CalSTRS – The Educated Guess

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.

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.

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.

Battle over pension spiking bill

The California Teachers Association and the state teachers retirement system are pushing for significant changes to SB 27, Sen. Joe Simitian’s bill that would prevent “spiking,” the practice of larding on compensation near retirement to boost a public employee’s pension – a practice that is drawing increasing scrutiny. It also would limit the types of compensation that would be used in calculating a standard pension.

The late-in-coming amendments pose a new challenge to the bill, which raced through the Senate without opposition, and could spur a larger discussion on pension changes. A similar bill by Simitian passed the Legislature last year but was vetoed by Gov. Arnold Schwarzenegger because it was tied to another pension bill that troubled him.

Simitian’s bill would apply to all current and future public workers. Any employee who received a pay increase of 25 percent or larger over the final five years of employment would automatically have the raise audited by the public pension system: CalSTRS in the case of educators. (Educators whose pay rose more than 25 percent in taking a job in another district would be excluded from an audit.)

Another provision, to thwart double-dipping – receiving a public paycheck and a pension simultaneously – would ban an employee from returning to work as a contract or full-time worker for 180 days after retirement.

The board of CalSTRS and the CTA want to limit SB 27 to future employees arguing that current workers have inviolable vested rights to benefits that have already been negotiated. Doing so, however, would substantially reduce immediate savings to the system at a time that CalSTRS is looking to the Legislature for a sizable boost in taxpayer subsidies because it has yet to recover from the stock market meltdown in 2008.

Proposed cap on pension benefits

CalSTRS and the teachers union are calling for a simpler – and more encompassing – way to deal with spiking: capping the amount of compensation that can be counted toward a defined benefit pension at $147,000 instead of requiring reviews. CalSTRS reports that, statewide, 1,600 administrators not covered by bargaining agreements earn more than $147,000; their compensation above that would be credited toward their individual defined benefit supplement accounts, which work like a 401(k) with a lower guaranteed rate of return, thus saving taxpayers money.

Doing it this way would exclude teachers, who rarely make as much as $147,000 and don’t get the kinds of perks that have led to spiking. SB 27 is aimed, in part, at school boards that have boosted the salaries of superintendents and high-ranking administrators through short-term promotions. A report in the Sacramento Bee found that nearly half of the 225 Sacramento retired educators with pensions above $100,000 got at least a 10 percent pay raise in one of their last three years. Depending on how long they’ve worked, employees’ pensions are based on either their highest-paying year or the average pay in their final three years.

Spiking has been an issue in municipal and county governments as well. In Contra Costa County, for example, two fire chiefs, ages 50 and 51, retired with pensions greater than their highest salaries.

Restrictions on qualifying compensation

Under Simitian’s bill, the value of non-salary income, like car allowances, life insurance, and unused vacation pay, would not count in determining a standard pension. This money would, however, be credited toward the supplemental program. To no surprise, the administrators’ lobby, the Association of California School Administrators, opposes the bill.

The only significant change for teachers is that unused sick pay would no longer boost years of sevice in pension calculations. It too would now be credited in the supplemental program. (Some readers will no doubt argue that, as in most private companies, unused sick pay shouldn’t count toward retirement benefits at all.)

The Pacific Research Institute estimated four years ago that pension spiking cost California taxpayers $100 million each year. CalSTRS estimates that SB 27 would yield savings of $10 million annually, but it also said that it would have to hire a dozen people to do the audits and spend $5 million to update a system to flag potential violations.

CalSTRS has been criticized recently for its failure to crack down on alleged spiking. This issue became public after CalSTRS executives fired Scott Thompson, a whistle blower whom they claimed lowered a pension without authorization and refused to restore it. Pension administrators recently told the CalSTRS board they planned to establish a new unit to review questionable compensation cases, regardless of SB 27’s fate.

Simitian, a Palo Alto Democrat, told me that the existing system that permits padding “isn’t fair to taxpayers and to most employees who aren’t in a position to have their incomes spiked and rely on pension systems to be solvent. The status quo undermines public support for appropriate pensions that retirees rely on.”

A newly retired teacher last year earned an average pension of $49,000. Educators receiving six-figure pensions remain a small proportion of the 852,000 teachers and administrators served by CalSTRS, but the focus of public ire – or envy.

CalSTRS this month reported an impressive 23 percent return on investments for the year ending June 30, the best in a quarter century. And it followed a 2010 return of 12.7 percent. But even so, CalSTRS, with $154 billion in assets, remains $25 billion below its peak in October 2007 – and only 70 percent funded. To become fully funded could require more than $2 billion in taxpayer subsidies, between additional school districts’ benefits contributions and the state general fund’s portion of retirement contributions.

Anti-spiking legislation, Simitian notes, “is the low-hanging fruit of pension reform. It should be easy.” He said he has not taken a position on the CalSTRS amendments.

Update: Education Week reports that other Legislatures are also curbing “double-dipping.”

Retirement oversight in budget bill

Collective bargaining usually involves some give and take. Even in times of extreme financial pain, labor can find something to grasp, like… well, saving their jobs. Finding the good may be more challenging for teachers if California’s projected revenues aren’t met and the state imposes midyear budget cuts on schools.

Currently, districts can’t fall below 175 days of school in an academic year or they lose some state funding.

What AB 114, the state budget bill, means for the teacher retirement system. (click on image to enlarge)

When lawmakers passed California’s new budget bill, AB 114, they created a one-time suspension of that limit of up to seven days if projected revenues fall $2 billion short and the state needs to make mid-year cuts to education. Of course, the teachers’ union must agree to this reduction.

What the legislature failed to do in AB 114 is approve a concurrent fix to another section of the Education Code, which requires teachers to work 175 days in order to receive a full year service credit with CalSTRS, the California State Teachers’ Retirement System.

Whoops.

That’s a significant omission for teachers, explained Suzanne Speck with School Services of California, Inc. “I will tell you that teachers are just not going to agree to work a full year and not a get a full year service credit.”

While seven days may not seem like too many, the way that CalSTRS works it could put a teachers’ retirement plans into turmoil. According to CalSTRS, there are three primary groups of teachers that would affected at various stages of their careers.

A member approaching her five-year vesting date could be delayed in reaching it due to potential service credit cuts. If she becomes disabled before her vesting date, she would not receive disability coverage under CalSTRS.

A member approaching the 25-year mark in her career, at which time she would be eligible for the one-year final compensation for the defined benefit pension, would be delayed in reaching that milestone.

A member approaching the 30-year mark in her career could be delayed in reaching it for the purposes of achieving the career factor, a 0.2 percent increase in the age factor calculation if a member retires with 30 years or more years of earned service credit up to the maximum age factor of 2.4 percent. [Example: if you are 61 years 3 months old at retirement without the career factor, your age factor is 2.167 percent. If you have the career factor (30-years or more) your age factor is 2.367 percent.]

That scenario puts local bargaining units in the position of pushing their districts closer to the financial abyss or accepting a reduction in school days. In the latter case, they’d be giving up both salary and service credits in CalSTRS.

“This is what happens when you pass bills in the middle of the night and don’t make phone calls and ask people, ‘If we do this, what are the consequences?'” said Speck, referring to the legislature’s eleventh-hour vote on the state budget bill. “That’s just an assumption on my part; I’m trying to give the legislature credit that it was an unintended consequence.”

Teachers already gave at the office

While Speck wants to give lawmakers the benefit of the doubt, William Habermehl, Superintendent of the Orange County Office of Education, is too angry to be munificent.

“This the stupidest piece of legislation I’ve seen come out of Sacramento,” said Habermehl, suggesting that it was an easy way for lawmakers to put a balanced budget bill on the table so they could get paid.

He said with all that teachers have already agreed to, including furlough days, reduced medical benefits, and increased premiums, no cost-of-living increases, and larger class sizes, expecting them to approve shortening the school year is probably non-negotiable. So if the state does withhold up to seven days of school funding, districts will have to borrow, dip into reserves, or go bankrupt.

“When they called it a trigger they did the right thing,” said Habermehl, “because we have a gun to our head with this legislation.”

CTA supports AB 114 despite CalSTRS

In an odd twist, however, the California Teachers Association (CTA) is giving its full support to AB 114 because it prohibits teacher layoffs in August, which the union says is of more immediate concern.

In addition, says CTA spokesman Mike Myslinsksi, the situation is too hypothetical at this point. “We’re aware of this concern about service credits,” he said, “but this would only come into play if projected revenues do not materialize. That’s speculation; we believe the revenues will be sufficient.”

Try telling that to Superintendent Gary Thomas of the San Bernardino County Office of Education. He’s cautiously optimistic, as they say, but also realistic. “The economy right now has not been bouncing back. I don’t know whether or not we can count on these projections,” he said.

Thomas said the legislature can help by passing legislation to change the CalSTRS service credit law so it conforms to any changes in the instructional days in the school year.

Using the CalPERS law as an example for creating similar legislation for teachers. (Click on image to enlarge)

CalSTRS officials say they’ve already written some language for a bill to address the discrepancy. The legislature approved similar legislation last year for CalPERS, the state employee pension system. AB 1651 gives teachers aides, janitors, cafeteria workers and other classified school employees their full service credits if the school year is cut.

In order to provide similar protection for teachers, lawmakers will have to act on a CalSTRS bill as urgency legislation or it will be too late to help teachers before the next school year is over.

LAO: Alter new teachers’ pensions

New teachers would be among public employees whose state-financed retirement benefits would shrink under a proposal that the non-partisan Legislative Analyst’s Office outlined last week to limit taxpayers’ future liability. Stating that the current pension system is “too expensive and inflexible,” Jason Sisney, the LAO’s director of state finance, said that the goal should be to “preserve a robust retirement system that more closely resembles that of other Californians.”

Sisney outlined two retirement models for future public employees. One would be a hybrid system, combining a smaller guaranteed pension with an employee-employer matching 401(k)-type investment plan like those found in private industry. The other would be to continue the current defined benefit pension, but with employees bearing a bigger share of risks and costs. Those aren’t spelled out in Sisney’s 14-minute online presentation and accompanying slide presentation. (Update: CalSTRS CEO Jack Ehlers took issue with some assertions in the LAO presentation in a Feb. 23 letter to the LAO. Read it here.)

Retroactive additional benefits – one cause for current problems facing public pension systems – would be banned. And new employees would be told from day one that pension benefits could change in the future; they would no longer be an iron-clad guarantee that puts taxpayers on the hook when investments turn sour. Public employees pension costs have risen over the past decade from 2 percent of the state budget to 7 percent – and are facing sharp increases.

The LAO also recommends that the pension system for teachers and administrators – CalSTRS – be weaned from state government subsidies. The state general fund currently funds 23 percent of annual payments (non-investment income) to CalSTRS – about $1.3 billion this year – with teachers and school districts roughly splitting the rest. (One way or the other – through the general fund or Proposition 98 funding to districts, it’s still house money.)

There have been rumblings, particularly among Republicans, that public pensions must be reformed this year as a price for their support of putting Gov. Jerry Brown’s $12 billion in tax extensions and revenues on the ballot in June. With its framework, the LAO’s proposal has now launched what’s expected to be an intense debate.

The LAO presentation coincided with a report last week to the CalSTRS’ Teachers’ Retirement Board confirming alarming liabilities for taxpayers and rising burdens for school districts. Because CalSTRS investments took a 25 percent hit in the stock market downturn two years ago, CalSTRS staff is saying that an additional $3.8 billion in annual contributions is needed to make the system sound over the next 30 years. Contributions as a portion of total teachers’ and administrators’ payroll would have to rise 14 percentage points above the current level of 20.75 percent, to nearly 35 percent (currently split 8 percent contributed by the employee, 8.25 percent by the district, and 4.5 percent by the state).

The CalSTRS report acknowledges that the additional contributions will have to be phased in over a number of years, because the state is broke. But it also assumes that school districts, not teachers or administrators, would pick up the total additional cost. The impact on districts, already reeling from budget cuts, could be substantial. As a rule of thumb, teachers’ and administrators’ pension costs now comprise about 4 percent of a school district’s budget. That could easily rise to 10 percent in coming years, based on current assumptions.

That’s because the state’s liability to meet CalSTRS’ pension obligations is distinct among the state’s public pension systems. Before he left, Gov. Schwarzenegger renegotiated with several state employees’ unions to raise their share of pension contributions to CalPERS, the state’s largest pension system. The state and its unions can do that. But only the Legislature can set contribution levels for CalSTRS, and, according to Sisney and others, courts have broadly interpreted employees’ vested pension rights. From the day they start, their pension contributions and promised benefits are locked in; employers and taxpayers bear the full risk. They can be modified only in exchange for something of equal value, the courts have said. Only the benefit levels of future employees can be altered.

It’s not a foregone conclusion that the Legislature couldn’t also change the future benefit levels of current employees. There’s a legal argument that this can be done in an economic emergency. But it would face “significant legal hurdles,” Sisney said.

That’s probably worth testing, because otherwise, new teachers will bear all of the burden for past investment problems and unwise pension bonuses given during the market’s go-go years. The more the Legislature can tinker with current benefits – raising the retirement age, restricting unused sick days in pension calculations or putting a top limit on pensions for administrators among options – the less new teachers will have to take it in the shorts.

Changing pension benefits of future teachers wouldn’t help solve the state’s immediate pension problems. But over time, the savings would help to offset districts’ higher obligations as they’re phased in over the next decade. But the longer the state waits to address the issue, the more it will to have to eventually kick in.

CalSTRS is not in crisis; do not begrudge the teacher’s pension that I earned

As a public school teacher, I am often gratified by the show of support that parents and others throughout California show for members of my profession. Everyone I talk with says they value education and the need to inspire and engage our youth to lead our nation’s future.

But I’m offended when I hear grumblings over teacher salaries and pensions. News reports of rich public pensions paid to local government officials lead many to reason that CalSTRS and its members are also to blame.

I take those criticisms personally. After all, given my education, training, and service, I’ve earned the pension I’ve spent a career in building.

Most CalSTRS members do not retire into a life of luxury. Ours is a modest pension, secured over nearly three decades of service. The median CalSTRS pension replaces about 60 percent of our working income. Unlike most workers, teachers in California do not earn any Social Security benefits for their classroom service. As such, the CalSTRS pension represents the only source of reliable monthly income a retired teacher receives. Moreover, most public school educators in the state retire without employer-sponsored health care after age 65.

Nor is it a taxpayer giveaway. Over the life of their careers, CalSTRS members contribute 8 percent of their monthly pay to help finance their retirement. Employers kick in another 8.25 percent of monthly pay (75 percent of which is offset by not having to pay Social Security taxes), the state contributes a little more than 2 percent, and the returns garnered by CalSTRS investments do the rest. These taxpayer contributions represented less than 28 percent of the resources used in the past 15 years to pay benefits.

In the past decade, the financial health of public pension funds, including CalSTRS, has been undermined by the dot-com bust and global recession. However, our situation is not as dire as many would have you think. As of June 2009, CalSTRS benefits were 78 percent funded and the system had sufficient assets and projected contributions to pay benefits until 2044.

Public pension funds like CalSTRS are not in crisis. Our long-term rate investment return of 8.2 percent for the past 20 years exceeds our assumptions. Our benefits are paid for and funded over decades.

Local and state governments, including California, must make hard decisions to ensure the solvency of their public pension systems. CalSTRS acknowledges that changes must be made to its system and is working with affected stakeholders to develop a responsible strategy to address the system’s projected long-term funding shortfall. While a fix is not immediately needed, the longer we wait to address funding issues, the costlier a solution will be.

We can manage our funding problems without eliminating the Defined Benefit pensions that California’s public educators have worked for and deserve.

Dana Dillon is an intermediate grade school teacher from Weed. She has served on the Teachers Retirement Board of CalSTRS since her election in 2003, including stints as chair and vice-chair. Dillon has been active in the California Teachers Association for more than 26 years, serving as state council representative, and was recently elected to the board of directors.

No easy way to cut CalSTRS benefits

Call it pension envy, matched by frustration over higher pension contributions that taxpayers will eventually be asked to fork over. The clamor for cutting public employees’ pension benefits has grown louder. And that includes calls to change CalSTRS, the pension system serving 852,000 teachers and administrators in California.

The Legislature approved bonus benefits in the fat years of Wall Street when it looked like pension systems would forever be fully funded. (See excellent post by Ed Mendel of Calpensions.com.) Then the recession hit, and, amid mortgage and bank fraud on Wall Street, stocks tumbled. The downturn on Wall Street in 2008 has left CalSTRS and CalPERS, which serves state employees and some school district employees, needing higher taxpayer and employee contributions to make up for problem investments. (See earlier post.)

But those who see cutting pensions as a way out of the current state budget deficit and school districts’ cuts should think again. Analysts say the state cannot legally renege on payments to retirees or promises to current employees. Courts have been protective of guarantees made to public employees, and the Legislature, which sets the pension benefits and contribution rates for CalSTRS, will have to provide some other comparable benefit, like higher pay, if tries to cut CalSTRS’ obligations to workers.

“This means that pension contracts for existing and past employees are uncommonly difficult – or expensive – to change,” said Jason Sisney, director of State Finance Policy for the non-partisan Legislative Analyst’s Office.

That’s not to say legislators or groups pushing reform by initiative may not try. Some argue that local governments and the state have the right to change future benefits for current employees after crediting them for what they’ve already earned. Courts will likely be skeptical, Sisney said.

What the Legislature could do is change the system for new employees: switch from a defined benefit to a matched contribution 401(k) plan, raise the retirement age, or alter the formula, based on a person’s age and years of teaching, used to determine the retirement benefit. But that wouldn’t help the state’s immediate budget crisis, and, if done punitively, could be one more factor to discourage potential teachers from entering the profession.

CalSTRS versus Social Security

CalSTRS is a much better deal than Social Security, where the full retirement age is later (66 or 67 for baby boomers, depending the year of birth) and the payout is less, calculated on a lifetime of yearly earnings, not the final – and usually the highest paying – year of work.

A teacher, principal, or superintendent who retires at the age of 60 after, say, 35 years of teaching and managing, will receive 70 percent of her final year’s salary. If she waits three more years, retiring after 38 years at age 63, she’ll get 91 percent of her last year’s salary. And if she works about 42 years and retires after 63, she can expect to receive her full final year’s pay every year for the rest of her life.

The average Social Security benefit – about $1,000 a month, or a little more than $12,000 a year – replaces about a third of workers’ average earnings. The median yearly benefit of newly retired CalSTRS members was $49,000 per year last year, or about $4,100 per month. At the high end were top district administrators with retirement incomes well exceeding $150,000.

But many workers in private industry get to combine Social Security with company-paid pensions or employer-matched 401(k) plans; CalSTRS members don’t have those. And teachers and administrators also pay substantially more into CalSTRS than workers in the private sector pay into Social Security: 8 percent of paychecks is deducted for CalSTRS members, versus 6.2 percent deducted for Social Security (actually only 4.2 percent this year, because of the one-year tax cut Congress passed in December). In addition, teachers who have worked other jobs in their careers also qualifying them for Social Security will not receive full benefits of both. They are penalized, with some portion of their Social Security benefits wiped out.

There may be ways that the Legislature can tinker around the edges without running afoul of the courts. Last year, legislators passed SB 1425, which would address “spiking,” the practice of boosting the last year of pay by throwing in non-salary items, like the value of a car allowance and unused vacation for upper-level managers. It would base the retirement benefit for all public employees on the average salary of the final three years of work, instead of the final year. That’s what done now for CalSTRS employees who retire with fewer than 25 years of service.

Gov. Schwarzenegger vetoed the bill because it was attached to another retirement reform he felt didn’t go far enough. Sen. Joe Simitian, a Palo Alto Democrat who sponsored SB 1425, has resubmitted it this year as SB 27. It’s likely to pass again.

(For a look at what other states are considering, check a blog in today’s EdWeek.

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Calculating CalSTRS benefits:

Under the defined benefit program, teachers contribute 8 percent of their salary; districts contribute 8 percent, and the state 2.01 percent.
Teachers are vested in the system after working five years;
Employees can retire as early as 50, at a lower rate: 1.1 percent of pay times number of years worked (25 years would yield 27.5 percent of pay;
At age 60, the rate becomes 2 percent of pay times years (25 years would yield 50 percent of pay); at 60 years, 9 months, 2.1 percent of pay; at 61 years, 6 months, 2.2 percent; at 62 years, 3 months, 2.3 percent. The maximum rate, 2.4 percent, kicks in at 63 years (25 years would yield 60 percent of pay).

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Teachers’ pension costs to escalate

CalSTRS, the pension system for teachers and school administrators, had a good year in 2010, with a 12.7 percent return on investments. But that’s far from enough to make up for the huge hit the system took during the recession two years ago. As a result, the state, school districts, and teachers themselves can expect to pay billions of dollars more annually into the system to keep it solvent for the next three decades.

Those added costs, coming at a time of severe budget cuts for education, will add to the arguments of those calling for pension system reform, like a switch to a 401(k) instead of a defined benefit program for new members. Gov. Brown has yet to reveal his ideas for pension changes, but some Republicans are saying that reform will be a precondition for them to vote to place any increased taxes on the June ballot.

The increases in pension contributions will be huge – as big as 80 percent more over the next several years – though the Legislature will have to decide who will bear the brunt: workers or taxpayers.

Currently, CalSTRS receives contributions based on 18.25 percent of a teacher’s or administrator’s pay. Teachers pay 8 percent, the employer (district) pays 8.25 percent, and the state’s general fund kicks in 2 percent. The state also pays an additional 2.5 percent for a supplemental benefit that protects retirees from the effects of inflation.

CalSTRS contributions from the state totaled $1.257 billion out of an $84.6 billion state budget this year.

As a rule of thumb, salaries of certificated employees make up roughly 50 percent of a school district’s general fund budget. So pension contributions currently make up about 4 percent of a district’s budget. In San Jose Unified, for example, CalSTRS contributions cost $10.8 million out of the $285 million budget – 3.8 percent. (Contributions for pensions of classified employees, including secretaries, custodians, and aides, are in the larger CalPERS system for state workers, and constitute roughly another 1 percent of district expenses.)

The CalSTRS board is **recommending that the contribution be raised 15 percentage points, to 33 percent of an employee’s pay – a steep hike. Unlike CalPERS, CalSTRS cannot impose the additional contributions. Only the Legislature can decide how much and who pays.

Most of the increase will make up for a shortfall in investments. In 2008, the value of CalSTRS’ portfolio fell more than 25 percent from its historic high in October 2007 of $180 billion. By the end of calendar year 2010, it was back to $146 billion. That still leaves it more than $30 billion short of meeting obligations over 30 years.

But an additional factor, accounting for 1 percentage point, is the decision of the CalSTRS board to lower the predicted rate of return on investments from 8 to 7.75 percent (CalPERS also has done so). Public employee pension programs nationwide have been under pressure to lower overly optimistic rates of return. The CalSTRS staff and actuarial consultants had urged lowering projections by a half-percentage point, to 7.5 percent. Even at 7.5 percent, consultants predicted only a 50 percent chance that the system would meet its investment target. But this would have meant even larger annual contributions from employees and taxpayers, so the board rejected the recommendation.

CalPERS and CalSTRS expect that investments will cover two-thirds of their income, with a third from contributions. Some economists say that the rate of return should be more conservative – 6 percent, as in many private pension plans, or lower.

CalSTRS provides retirement and disability benefits for 852,000 educators at 1,600 school districts, community colleges, and county offices of education. Salaries of members this year are projected to be $29.5 billion. So raising contributions 15 percentage points would require an additional $4.42 billion, split three ways. If the Legislature kept the same proportions, teachers would pay $1.9 billion, districts $2 billion, and the state about an additional $442 million. But, with the state facing a $25 billion deficit this year and many teachers facing salary cuts through deferrals, the Legislature is not expected to make any significant change this year.

But the longer it takes to phase in the increase, the bigger the adjustments must be in future years.

Enough numbers for one post: I’ll take a look at teachers’ pensions and one proposed reform later this week. The journalist who follows the pension system closely – and who helped me with this piece – is Ed Mendel. He writes an informative blog, Calpensions.com.

** Clarification: The CalSTRS board has identified the cost of full funding but has not made a recommendation on what action to take.