Planning for pensions

An eye-popping new report by an economist at Stanford University claims that the independent pension plans for city and county employees in California — that is, those who aren’t covered by the giant CalPERS system — may be underfunded by as much as $195 billion. Author Joe Nation argues that these retirement plans are assuming unreasonably high rates of return on their investments, leading city and county governments to contribute too little to their pension funds.

Nation’s assumptions probably go too far in the other direction, understating the pension funds’ growth. Nevertheless, his findings add to the evidence that state and local officials need to rework public employee retirement programs before California taxpayers have to bail them out.

The report released last week is a follow-up to a similar examination in April that found more than $400 billion in unfunded liabilities at three state pension systems. Nation argues that local officials are making the same mistake as the trustees who run the state funds: They’re counting on average gains of about 8% annually, when a “risk-free” assumption would be 4%.

There’s just no telling how well the local pension funds’ mix of stocks, bonds, real estate and other assets will perform in the future. What we do know is that, like most investors, they racked up heavy losses when the market plummeted in 2008-09. As a result, they’re obligated to pay billions of dollars in benefits that they can’t afford, even under the pension funds’ projections for future earnings. And if those projections prove too optimistic, as Nation warns, the cities and counties they represent will have to kick in ever-larger amounts to cover the shortfall. That means cuts to other services, higher taxes or both.

Other risk factors are the laws and contracts that allow workers to reap outsized pension benefits while limiting the contributions they have to make to the system. Gov. Arnold Schwarzenegger persuaded several groups of state workers to make important concessions on those fronts; city and county officials need to follow suit.

Voters in the city of Los Angeles — whose pension systems could be underfunded by $34 billion, according to Nation — will have a chance to vote in March on a ballot measure that would provide newly hired public safety employees less costly pension and health benefits than current ones receive. That’s a start, but local officials statewide still need to address other forces that can drive individual pensions to unreasonable levels.

These include contracts that offer many public employees benefits based on the compensation they collect in their final year — a calculation potentially inflated by the inclusion of longevity bonuses and unused vacation and sick pay. Meanwhile, the state needs to give local officials the power to negotiate for larger retirement contributions by public employees, which could help them respond to pension underfunding. If Nation is right, they’ll need all the help they can get.