CalSTRS Gets New Power to Set State, School Rates

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.

As its pension debt soared after the financial crisis, CalSTRS struggled for years to get legislation needed to raise rates — meeting with legislators, looking at suing the state, and even issuing a $600,000 public relations contract to help sway lawmakers.

“Pay now or pay more later” was the refrain.

Actuaries calculated that during each year of delay, the total cost of the rate hike needed to project full funding in 30 years was growing at a rate of roughly half of one percent of pay.

But the century-old California State Teachers Retirement System was helpless for historical reasons, lacking a key power held by most California public pension systems. It could not set annual rates that must be paid by employers.

Then two years ago, after nearly a decade of CalSTRS pleading, the Legislature and Gov. Brown enacted a record rate increase. School district rates will more than double by the end of the decade, while teachers and the state have smaller increases.

Little noticed at the time, the legislation (AB 1469) also gave CalSTRS some long-sought power to raise employer and state rates — a big step toward normalizing the teachers’ pension system and a rare loosening of legislative control over the state budget.

“We were quite happy with the outcome,” Ed Derman, CalSTRS deputy chief executive officer, said last week as the new rate-setting power got a double dose of public attention.

The CalSTRS board approved a one-year delay in the “experience” study done every four years to help actuaries keep projections on track. The extra time will allow improved estimates of life spans before new rate-setting power begins.

The nonpartisan Legislative Analyst’s Office issued a review of the CalSTRS funding legislation suggesting tweaks may be needed to reduce the complexity, correct how debt is shared between employers and the state, and improve oversight.

In what could be a major change, the legislation lifted a cap that limited the basic CalSTRS state rate to 3.5 percent of pay. Now the CalSTRS board has the new power, beginning next year, to raise the state rate up to 0.50 percent of pay each year.

Another change gives CalSTRS the power, beginning in 2021, to raise the rate paid by school districts and other employers up to 1 percent of pay a year. But these rates are limited to a range of no less than 8.25 percent of pay and no more than 20.25 percent.

The Legislative Analyst thinks there is a “good chance” the state will not pay more under the new funding plan than it would have paid to CalSTRS under the previous funding law.

But like other California public pension systems, CalSTRS expects earnings from its large investment fund (valued at $186 billion last Dec. 31) to provide about two-thirds of the money needed to pay pensions in the future.

So, there also is a possibility that if the critics are right and investment earnings fall well short of the 7.5 percent annual long-term average expected by CalSTRS, new rate increases will be needed to fill the funding gap.

The uncapped state rates soon to be set by CalSTRS would have to cover most of a big new funding gap. Not only are school district rates capped at 20.25 percent of pay, but the legislation pushes them near the cap, going from 8.25 percent to 19.1 percent by 2020.

Depending on whether investment earnings exceed or fall below the CalSTRS forecast, said the Legislative Analyst’s report, the basic state rate in about 30 years could drop to zero or soar to 18 percent of pay.

“In the context of current statewide teacher payroll, the difference between these two extremes is roughly $5 billion — more than three times the state’s current contribution to CalSTRS’ main pension program,” said the analyst’s report by Ryan Miller.

“We note that the state’s share of CalSTRS’ unfunded liability would be higher than reflected in the figure (chart below) if CalSTRS lowers its assumption concerning future investment returns.”

The basic state CalSTRS rate increases to about 6 percent of pay in the new fiscal year beginning in July. It’s the last of three annual increases under the legislation, which tripled the state rate that was about 2 percent of pay three years ago.

The new power CalSTRS gets next year to raise the basic state rate does not include a separate state payment, frozen at 2.5 percent of pay, for a fund that keeps teacher pensions from falling below 85 percent of their original purchasing power.

As reported in a recent post, the Supplemental Benefit Maintenance Account had an $11.5 billion reserve last fiscal year for an annual payment of $193 million. There has been no analysis of whether the huge reserve is an efficient use of taxpayer funds.

The California Public Employees Retirement System provides similar inflation protection through a single employer-employee contribution rate that also covers the cost of pensions and annual cost-of-living adjustments.

And if the 85 percent guarantee is a “vested right” under state court decisions widely believed to mean that public pension benefits cannot be cut, there may be no need for a huge reserve to ensure inflation protection for many decades into the future.

Teachers got the smallest rate increase under the legislation two years ago because their contribution to CalSTRS was said to be a “vested right” that could only be cut if offset by a new benefit of comparable value.

For teachers hired before a pension reform in 2013, the rate went from 8 percent of pay to 10.25 percent. The offsetting new benefit was a provision in the rate legislation explicitly making a routine cost-of-living adjustment a vested right.

CalSTRS pensions get an annual 2 percent cost-of-living adjustment, a fixed amount based on the original pension. In the past this “improvement factor” has not kept pace with inflation, creating a need for the fund to protect original purchasing power.

Last week, the CalSTRS board was told that the life spans of retirees have been increasing faster than anticipated. Two years ago CalPERS increased employer rates to cover longer life spans expected for its retirees.

Rick Reed, CalSTRS chief actuary, said the same mortality table has been used for persons age 20 and age 60. A weighted average tends to estimate a life span that is too long for the 60-year-old and too short for the 20-year-old.

With new computer technology, Reed said, it’s possible to have a mortality table for each individual for each year. For a person age 20, there would be 70 mortality tables by age 90.

“Conceptually, it’s not new,” Reed said. “It’s just more doable now.”

By delaying the experience study until next year, the CalSTRS board hopes to have more accurate and stable mortality data, audited by an outside actuary, when its new rate-setting power begins.

Photo by Stephen Curtin via Flickr CC License