State Pension System Needs Overhaul


As more and more people tack up their “Gone Fishin’ ” signs, the institutions they had counted on to fund their retirements are wriggling right off the hook.

They say they have no choice but to force workers to make more of a go of it themselves, given all the pressure the baby boomers will soon bring to bear.

Indeed, the fact that this outsize population group of more than 70 million Americans, born between 1946 and 1964, will begin retiring in a few years has aroused concerns that a flood of pension obligations will soon swamp the system.


Such anxiety, of course, is stoking the Bush administration’s push for private stock and bond accounts to finance part of Social Security.

Yet in that case, at least, these fears are overblown -- a crisis manufactured by a White House bent on pushing its free-market ideology.

Although the administration makes it sound as if the Social Security Trust Fund is destined to run out of dough by 2042 unless the president’s beloved private accounts are put in place today, that’s just not so. The problem might well be fixed with a combination of modest increases in the payroll tax, benefit reductions or other tweaks.

At the same time, though, there are other levels of government putting the brakes on guaranteed pensions -- and their actions are a lot more justified.

For years, most state and municipal employees have enjoyed surefire retirement payouts -- “defined-benefit plans” in industryspeak -- even as 60% of private-sector workers have seen such arrangements disappear.

But now, that’s starting to change.

Over the last decade, Michigan, Florida, Ohio, Washington and about 15 other states have introduced 401(k)-style retirement plans in which funds are invested in the markets with no assurance of the outcome.


California may well make the move too -- and it should.

Assemblymen Keith Richman (R-Northridge) and the Howard Jarvis Taxpayers Assn. have introduced measures that would require new public employees in 2007 to be in a 401(k) or similar “defined- contribution” plan.

Gov. Arnold Schwarzenegger, for one, is in favor of the idea. Branding the public pension system “another government program out of control,” Schwarzenegger recently called for a retirement system “that is fair to employees and to taxpayers” alike.

It is a tricky balance to strike. Research shows that defined-contribution plans tend to earn 1% to 2% less per year than defined-benefit plans do.

Part of that is because of expenses. Plans such as 401(k)s are often invested in mutual funds that charge annual management fees of 1% or more. By contrast, the California Public Employees’ Retirement System manages its funds of stocks and bonds for less than one-fifth of 1% of the investment total.

More important, regular folks simply don’t know how to manage money as well as the professionals do. CalPERS, in particular, has “excellent investment people,” says Barton Waring, a San Francisco-based pensions expert and managing director of Barclays Global Investors.

Not surprisingly, California’s public employees’ unions are fighting to preserve the status quo: an ironclad deal in which their members receive their full pensions, regardless of how well CalPERS and its sister fund for state teachers have done with their money. (If the funds face a shortfall, that’s the state’s problem -- not the workers’.)


On top of that, these public pension plans are quite generous compared with their private-sector counterparts.

But the unions’ case is weak. Traditionally, the rationale was that public employees were entitled to sweet pensions because they weren’t paid all that well. Today, however, public employees are more than holding their own.

The average weekly pay in state government is $966 -- well above the private-industry average in California of $805. (Local government workers pull down an average of $850 a week.)

Meanwhile, concern about the future of CalPERS, as well as the California State Teachers’ Retirement System, is mounting. At present, the funds have only enough money to meet 88% of their future obligations because the municipalities that pay into them, beset by their own budget woes in recent years, have deferred their annual contributions.

And some worry that the state funds may be overestimating their future investment returns and underestimating their future liabilities.

CalPERS assumes that it will earn 7.75% or more a year in the long term, even though it netted only 3.5% on average from 2000 through 2004. Ron Seeling, CalPERS’ chief actuary, says it would be “crazy” for the fund to lower its expectations, pointing out that the $177-billion giant has racked up double-digit investment returns in 13 of the last 20 years.


Others, though, aren’t quite so confident.

Renowned investor Warren Buffett famously declared two years ago that he was lowering his assumptions of future returns on pension obligations at his holding company, Berkshire Hathaway Inc., to 6% a year. And Waring, of Barclays Global, believes that 5% a year is a better guess.

If Seeling and his CalPERS colleagues turn out to have been too rosy in their forecasts, the result would be enormous annual shortfalls in pension obligations -- and many additional billions of dollars in state budget deficits.

But even if they’re right, California can’t afford to keep its current pension system in place.

As my colleague Catherine Saillant reported recently, municipalities are borrowing more than ever to keep up with their pension obligations. Indeed, local governments in California issued more than $2 billion in pension obligation bonds last year. And the state government plans to issue $800 million in such bonds to cover funding shortfalls.

At a time programs for the poor and sick are getting squeezed, this doesn’t make sense. We must bring state employee pensions in line with private-sector plans.

White House talk of a Social Security meltdown may be hype. But the state system, for its part, is in need of an honest-to-goodness overhaul.



James Flanigan can be reached at