IRVINE–The author of a bill in Congress that would result in public pensions reporting much larger debts expects the same outcome as his opponents — a move to switch to the 401(k)-style individual investment plans now common in the private sector.
As U.S. Rep. Devin Nunes, R-Visalia, spoke to local government officials last week at a pension “boot camp” held by reformers, he said the federal action could spark action by “folks on the ground” in the states.
A week earlier the CalSTRS federal lobbyist, John Stanton, told the board that one observer said the Nunes bill is “providing air cover for the troops on the ground in the states” as they push for a switch to 401(k)s and attack public employee unions.
Nunes and other critics contend that public pension funds conceal the size of their taxpayer-backed debt by using an overly optimistic forecast of future pension fund earnings, 7.5 to 7.75 percent a year for the three California state funds.
Some economists argue that the proper way to report debt is to assume that the investment fund will earn the “risk-free” government bond rate to offset or “discount” future obligations.
A report by Stanford graduate students last year shows what happens when a government bond rate, 4.1 percent, is used rather than the pension fund’s forecast of earnings from a diversified portfolio with stocks, bonds and other investments.
The “unfunded liability” or shortfall of the California State Teachers Retirement System, the California Public Employees Retirement System and the UC Retirement Plan ballooned from a reported $55 billion (before the stock market crash) to $500 billion.
The Nunes bill, HR 567, would require pension funds to report debt with a discount rate based on U.S. Treasury bonds along with their regular plan for handling debt.
If the debt using a lower discount rate is not reported, the state could not issue bonds that are exempt from federal taxes. The bill also would ban federal bailouts of state and local public pensions.
Nunes said the “unions who are running those plans” oppose the “apples to apples” comparison of debt with a risk-free discount rate, which would reveal that the “emperor has no clothes” and that many of the plans are in trouble.
“So what this will only set up, what the folks in the private sector have figured out a long time ago, was that you have to get away from the defined benefit plan (pensions) and somehow get to a defined contribution (401(k)-style plan),” Nunes said through an audio hookup.
“That’s not the federal government’s decision to make,” he said. “It’s up to you folks on the ground in local government.”
Critics say the 401(k) was intended to be a supplement, part of the “three-legged stool” of pensions, investments and Social Security. When stock markets dip or crash, workers nearing retirement have little time for their investment funds to recover.
“Retiring Boomers Find 401(k) Plans Fall Short,” said a Wall Street Journal story Saturday. A study said the median household headed by a person age 60 to 62 with a 401(k) has less than a quarter of what is needed to maintain their standard of living in retirement.
But for the employer, a 401(k)-style plan has the major advantage of not creating debt like a guaranteed monthly pension, a cost spanning decades. Instead the employer makes an annual contribution to an employee’s tax-deferred investment plan.
Unlike pension plans that expect to get two-thirds of their revenue from investment earnings, a 401(k) does not make the employer vulnerable to stock market crashes or the temptation to cut contributions and increase pensions when the market is booming.
All three of the state pension plans increased pensions and cut contributions during good times. Now after the stock market crash, their costs are projected to increase at what some think is an “unsustainable” rate, even if they meet their earning forecasts.
Most but not all of the state worker union members in CalPERS have agreed to increase employee contributions and give new hires lower pensions. UC Regents adopted a similar long-range plan to cut pension costs.
The outlier is CalSTRS, which unlike the other two state systems lacks the power to raise contribution rates, needing legislation instead. As of June 2009, CalSTRS was 78 percent funded and needed a $3.8 billion annual contribution increase to be fully funded.
The CalSTRS response so far has been a legal analysis that teacher contributions can’t be increased, without providing a benefit of equal value, and a $600,000 public affairs contract to push for higher contributions from school districts or the state.
The CalSTRS federal lobbyist, Stanton, told the board on Feb. 11 that public pensions face increased scrutiny from Congress, the Securities and Exchange Commission, and the Internal Revenue Service.
He said a “carefully orchestrated and well-financed attack on public plans” is being led by Grover Norquist of Americans for Tax Reform and “think tanks of negotiable virtue.”
Stanton said they are “peddling fright about the supposed imminent insolvency of public plans” with the aim of promoting 401(k)-style plans and attacking public employee unions, a major source of campaign funds against Republican congressional candidates.
“The public plan community is actively working on the hill (Congress),” he said. “It’s really going to require a grass-roots effort, I think, by all of your peer plans to contact their members of Congress and say:
“‘OK, don’t believe what you read in the newspapers. We are not in crisis. We are taking steps to deal with it. We are on the rebound. We don’t need sort of a one-size-fits-all federal solution.’”
Stanton said the peddlers of fright “rely on the work” of Joshua Ruah of Northwestern, a pioneer in the use of a risk-free discount rate to determine pension debt who estimates that 11 state pension funds could run out of money by 2022.
A liberal economist, Dean Baker of the Center for Economic and Policy Research, said in a paper this month that a risk-free discount rate is not needed for government plans with a long time horizon and little worry about the timing of market fluctuations.
But a risk-free rate is getting traction with the Governmental Accounting Standards Board, which is proposing that a risk-free rate be used for any part of pension debt not covered by using the earnings forecast for the fund’s assets.
A supporter of public pensions, Alicia Munnell at the Center for Retirement Research at Boston College, said in a paper last June that a risk-free rate is appropriate for public pensions, because their taxpayer-backed guarantee makes them risk free.
After the Stanford report showing a $500 billion shortfall for state pension funds was issued last April, Jack Ehnes, the CalSTRS chief executive officer, told the board, “Unfortunately, I think most people would give this a letter grade of ‘F’ for quality.”
One of former Gov. Arnold Schwarzenegger’s last-minute appointments to the CalSTRS board on Dec. 30 is Cameron Percy, 26, a co-author of the Stanford report. He did not speak during a lengthy board discussion of the Nunes bill.