California Has To Be Dreaming For This Solution To Take

I finished California Dreaming and the suggested solution for their public pension crisis is similar to what Christie is looking to push in New Jersey:

  1. Freeze the current Defined Benefit plans
  2. Set up 401(k) plans with profit sharing for everybody
  3. Use the savings to fund the massive shortfalls developed under the Defined Benefit system

My problem with that (in both states) comes down to:

  1. There won’t be any savings.  Contributions for the current Defined Benefit system have been ridiculously understated (which is the main reason for the massive shortfalls that developed) so a Defined Contribution plan that provides substantially lower contributions would still cost about the same for governments;
  2. The transparency of Defined Contribution plans would make it a tough sell to public workers; and
  3. Private sector workers were fooled into accepting 401(k) plans in the 1980s and look where they are.

In any case it was a useful read and below are notable excerpts:

Under current federal law, a private-sector pension cannot be based on an average compensation using fewer than 5 years (page 6).*1

California Rule. With few exceptions, the pension formula in effect on the date of hire becomes a contract between the government agency and the employee for all service the worker will provide and the contract cannot be impaired unless offset by a new benefit of comparable value. (page 8)

California has six statewide defined-benefit public pension systems: Judges’ Retirement System I, Judges’ Retirement System II, Legislators’ Retirement System, CalPERS, CalSTRS, and UCRP. (page 13)

Some argue that a funding ratio of 80 percent or more is adequate, but the American Academy of Actuaries calls this a “myth”: “Pension plans should have a strategy in place to attain or maintain a funded status of 100 percent or greater over a reasonable period of time.” The reason for this strongly worded admonition is that investment markets fluctuate wildly over time and commitment by government officials to full contributions often weaken over time, making anything less than an explicit goal of 100 percent funding a dangerous path. (page 15)

if the funding ratio falls below 60 percent , private pensions must freeze plan benefits regardless of collective-bargaining agreements. (page 16)*2

The bottom line is that officials at California’s public pensions are permitted to engage in behavior that would be considered criminal under ERISA if done by officials overseeing private-sector pensions. (page 17)

the financial methodology used by California’s public pensions (and virtually all public pensions in the country) has been deeply flawed. There is almost no dispute among academic economists on this point. These flaws systematically overstate assets and understate liabilities so public pensions appear to be healthier than they are. (page 18)

These public pension systems use a dramatically longer amortization period than the private sector: 30 yers versus 7 years. If used in the private sector, this amortization period would be considered criminal under ERISA. (page 19)

As Stanford professor Joe Nation has concluded: “In short, public pension systems utilize assumptions and methods supporting a consistent theme of understating liabiliti3s, overstating assets, and pushing costs into the future.” This has allowed California’s public pensions to hide the true extent of the funding problem from the public. (page 2))

Ed Ring with the California Public Policy Center noted: “If a fund is 50 percent funded instead of 100 percent funded, it cannot survive by hitting its return on investment target of 7.5 percent because it is earning that 7.5 percent on half as much money as it needs. It has to earn 15 percent just to stay at 50 percent funded.” ((page 24)

CalSTRS’s m,embers do not make contributions to Social Security while employed as teachers in California and, thus, do not directly qualify for Social Security benefits at retirement. The absence of participation in Social Security is often mentioned to justify the higher pension contribution rates for teachers compared to some other job classifications. (page 40)

It is also common, bu little known, that many California public employees do not contribute anything into their pensions, even when there isn’t a so-called pension holiday. This perk is called a “pension pickup,” and it can increase taxpayer costs. (page 42)

When the bubble burst, “CalPERS lost 103 percent of the value of its housing investments in one fiscal year” because it had borrowed money – up to 80 percent in some cases – to finance the deals. CalPERS had to pay back the borrowed money because it guaranteed the debts. (page 43)

In 1999, the California legislature and then governor Gray Davis dramatically increased pension benefits and made the increase retroactive. (page 49)

To the extent that California’s pension crisis was driven by an inaccurate picture of the extent of the problem, the cause does not appear to be financial-control personnel ignoring generally accepted practices. Rather, the problem is in the practices themselves that result in actuarial estimates that are “smoothed, stretched, backloaded, and otherwise spread across time,” as described by the New York Times. (page 60)

According to data analyzed by the Employee Benefit Research Institute, only 3 percent of private-sector workers in the United States in 2011 participated only in a guaranteed DB pension plan. In contrast, 89 percent of public-sector workers participate in a traditional DB pension, including almost all government employees in California.

increasing numbers of financial experts and political scientists are concluding that agents in the political arena cannot operate financially sustainable defined-benefit pension plans over the long haul. The incentives for political mischief are too great. (page 85)

The New York Times has noted that the “politically difficult steps taken recently by many states to fix their pension problems – raising retirement ages, requiring bigger contributions from workers, lowering benefits for new hires – will prove insufficient, because they were based on uderestimates of the problem. This is certainly true in California.

First, the arbitrage has to be executed at just the right moment for market timing to yield a positive net return. Pension fund returns must average more than the cost of financing the debt, which is often not the case. Second, as of 1986, POBs are not exempt from federal taxation, thus their interest rate is higher than ordinary state and local bonds. Third, fees are charged by brokers for issuing POBs that make the arbitr4age less likely to be successful. Fourth, POBs are an inflexible debt with required annual repayments unlike amortizations of unfunded pension liabilities. (pages 88-9)

In early October 2014, Judge Christopher M. Klein of the US Bankruptcy Court, Eastern District of California, ruled that the city of Stockton may legally cut already-promised pension payments and walk away from its CalPERS contract as part of a bankruptcy restructuring plan. For the first time, a judge in California said a local government has the right to reject its contract with CalPERS in bankruptcy. Klein stated: “impairing contractual obligations – that’s what bankruptcy’s all about” and ruled that state law protecting pensions takes a back seat to the federal bankruptcy code and the US Constitution, otherwise, “the California legislature can edit the federal law.” Even though Stockton’s final restructuring plan did not cut pensions, Klein’s groundbreaking decision stands, making this a possible avenue for trimming the pensions of current retirees and employees of bankrupt local governments in California. Public pensions are no longer sacrosanct. (page 94)

DB plans and hybrid plans leave the door open for vote buying through political manipulation of pension plans. Long-term, it is best to terminate the DB plans. (page 96)

Overall, pension costs as a share of local budgets were, on average, five times higher in 2011 than in 1999. Reducing pension shares by freezing DB plans and switching to DC plans will free room in budgets for other services. (page 110)




* Not quite true (I think):

1) It’s at least highest consecutive 3-years needed for average compensation in the private sector

2) The 60% benefit freeze applies to single-employer plans.  Most collectively-bargained plans are multiemployer.  Whether a single-employer plan with union employees can trump the CBA and freeze accruals if the funded ratio drops below 60% could be a subject of litigation.

26 responses to this post.

  1. Posted by PatB on July 21, 2015 at 12:11 am

    Off topic but very interesting article on diversion of pension moneys. Not a lot of attention on the comments.


    • Posted by Tough Love on July 21, 2015 at 1:02 am

      NJ(DOT)COM is the bastion of pro-Public-Sector-Union articles, and the author of your linked article Edward Buttimore is a 2005 NJ retiree with a vested interest in no reductions to his pension or healthcare subsidies.


    • Posted by S Moderation Douglas on July 21, 2015 at 7:35 am

  2. Posted by Tough Love on July 21, 2015 at 12:41 am

    I couldn’t agree more, with the author or your commentary … with 2 tweaks:

    You suggested that Christie’s Plan (meaning the Pension Commission’s proposals) provides no opportunity for “savings” because the current very low taxpayer DB Plan contributions would be no less then the DC (or Cash Balance DB) contributions that would replace them. But ………

    (1) Not true for the “LOCAL” Plans, where taxpayer DB Plan contributions (especially for Police Plans) are quite a bit higher than what likely would be the replacement DC contributions.

    (2) The Commission’s proposals identified “savings” by replacing the current “Platinum+” active and retiree healthcare coverage with coverage more in line with what large Private Sector employers offer their employees. While I seriously doubt such saving would be sufficient to amortize the unfunded liabilities for PAST service accruals in the current DB Plans, this is indeed a source of SOME savings if it can be pushed through (no small task).


  3. Posted by Greg Lamon on July 21, 2015 at 5:58 pm

    With regard to the “perk” of a pension pick-up, the majority of public sector employees in California have been required to contribute to their pension plans, but some local governments did cover that employee share as part of the total compensation package. The 2012 California Public Employee Pension Reform Act (PEPRA) requires that all of the approximately 5,000 government entities in California must end such a practice no later than 2018 with employees being required to pay 50% of the retirement plan contribution cost going forward. Some public agencies that did not require such a 50% contribution rate have changed to now require it. Others are gradually shifting to it in a phase-in approach, but by the end of 2018 California law will require all of them to reach the 50% employee contribution level. As might be expected, for those employees who have not been required to contribute 50% a shift to that level results in their take home pay going down and that has produced some vocal howls of protest. Some local government agencies have voiced concerns that this new State law usurps local control with regard to local government compensation policy.


    • Posted by Greg Lamon Is Wrong Again on July 21, 2015 at 7:49 pm

      The 2012 California Public Employee Pension Reform Act (PEPRA) only requires employees to pay half the NORMAL cost, and it is capped at 14%, public safety pensions cost as much as 60% of base pay, and 14% is not half of 60%, it is not even 25%. The pubic employees pays NO part of the unfunded liability. No public employee has seen their take home pay go down as a result of paying THEIR share of pension costs because they are given raises by the same amount to offset the pensions costs. Pubic employee spin never seems to stop….


      • Posted by S Moderation Douglas on July 21, 2015 at 8:11 pm

        14% ?

        Assembly Bill No. 340, 20516.5.(b)

        “However, that contribution shall be no more than 8 percent of pay for local miscellaneous or school members, no more than 12 percent of pay for local police officers, local firefighters, and county peace officers, and no more than 11 percent of pay for all local safety members other than police officers, firefighters, and county peace officers.”


        • Posted by Tough Love on July 21, 2015 at 8:31 pm

          Then it’s an even BIGGER farce.


          • Posted by S Moderation Douglas on July 21, 2015 at 10:07 pm

            Nothing in Greg Lamon’s 5:58 pm post was untrue. The farce is the sarcastic response, who didn’t even bother to check his basic facts. And then fabricates his own i.e. :”safety pensions cost as much as 60% of base pay”

            “Greg Lamon Is Wrong Again” is wrong again.

          • Posted by Tough Love on July 21, 2015 at 10:58 pm

            CA’s COLA-Increased 3%@50 pension formula (applicable to almost all Safety workers hired before the recent changes) when valued in the same manner now employed by Moody’s (and quite similar to the methodology REQUIRED of Private Sector Plans) does indeed require a level annual 60% of pay to fully fund the promised pension over the employee’s working career.

          • Posted by S Moderation Douglas Is Wrong Again on July 22, 2015 at 1:03 pm

            S Moderation Douglas is also WRONG again, as he usually is on all issues relating to pubic pensions. He was claiming a few days ago the average income in CA was $61K, when in fact that was the average HOUSEHOLD income. Pay no attention to Mr. S, he is living at the trough, posting false and untrue spin, and is, as usual, wrong again.

          • Posted by S Moderation Douglas on July 22, 2015 at 2:51 pm

            California Average weekly wage: $1,175

            $1,175 x 52 = $61,100

            The discrepancy was between this and:

            California Mean hourly wage: $25.91

            $25.91 x 40 x 52 = $53,892

            The discrepancy is ….not….. as suggested by:

            “Jack Thom Rank 1260
            @S Moderation Douglas .. of course, those figures are factoring in the public union employees pay, duh.”

            because “public union employees pay” is included in both sets of data.

            The only likely explanation I have found for the discrepancy is that “weekly earnings” may include overtime pay, tips, and commissions, whereas the “hourly earnings were merely multiplied by 2080 (40 x 52) to arrive at the annual average.

            “Usual weekly earnings. Data represent earnings before
            taxes and other deductions and include any overtime pay,
            commissions, or tips usually received (at the main job in the
            case of multiple jobholders).”

            I am eponymous; Moderation is my middle name.

            You are welcome.

          • Posted by S Moderation Douglas Is Wrong Again on July 23, 2015 at 3:03 am

            I think Mr. Richard Rider already debunked your false numbers Mr. S.

          • Posted by S Moderation Douglas on July 23, 2015 at 9:29 am

            I think your problem is still reading comprehension, Surfpuppy.

      • Posted by Tough Love on July 21, 2015 at 8:17 pm

        To fully fund a 3%@55 pension over a 30 year career with COLA-increased payments commencing immediately upon retirement at age 55 (with no reduction for collecting at such a young age) requires a level annual total contribution of 55%-60% of pay. And that’s just the “Normal Cost” assuming there is no underfunding that needs to be amortized.

        A 14% contribution cap that is supposed to cover HALF the Plan’s total cost is a FARCE.

        The 2-nd Greg Lamom (doubting that these came from the same commentator) is dead-on-the-money in his commentary.


        • Posted by S Moderation Douglas on July 21, 2015 at 10:36 pm

          “To fully fund a 3%@55 pension over a 30 year career with COLA-increased payments commencing immediately upon retirement at age 55 (with no reduction for collecting at such a young age) requires a level annual total contribution of 55%-60% of pay.”

          Are you planning on investing your entire portfolio in Treasury bonds?


          • Posted by Tough Love on July 21, 2015 at 11:08 pm

            S. Moderation Douglas,

            Since you like to quote Andrew Biggs so often, I suggest that you …. and readers who would like to hear an impartial scholarly discussion of the subject …….. read the attached link which Mr. Biggs submitted to the Actuarial Standards Board in response to their “Request for Comments” regarding the valuation of Public Sector pensions.


          • Posted by S Moderation Douglas on July 22, 2015 at 12:22 am

            Or, as per Girard Miller:

            “As I’ve testified to the GASB during their public hearings, a risk-free discount rate would ultimately result in excessive burdens on today’s generation of taxpayers and invite mischief in the future as this approach is a sure-fire way to produce over-funded pension plans in the long run. (I know this sounds laughable in today’s funding environment, but that is the logical multi-generational result of the risk-free model.)”

      • Posted by Greg Lamon on July 21, 2015 at 8:47 pm

        The irony of any such raise is that it would increase the employee’s pensionable income, meaning that any such employee working long enough to draw a pension would receive a larger pension because of the raise.. Unwise.


      • I think he meant 50% of the employee share which before the new laws was paid for by the employer in addition to paying their own share. This is the type of insanity from the public sector that is unfathomable in the private sector. It would be like the employer paying both sides of the SS tax. And I love that he predicts that “vocal howls of protest” will be forthcoming from the aggrieved PS drones now actually having to contribute to their own pension. Imagine that.


    • Posted by Tough Love on July 21, 2015 at 8:03 pm

      Quoting Greg Lamon …. “with employees being required to pay 50% of the retirement plan contribution cost going forward”

      That would be wonderful IF (a BIG IF) those pensions were valued (for this measurement purpose) under the NEW GASB rules or using the conservative methodology that the US Gov’t requires of Private Sector Plans.

      Dollar-to donuts, that measurement will be based on the super-rosy methodology in place before the GASB changes, which means that the worker’s share will likely never exceed 1/4-1/3 of the TRUE “cost going forward”.


  4. Posted by Jim on July 21, 2015 at 8:41 pm

    The Good Pension Fairy will rescue us all.


  5. Posted by Anonymous on July 22, 2015 at 1:31 am

    OK – let me try again. The point I was trying to make in my post is that the days of an employer pickup of all the retirement costs of an employee in California are numbered, and will end no later than 2018. What the funding ratio will be after that is subject to the employee caps mentioned by S Moderation Douglas which is also spelled out in this new California Pension Reform law. To put it simply, the law imposes caps on the maximum amount of a pension for employees hired after January 1, 2013 and a cap on the maximum employee contribution for all employees. For those wanting to get into the weeds on this one beyond the issue of whether an employer pickup is allowed in California after 2018, this publication might help – “A Guide to Pension Reform Under AB 340 and AB 197”, Renne Slan Holtzman Sakai, December, 2012, This is my source of information, and to the extent it is wrong then I am wrong, so if anyone can demonstrate that this publication contains significant errors please share with us all.

    Happy reading.


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