The Little Hoover Commission is urging that the Legislature substantially cut future benefits of current public employees, including teachers and other unionized school employees, as the centerpiece of pension reform – an option that it says is financially critical though tenuously legal.

It’s also recommending that state and local pension programs covering half of public workers not now paying into Social Security consider joining the federal systems as a way to reduce pension obligations – a move that CalSTRS, serving 852,000 teachers and school administrators, has rejected.

With the release Thursday of its report on public pension system reform, the bipartisan Commission is assured maximum impact. Pension reform could dominate debate in the Legislature in coming weeks, as some Republicans thrust the issue into the mix of possible tradeoffs for their votes to put tax extensions on the June ballot. They should like much of what they see with the Commission’s call for benefit reductions for current employees and a shift to a risk-managed 401(k)-style plan, especially for higher-income workers.

“Public agencies must have the flexibility and authority to freeze accrued pension benefits for current workers, and make changes to pension formulas going forward to protect state and local public employees and the public good,” the Commission concluded.

Most of the 106-page report focuses on CalPERS, the largest pension system, covering all of state workers and classified school district employees, and on separate pension programs serving cities and counties. Combined with its retiree health care commitments, CalPERS is among the nation’s most generous pension programs, the report says. CalSTRS offers retirement benefits only slightly above the national average among those states not tied into Social Security, the report says. Its maximum retirement payout for teachers who retire at age 63 is 2.4 percent benefit per year of service, compared with a national average of 2.3 percent – although California’s teachers’ salaries are also among nation’s highest.

That said, all of California’s public pension programs, including CalSTRS, are seriously underfunded, and will be gradually seeking large increases in taxpayer contributions over the next decade – an increase of nearly 80 percent in the case of CalSTRS, according to its projections. CalSTRS lost 25 percent of the value of its investments in the stock market two years ago and is now 78 percent funded, according to the latest CalSTRS report. (A Little Hoover graph puts it is only 58 percent funded.) CalPERS and municipal systems unwisely expanded benefits significantly, especially for fire and safety workers, preceding the plunge in investments.

Although CalSTRS is mentioned infrequently in the report, Little Hoover Commission Executive Director Stuart Drown said that the recommendations in the report also apply to it.

These include:

• Freezing earned pension benefits and resetting pension formulas at a “more realistic level going forward for current employees” to allow governments to reduce their overall liabilities;
• Capping the salary that can be used to determine pension allowances “at a level that is reasonable and fair” – most likely between $80,000 and $90,000. This would fully cover most teachers, though not principals and district administrators. Once they exceed the threshold, they and school districts could make could make additional retirement contributions into a  401(k)-type defined-contribution plan.
• Setting pension eligibility ages to discourage early retirement of “productive and valuable employees.”
• Tightly defining final compensation, computed on base pay only – excluding sick pay, which is currently allowed –  over a five-year average to prevent pension “spiking.” In CalSTRS, compensation is now determined based on the highest year of pay for teachers with more than 25 years of service and the highest three-year average for teachers with less than 25 years.
• Prohibiting retroactive pension increases.
• Requiring  employees and employers to annually adjust pension contributions based on an equal sharing of the normal costs of the plan.
• Exploring options of coordinating pension benefits with Social Security.

Model based on federal system

The Commission said the model would be the three-tiered system that the federal government adopted a quarter-century ago: a defined-benefit formula up to 1.1 percent of final compensation for every year of service; a 401(k) plan with an employer match of up to 5 percent of salary (the first 1 percent is automatic); and Social Security benefits to augment the workers’ retirement income.

The Commission acknowledged that courts have held that “only under extreme” conditions can future obligations to current employees be changed ­– basically a fiscal emergency. This would be difficult to prove in any case, but especially for CalSTRS. It is unique among California public pension programs in that benefit levels are set exclusively by the Legislature and are not subject to negotiation between local teachers and districts. In its package of pension reforms for CalSTRS, the  non-partisan Legislative Analyst assumed the legal barrier would be insurmountable and recommended changes only for new employees.

The Commission concluded that taxpayer savings could not be achieved quickly unless benefits for current employees were thrown into the mix.

Drown said the Commission realized that CalSTRS is “a separate animal really bound by the will of the Legislature in terms of how much money it decides to give it.” However, like other public pension systems, it is underfunded and will need a massive infusion of taxpayer money to keep it solvent in coming decades.

Update: Ricardo Duran, spokesman for CalSTRS, issued this statement on the Little Hoover Commission report: “Any recommendation that weakens the financial security of our members, who are entirely reliant on CalSTRS for their retirement income, will not advance the discussion of constructive solutions. This includes recommendations that suggest breaking long-held legal decisions protecting vested pension rights.”