What Happened?
Cities in California are struggling to avoid bankruptcy due to a laundry list of costs as well as swelling unfunded liabilities in the state pensions. After being reevaluated under new standards, the unfunded pension liabilities are at $8,600 per Californian, with just 64 percent of state and local pensions fully funded.
So What?
Moody’s Investors Service proposed new credit evaluation standards for public pension liabilities that could increase unfunded liabilities in state and local public pension plans to $328.6 billion, up from $128.3 billion. Under Moody’s new standards the assumed rate of investment returns for public pension plans will be lowered to 5.5 percent , lower than the 7.5 percent return rate target the California Public Employees’ Retirement System (Calpers) currently has. In 2012, Calpers posted a return rate of 13.26 percent. However, many local pension funds have struggled to maintain return targets in the long-term, with Moody’s projecting most cities unable to exceed 5.5 percent return rate.
The California state constitution has pension protections in place that prevent lawmakers from reneging on promises to public workers such as cuts in payouts, significantly more airtight than any private pension system. Cities such as Stockton, however, are entering bankruptcy and at risk are millions owed to the state pension plan. A mediation process is determining if the city files Chapter 9 bankruptcy whether federal law will override state protections and force lawmakers to change the pension system. State lawmakers have already proposed several reforms to public pensions such as increasing worker contributions, adjusting the retirement age and capping cost-of-living figures.
Study: Losses Offset By Reforms
A recent study from the Center for Retirement Research at Boston College analyzed the long-term effects of statewide pension reforms on both employer costs and state budgets. The research revealed debts and liabilities accumulated in the wake of the financial crisis were significantly reduced with pension reforms¸ potentially falling below crisis levels at the state and local level within 30 years. For the losses to be offset, however, municipalities must make permanent reforms, forcing employers and employees to both meet their contribution obligations.
Furthermore, cost-cutting reforms to pensions made in the past must be repealed so contribution levels are reinstated and the system can slowly rebuild itself. Instead of cutting costs in the system, researchers recommend public employers offer a hybrid system with a smaller pension and a 401(k)-style investment plan to reduce employer risk and make the liabilities easier to maintain. The study revealed the average pension costs before the financial crisis were 4.1 percent of state-local budgets in 2007. In 2011, costs increased to 6.5 percent. By 2028 with the addition of pension reforms, costs could be lowered to 5.3 percent, and then to 3.3 percent in 2046.
The California Public Employees’ Pension Reform Act of 2013 discusses several reforms including:
- Reduced benefit formulas
- Increased retirement ages
- Pensionable compensation caps
- Replacement benefit plans
- Increased employee contributions
- Hybrid retirement plans for new members
- Cost sharing of employer contributions
Other Pension Debates
Municipalities outside of California are facing bankruptcy and implementing reforms to improve budgetary performance.