LOS ANGELES — 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 new report, 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.
The report analyzes the pension shortfalls against the demographic trends at work in the general population and in the state workforce as the baby boomers near retirement and life spans grow longer. The benefits promised to public-sector workers have not taken into account the impact of these shifts. As a result, California is on a perilous fiscal course.
"We′re talking about a perfect storm: more state services needed for an aging population, a workforce that will spend more years in retirement than they did contributing to the funds, and a smaller ratio of working-age taxpayers and contributing state workers to pay for it all," said Perry Wong, Director of Regional Economics at the Milken Institute and co-author of the report. "We′re only starting to feel the squeeze now, but every year that we wait to tackle the issue, it gets worse and progressively harder to address."
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 liabiliteis 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.
The full report is available for download at www.milkeninstitute.org. Its findings were discussed at the 2010 State of the State Conference in a panel featuring Jon Hamm, CEO, California Association of Highway Patrolmen; Jerilyn Harris, Chair, California State Teachers' Retirement System; Dennis Hollingsworth, State Senator and Minority Leader; Bill Lockyer, California State Treasurer; and Scott Minerd, Chief Investment Officer, Guggenheim. The session was moderated by Emily Chang of Bloomberg TV. Video of the panel is available on the Milken Institute website after the conference ends.