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Public Pensions: What They Cost and Why Reform is Looming
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Public Pensions: What They Cost and Why Reform is Looming
By Linda Fridy
[Editor's Note: This is the first in a series of articles explaining public pensions and issues around their escalating costs.]
The buzz around pension reform continues to grow in political and financial circles. As stock market drops have erased years of earnings in 401(k) plans and state and local agencies face record reductions, the costs of "generous" public pension plans have come under scrutiny.
While the 30-year police officer's pension is generally not reported, the retirement salaries of top administrators are making headlines.
Not just public safety chiefs get criticized – top government and city officials are also under fire, along with veteran auto factory workers and other specialized work forces. It's just public safety officers generally get to retire earlier.
The issue is not just a matter of pension envy from disgruntled private sector employees who wish they could retire at 50 or 55 with as much as 90 percent of their former salaries. It's a question of whether taxpayers can afford to continue to fund those benefits even as education and social service programs are cut.
Once a pension plan is granted, it cannot be revoked, which means the benefits that governments could afford when the stock market was booming and veteran employees were working longer are difficult to afford in a recession-battered economy.
At best, governments and agencies can renegotiate the employee's contribution level and offer a different pension plan for new hires. But that won't help – it's estimated – for more than a decade.
And there's more trouble.
In the '90s, forecasters said improved benefits were a bargain for agencies trying to attract working in a booming economy. Now, the same number-crunchers are saying the opposite.
Forecasting pension costs is a challenging mathematical dilemma, and economists are taking sides on how to do it. What most officials agree upon is that the public pension landscape has changed dramatically since the days when investments were made in guaranteed bonds and offered as a perk to offset lower-paying civil service jobs.
Boom to Near Bust?
Public employee pensions got a big boost in the late 1990s, when large gains in the stock market increased the amount of money in funds such as the California Public Employees' Retirement System. CalPERS, as it is better known, is the nation's largest public pension fund with assets totaling $211.2 billion as of Apr. 30.
Rising investments at that time meant the fund had more money than it needed to pay retirees and cover future projections.
So CalPERS offered public agencies the chance to boost retirement programs with lower retirement ages and higher payout calculations at virtually no cost. The state of California led the way with new plans for union members in 1999, like the CHP and CalFire safety employees. Like most agencies, the "safety" designation meant only those sworn officers working in the "line of duty."
Others soon followed.
At the time, many public safety agencies faced a shortage of applicants and welcomed a way to attract recruits. In an effort to remain competitive, soon most departments offered retirement benefits at age 50 with a higher 3 percent lifetime multiplier rate.
Previously the earliest retirement age in public safety had been 55.
Other government agencies negotiated plans that allowed retirement at 55 instead of 60 for the groups known as miscellaneous or general workers – clerks, planners, etc. These plans could also adjust the percentage of earnings, from 2 percent to 2.5 or 3 percent. At first, increased investment values covered the cost of these more generous plans. That all changed when the stock market dipped and more workers retired.
The problem has been that as earnings dropped, they no longer covered the amount needed to pay retirees and fund future demands. That left public agencies to make up the difference with money that would otherwise go to programs.
"Can we really afford to pay healthy, productive people to retire when they are 50? How sustainable is that?" asked Scotts Valley Mayor Jim Reed, who has been following the public pension debate. "Everybody everywhere is coming to the conclusion that we just can't afford this."
Local Costs and Programs Vary
Public pensions are supposed to be funded by a combination of investments and contributions by both public employers and employees. Yet when the stock market was high, Santa Cruz County personnel director Mike McDougall said there were years that CalPERS did not ask for those contributions because investment returns provided all the necessary increase.
Now that money, millions of dollars at the local level and billions at the state, is taking funding that used to go elsewhere.
The biggest effect is seen in public safety pensions since they have earlier retirement ages and a tradition of workers who spend their entire careers in that field, often with one agency. Today, local agencies are paying a quarter to a third as much to fund pensions as to pay employees, outpacing even health care insurance costs.
Santa Cruz County followed the state trend in upping its pension offering for law enforcement to 3 percent at age 50, but remained on the lower scale for its other employees, said McDougall. Sworn safety officers cost the county 25.14 percent of salaries, plus they contribute 9 percent.
For all other employees, the pension plan is 2 percent at age 55, for which the county is paying 12.15 percent of salaries. It also covers the 7 percent "employee share" for all Service Employees International Union members.
For management and other groups, that percentage comes out of their paychecks, much like private sector workers who have Medicare and Social Security costs deducted from gross wages.
Although the county's plan has lower costs and has seen less dramatic increases than some others, McDougall wonders if everyone across the state had known the cost of market volatility, they would have approved the more generous plans.
"All the risk associated with the market is on the employer [at the county]," said McDougall.
However, that is not true elsewhere.
Capitola Caps Costs
One local city may have found a way around that unpredictability.
Capitola waited until 2008 to increase its pension calculation plans. In exchange for the plan bump, employee unions agreed to a cap on the city's contribution, explained Lisa Murphy, assistant to the city manager.
That means that if CalPERS wants a higher payment, the difference comes out of the employees' paychecks, not the general fund.
Now the city's police officers have a 3 percent at 50 plan, but the city will pay no more than 28.2 percent. The actual cost is currently 30.6, said Murphy, and officers pay that extra 2.4 percent.
For other groups, the cap is 16.4 percent, and employees are covering 4.1 percent under current costs.
"We're at a really big advantage having this cap," Murphy said, although the city is investigating whether it would benefit from a two-tiered approach, offering new employers a different and less expensive plan.
"It's difficult to calculate for small city," she said, noting it has a hiring freeze and relatively low turnover.
Santa Cruz, which is facing a million-dollar deficit even after employee unions agreed to continued concessions, just announced it may consider a different pension plan for new hires.
In Scotts Valley, union agreements were just renewed with no pay increase for two years but retaining the same pension plans.
Scotts Valley offers its police the now-common 3 percent at age 50, which costs 29.7 percent, and its other "miscellaneous" employees get 2.5 percent at age 55 at a 16.6 percent cost.
Scotts Valley city manager Steve Ando said the city gave employees the percentage increase instead of a salary bump.
He added that while a salary increase also raises the costs of pension contributions and payroll taxes, the pension rate change was a simple increase that cost the city less.
That city also pays the full contribution, rather than asking employees to cover a part of the pension costs. In exchange, the city offers lower salaries than other municipalities that pay more but take contributions from each paycheck, he said.
Demographics Matter
While fluctuations in stock market returns have gained a lot of the attention and taken blame for rising pension costs, local officials note that demographics play a large role. As an example, the Aptos La Selva Fire District never moved its pension plan into the highest 3 percent at age 50. Instead, its employees are not eligible to retire until age 55. Yet it was hit with large catch-up payments within its pool of agencies, and for the next six years faces large CalPERS contributions, which are now 34 percent of earnings, plus the 9 percent employee portion also covered by the district.
That's a whopping 43 percent for less retirement benefits.
"Investment returns is a big part, but demographics are a strong item, too," said district business manager Fred Malmlund.
Chief Tom Crosser said part of the issue is the age of his workforce and a desire for paramedic training are also part of the complicated equation.
"We tend to hire firefighters that are a little older because we want that experience. That gives less time to fund retirement and pushes costs up," he said.
Fortunately, fire districts have not faced the same level of revenue drops as other public agencies and both men said the district has included those costs in its long-range planning.
"There is no reduction of services built into the forecasts," said Crosser.
"The big picture for us is, yes, it's a significant cost, but yes, we're able to meet it," said Malmlund.
Plus, they have the pleasure of knowing their costs should plummet in several years.
Translating Number Mumbo-Jumbo
Public pensions are often referred to in abbreviations. They represent how soon a worker can retire and what that worker will receive per year of service, as described by the percent of a year's pay. But be careful when considering the stated percentage. The percentage of the year's salary can be very different depending on how an individual agency calculates what makes up a "year."
For example, in California most public safety workers such as police and fire get "3 percent at 50."
What does that mean? At age 50, they can retire and get a pension. The pension amount is calculated by multiplying the designated "salary year" times the number of years in the system by 3 percent. In some cases, that could be the last year worked. In other cases it could be an average of the last three years worked.
For example, if a firefighter was hired at age 25 and retired at 50 with top earnings of $125,000, the pension would be 25 years multiplied by 3 percent of $125,000 or $93,750. Once someone is hired under a pension plan, that calculation and payment is guaranteed. It cannot be reduced by negotiation or the status of the payment fund or removed by a bankruptcy declaration. At least, this idea has been tested in court before and that is the present standing decision.
Actuaries look at not only the plan formula, but the demographics of each agency's employee pool to come up with how much it must pay. That's why public safety percentages are higher – they can retire earlier. An agency with lots of veteran employees nearing retirement age will pay more than one with younger staff to the state's retirement pool.
When most of the benefits increased in the late '90s at the urging of then-governor Gray Davis, the stock market was soaring and the public retirement agency (PERS) was making so much on the funds, few agencies had to make any retirement contributions.
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