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Addressing California's Pension Shortfalls: The Role of Demographics in Designing Solutions
Oct 01, 2010

Concurrently raising the retirement age and increasing employee contributions is only the first step in addressing California's looming public pension liabilities, according to a report from the Milken Institute, Addressing California's Pension Shortfalls: The Role of Demographics in Designing Solutions from the Milken Institute. The situation will eventually call for even bolder action, such as shifting to hybrid plans with only a partial defined-benefit component.

Some of the key findings in the report include:

  • By around 2012 or 2013, the three major state pensions' total obligations will be more than five times as large as total state tax revenue.
  • Not only will California's growing senior population depend on Medi-Cal and other state services, but public school enrollment is likely to rise in the coming years. The state can ill afford to fund pensions by cutting back on these services.
  • In 2009, the unfunded pension liabilities came out to $3,000 per working-age adult in the state. By 2014, they will triple to over $10,000 per working-age Californian.
  • Raising employee contributions alone will be less effective over time as the ratio of actively contributing members to benefit recipients continues to decrease.
  • Currently, the average state employee contributes to the system for 25 years, but will receive benefits for 26 years - and the number of benefit-receiving years is increasing as longevity improves.

To curtail the growth of unfunded liabilities, the report offers two key recommendations:

  • Raise the retirement age and simultaneously increase employee contributions: Delaying retirement improves the ratio between the number of years state workers spend contributing to their pensions vs. the years they spend receiving benefits. But since this change alone results in more years of service and a higher final year's salary - both of which factor into the retirement formula - it must be undertaken in tandem with raising workers' contributions.
  • Shift to a risk-sharing plan: The current system provides public workers a guaranteed benefit regardless of the pension funds' investment performance - and taxpayers are on the hook if returns fall short. California will eventually need to switch to a hybrid plan in which a portion of the benefit is guaranteed and the rest is subject to market risk, as with a 401(k). This will require a significant shift in thinking about the public sector's entitlement to a risk-free pension.

The report notes that kicking the can down the road only allows the problem to grow in magnitude. Swift action is the best way to ensure that California has a stable and sustainable economic future.