Public Pensions in California
- Nearly one in ten Californians is a member of a public pension program.
There are 85 pension programs across California that offer some kind of benefits to about four million state, county, and local employees. But most state employees (65%) are covered by either the California Public Employee Retirement System (CalPERS) or the California State Teacher’s Retirement System (CalSTRS)—the largest and second-largest public pension funds in the US. Members of CalPERS include current and former employees of the state government and California State University, as well as non-teaching public school employees and judges. CalPERS also administers retirement benefits for more than 3,000 local governments, agencies, and school districts. Some state retirement plans include health benefits, and some state employees—teachers, primarily—receive pensions in lieu of Social Security.
- California is moving away from defined benefit pensions.
Defined benefit pensions provide specific monthly benefits to retirees and their beneficiaries. These benefits are determined by a formula that typically incorporates employee salaries, years of employment, and age at retirement. Most public pension programs take contributions from both employees and employers and pay pension benefits out of those contributions plus the returns on investment. But California is moving toward a hybrid benefits model: in 2013, new state employees began to make higher contributions to less generous defined-benefit plans, which they can supplement by contributing to individual 401(k) or 403(b) retirement accounts.
- Evaluations of pensions’ fiscal health are based on many assumptions.
Like other pension systems, CalPERS, CalSTRS, and other California programs use actuaries to assess their financial condition. Actuarial valuations estimate the present value of a system’s liabilities and compare it with the value of assets on hand. These assessments are based on a complicated—and sometimes contested—mix of investment, macroeconomic, demographic, and other assumptions. For example, some have argued that it is overly optimistic for CalPERS to assume a 7.5% annual investment return; lowering this assumption would increase its estimated liability by several billion dollars.
- Pension funds are long-term investors.
Pension funds can withstand short-term volatility for the long-term benefit of higher returns—unlike individuals, who need to invest more conservatively as they get closer to retirement, a pension plan should be able to take more risks and earn higher returns. But accounting standards and public scrutiny on short-term volatility—especially during economic downturns—can make this difficult in practice. Over the past 20 years, short-term investment returns have varied for CalPERS and CalSTRS, but their average returns have exceeded expectations.
- California’s local governments are especially affected by volatility in pension costs.
Nearly 60% of pension contributions to state retirement systems in California come from local governments. That is about 20% higher than the national average and second only to Florida among large states. Since local governments have smaller budgets and fewer ways to generate revenue, increases in pension costs are difficult for local governments to absorb. For example, in San Jose pension payments rose from $73 million in 2001 to $245 million in 2012; the city laid off 25% of its workforce to meet its obligations.
- State public pension benefits are constitutionally protected; local benefits may not be.
California courts have long ruled that pension benefits for current and past public employees are protected under the Contract Clauses of the US and state constitutions. But public retiree health benefits are considered “other post-employment benefits” and are not protected. And recent federal rulings during bankruptcy proceedings in Detroit and Stockton put federal bankruptcy law ahead of state law—which suggests that municipalities in bankruptcy can cut payments to public pensions. Stockton emerged from bankruptcy without cutting pension payments, though it did eliminate health care benefits for 2,400 retirees.
California’s public pension investment returns have exceeded expectations
Local government contributions to California retirement systems are higher than the national average
SOURCES: Legislative Analyst’s Office, Addressing California’s Key Liabilities (May 7, 2014). Pension funding and investment returns: CalPERS and CalSTRS Actuarial Reports. Effect on local government: Stephen Eide, California Crowd-Out, Civic Report No. 98 (Manhattan Institute, April 2015); Thom Reilly, “Reforming Public Pay and Benefits,” State and Local Government Review 45.1 (2013): 57–64: Iris J. Lav, “Curbing the Consequences: Achieving Better Outcomes for Workers in Municipal Bankruptcies,” New Labor Forum (SAGE Publications, 2014).