California State Auditor Report Devastating for Pensions, Healthcare, More
Utter failure to protect retirement security for school employees, an unwillingness to set aside money for employee healthcare, and budget gimmicks galore are just three of the crushing items highlighted in the California State Auditor’s recent assessment of high-risk issues facing the state. The 2013 update of the State Auditor’s annual report is a devastating indictment of the current state of affairs in California, and succinctly details the many failures and false solutions that have brought the Golden State to this point.
Much of the State Auditor’s report focuses on the desperate funding situation facing the California State Teachers’ Retirement System, or CalSTRS. As Elaine Howle, the State Auditor, writes, “at the current contribution rate and actuarially estimated rate of return on investment, the Defined Benefit Program’s funding ratio will continue to drop and assets will eventually be depleted.”
One reason is the plan’s inability to adjust contribution rates in accordance with funded levels, which are instead set by the legislature. The 8 percent member contribution rate has been in place since 1972. The 8.25 percent employer contribution rate has been in place since 1990.
According to the state, the plan is currently 67 percent funded. That estimate, however, relies on flawed assumptions like a 7.5 percent investment rate of return. According to risk-free estimates, which provide the only guarantee of benefit funding, CalSTRS is only 37 percent funded and carries a $250 billion unfunded liability. This is just one portion of the state’s overall $641 billion funding gap.
Even by the state’s flawed assumptions, though, the situation is dire and demonstrates the impact that the costs required to service an unfunded liability can have on other spending priorities. The current combined contribution rate, including members, employers, and the state, is 19.47 percent of salaries. To reach full funding in 30 years would require contributions equal to 34 percent of salaries, and again, that is according to overly optimistic assumptions,
At its current pace, the CalSTRS plan will run out of money and seriously threaten the promises of retirement security made to public employees across the state. The threat of a crisis is no longer distant.
California also faces a massive unfunded retiree healthcare liability. The massive liability is both the product of an exploding retiree population and skyrocketing premiums combined with the state’s unwillingness to pre-fund its obligations. The estimated liability has grown from $59.9 billion in 2010 to $63.85 billion in 2012. Annual expenditures ballooned 36 percent, to $1.5 billion, between fiscal years 2010 and 2012.
According to the Center for State and Local Government Excellence, only half of states chose to pre-fund their retiree healthcare obligations in 2012. This failure increases costs in the future. In California, according to the Auditor’s report, “the State could have reduced its OPEB liability by almost $22 billion if it had committed, as of June 30, 2012, to fully prefund its future retiree health benefits. Even partially prefunding its future retiree health benefits at 50 percent would have reduced the State’s total OPEB liability by over $12 billion.”
The growing current cost of California’s long-term obligations has impacted the state budget for years. The state has regularly faced annual deficits, but the legislature and governors have too often chosen short-term, gimmicky fixes instead of addressing the problem.
Over the last twelve years, just 59 percent of deficits have been tackled directly through expenditure reductions or revenue increases. Temporary gimmicks have instead addressed the remaining 41 percent. These include increased debt (16 percent), fund shifts or transfers (12 percent), accelerated revenues (4 percent), expenditure deferrals (4 percent), federal stimulus funds (4 percent), and accounting changes (4 percent). None of these tactics have any actual effect on the state’s fiscal situation, but only mask the problem in the near-term in order to “comply” with balanced budget rules.
Until California stops the gimmicks, the cycle of one desperate budget crisis after another will continue. This includes those that apply to long-term obligations, like the use of overly optimistic investment return assumptions that mask the true size of pension liabilities and the decision not to pre-fund retiree healthcare costs.