Yesterday we had Mr. Crane's testimony to the S.E.C. on CalPERS "Alice-in-Wonderland accounting" which itself was a follow-up to Saturday's "New York Times: S.E.C. Investigating California Public Employees' Retirement System (CalPERS)".
Today we see his earlier testimony before the Senate Public Employees and Retirement Committee on pension reform.
From Public CEO:
Good afternoon, Mr. Chairman, and thank you for allowing me to appear before the committee today on this important matter.
I will divide my remarks into five categories:
Please note that I will focus just on the state's pension costs associated with CalPERS, but in substance those comments also apply to state pension costs associated with CalSTRS, which this year will cost the state $1.2 billion and has announced it will be seeking more from the state. Also please note I will not be addressing the other principal retirement cost paid by the state, retiree healthcare, which this year will cost the state $1.3 billion and also is rising.
- The nature of pension promises
- The rising costs of meeting those promises
- The consequences of those costs
- The causes behind those costs
- What the state can do about it
The Nature of Pension Promises
Pensions are a simple concept often made unduly complex, so to make sure we're all on the same page, I'd like to start with a few basics.
When the state makes a pension promise to a state employee, it is simply promising to pay money to the employee at points in the future. Thus, state pension obligations are no different than state debt obligations, which also are promises to pay amounts in the future. But they differ in two important respects: (1) voter approval is not required for pension obligations -- governors and legislators have all the responsibility in that regard, and (2) pension costs, unlike debt service costs, are neither capped nor precisely quantifiable in advance.
Pension promises translate into costs for the state budget at two times:
First, when the promise is made, at which time the state and the employee jointly make payments known as "contributions" to CalPERS with the expectation that the combination of those contributions and investment earnings on those contributions will meet the cost of the future pension payments promised to the employee.
Second, if and when additional payments are required in the event that combination is not sufficient to meet the promised pension payments. In that case, only the state is required to make up the deficiency.
It's the second of those two items that makes our pension system a "defined benefit" system, because the state employee is assured of a defined pension benefit regardless of how well or poorly investments perform. And it's also the second of those two items that explains in part how the state can end up with extra costs such as we're seeing now.
The Rising Costs of Pension Promises
In 1999, CalPERS projected that pensions would cost the state budget an average of $450 million per year during the next eleven fiscal years from 2000 through 2011 , or a total of $5 billion.
But CalPERS will cost the state an average of $2.3 billion per year for that period , or a total of $25 billion. As you can tell, CalPERS was off in its projections by a factor of five. This resulted from CalPERS earning less than it assumed it would earn, forcing the state to make up the difference.
For the next twenty-nine fiscal years, CalPERS projects it will draw $9 billion per year on average, or $265 billion . That projection also is based on assumptions, a subject that we will come back to in a moment.
I have not seen CalPERS's projections beyond the next 29 years. Because state pension promises extend well beyond 29 years, such projections are needed.
The Consequences of Rising Pension Costs
Pension payments are senior obligations of the state to its employees and accordingly have priority over every other expenditure except Proposition 98 (i.e., K-14) expenditures and arguably even before debt service. This senior priority of pension promises means two things...MORE