University of California President’s Pension Cap Has Lower Supplement

Reporter Ed Mendel covered the California Capitol in Sacramento for nearly three decades, most recently for the San Diego Union-Tribune. More stories are at Calpensions.com.

University of California President Janet Napolitano’s proposal last week to cap pensions for new hires, part of a deal with Gov. Brown, has a less generous 401(k)-style supplement than a task force proposal to help attract top faculty.

But by lowering employer contributions to the tax-deferred individual investment plans, Napolitano’s revision of the task force proposal increases UC savings, which can be used to pay down pension debt and increase the effort to recruit and retain faculty.

A faculty-staff task force formed by Napolitano last summer to recommend a pension cap plan issued a report in December that said a recent study found UC faculty salaries were 12 percent below market.

Retirement benefits are an important way that the University of California can remain competitive for top faculty, the report said, particularly in competition with some leading universities that only offer 401(k)-style plans without pensions.

Napolitano said in a letter to colleagues Friday her proposal (scheduled to be considered by the UC Regents on March 23) builds on the work of the task force and reflects comments she received in January and February.

“Many of you expressed concern that a new set of retirement benefits could harm the University’s ability to attract and retain top-tier faculty,” she said. “Improving overall employee compensation and the stability of the UC pension plan were also common concerns.”

Napolitano said her proposal will, among other things, allow regular pay increases for faculty and staff and make “merit-based pay a regular component of system wide salary programs to reward employees based on their contributions to the university.”

Under the agreement with the governor, she said, UC is “receiving nearly $1 billion in new annual revenue and one-time funding over the next several years” that includes extending a 4 percent annual budget increase.

In exchange, UC is freezing tuition through fiscal 2016-17 and will begin enrolling 5,000 new California students this fall. The linchpin of the deal is $436 million from the state over three years to help UC pay down its pension debt.

For the big pension payment Brown wants a cap on UC pensions similar to the one his pension reform imposed on most new hires of state and local government three years ago.

UC Regents, who have some independence, approved lower pensions for new hires in 2013, much like Brown’s Public Employees Pension Reform Act. But they did not adopt the PEPRA pension cap based on the wage amount taxed for Social Security.

The task force example used for the proposed UC cap would base the calculation of pensions for new hires on pay up to a cap that would be $117,020 this year, sharply reducing pensionable pay that now goes up to $265,000, the current IRS limit.

To offset the reduced pension, the task force proposed giving the new hires a 401(k)-style plan for pay between the new cap and the IRS limit. UC employers would contribute 10 percent of pay to the 401(k) plan, employees 7 percent of pay.

In addition, new hires would be given the option of choosing to receive no pension, but instead a 401(k) plan covering all pay from the first dollar up to the IRS limit with similar contributions: employers 10 percent of pay, employees 7 percent.

Napolitano’s proposal follows the basic task force model, but reduces the employer contribution to the 401(k) individual investment plan. The employee contribution remains at 7 percent of pay.

For the gap between the pension cap and the IRS limit, the employer contribution is not 10 percent of pay but 5 percent for faculty and 3 percent for staff. For the 401(k)-only option the employer contribution is 8 percent of pay for all employees.

Over the next 15 years, the task force estimated that its proposal for new hires would save UC employers $15 million a year. The Napolitano proposal is expected to save an average of $99 million a year over the next 15 years.

“Since we compete in a global market for faculty, often against elite private institutions that can typically pay more than UC, maintaining a pension benefit along with a 401(k)-style supplement is important to attracting and retaining the caliber of personnel we need to maintain UC’s excellence,” Napolitano said in the letter.

For a diverse workforce, she said, the option of a stand-alone 401(k) plan is attractive for short-term UC employees who want a portable retirement plan and for those who prefer to personally manage their retirement savings.

A retirement plan that combines a smaller pension with a 401(k)-style plan, like the one for federal employees, is often called a “hybrid.” Brown’s original 12-point pension reform included a proposal to switch new hires to hybrid plans.

But a hybrid, strongly opposed by unions, was rejected by the Legislature. A public pension is a lifetime monthly payment backed by taxpayers. A 401(k) plan can rise and fall with investment earnings, shifting risk from the employer to the employee.

UC will need to bargain union agreement to impose a pension cap on new hires. The 401(k)-style supplement, said to be part of the deal with Brown, is an exception for UC not included with the PEPRA cap for other state and local government employees.

Estimating how many employees hired after July 1 this year will retire decades from now with final pay exceeding the new pension cap is difficult. The task force report said it’s likely to be well over 8 percent, perhaps as high as 24 percent for some groups.

When the governor proposed a hybrid plan, a CalPERS analysis said closing pension plans to new hires could destabilize them. Brown said it reminded him of a “Ponzi scheme,” where money from new investors pays the earnings for earlier investors.

Napolitano’s proposal deals with this problem by adding an additional 6 percent of pay to the employer contribution for the hybrid plan to pay down pension debt or the “unfunded liability” and an additional 4 percent to the stand-alone 401(k) plan.

Compared to other California public pension systems, the UC employer contribution of 14 percent of pay is low. The employer contribution for some police and firefighter pensions is more than 50 percent of pay.

Napolitano’s proposal would use 57 percent of the expected $99 million annual saving to pay down pension debt. The UC plan, using market value assets, is 83 percent funded with a $9.8 billion unfunded liability, the task force report said.

About 5 percent of the funding level is the result of $2.7 billion in loans, mainly from an internal short-term investment fund, that are being repaid through a payroll assessment.

The loans from the short-term fund earning 1.5 percent are expected to earn a long-term 7.25 percent in the UC pension fund, yielding an arbitrage profit over the 20 to 25 year terms of the loans.

The UC pension system is known for a rare two-decade contribution “holiday,” when employers and employees did not put money into the pension fund. Contributions that stopped in 1990 were restarted in 2010.

Another task force report said that if annual normal cost contributions had been made during the 20-year holiday, UC pensions in 2010 would have been 120 percent funded instead of 73 percent funded.