by Chairman Felipe Fuentes, or through horse trading between Speaker John Perez and Senate President pro Tem Darrell Steinberg, both Democrats.

They must decide by Thursday.