LAO Report on Higher Ed Contains Significant Pension Recommendations

Retirement Costs

The Governor proposes major changes to the way in which some retirement costs are funded for higher education. For CSU, the Governor proposes to no longer make base adjustments to reflect changing retirement costs. For UC, the Governor proposes (1) a $90 million base augmentation that could be used for pension costs or other purposes, and (2) no out–year adjustments for retirement costs. The budget proposes no changes to the way retirement is funded for CCC.

Background

CSU Pension Benefits. CSU employees are members of the California Public Employees Retirement System (CalPERS)—the same retirement system to which most state employees belong. Funding for this system comes from both employer contributions and employee contributions. Each year, as is the case with other state departments, CSU’s employer contributions to CalPERS are charged against its main General Fund appropriation. The employer contribution is based on a percent of employee salaries and wages that is determined by CalPERS and specified in the annual budget act. The Governor’s budget annually adjusts CSU’s main appropriation to reflect any estimated changes in the employer contribution. For example, the Governor’s budget reduces CSU’s main appropriation by $38 million due to a lower employer rate and lower payroll costs in the current year. The CSU is expected to contribute $404 million to CalPERS in 2012–13.
UC Pension Benefits. Employees of UC (and Hastings) are members of the University of California Retirement Plan (UCRP). This retirement plan is separate from CalPERS and under the control of UC. Prior to 1990, the state adjusted UC’s General Fund appropriation to reflect increases and decreases in the employer’s share of retirement contributions for state–funded UC employees. Starting in 1990, however, UC halted both employer and employee contributions to UCRP because the pension plan had become “superfunded.” Specifically, the plan at that time was enjoying exceptionally strong investment returns, resulting in assets that exceeded liabilities by more than 50 percent. This “funding holiday” lasted nearly 20 years until the plan’s assets had declined considerably and contributions once again became necessary. In April 2010, both UC and its employees resumed contributions to the plan. The state, however, has not provided UC with any additional funding specifically for that purpose.

Governor Proposes New Approach To Funding Retirement Costs

The Governor proposes two major changes related to funding for university retirement plans:

• A $90 million base budget augmentation for UC that, according to the administration, “can be used to address costs related to retirement program contributions.” The administration emphasizes that this funding is not being provided specifically to fund costs for UCRP. Rather, UC could use it for any purpose related to its state–related programs—including, but not limited to, UCRP.
• A new policy that the segments’ budgets no longer be adjusted for changes in retirement costs in the future. Instead, state–related retirement costs would be funded entirely from the segments’ unrestricted base appropriations.

Unclear Which Retirement Costs Are Affected. The Governor’s proposed language refers simply to “retirement costs.” At the time this analysis was prepared, the administration had not provided sufficient clarity on whether this would include costs for retiree health and dental benefits. For example, funding for CSU’s retiree health care costs are currently bundled together with funding for other CalPERS retiree health care costs. Since the administration has not yet indicated how it would split out funding for CSU, we are unsure whether the proposal applies to these costs. The administration also was unable to provide information regarding base funding for retiree health costs for UC. For these reasons, our budget analysis only focuses on funding for pension costs for UC and CSU.

UC Proposal Has More Merit,But Raises Several Questions

The request for pension–related funding for UC is more difficult and complicated than that for CSU. This is because (1) the state currently is not providing any pension–related funding to UC, and (2) UC has full control over its pension system. To address the Governor’s proposal, the Legislature should consider the following questions:

• What is the main justification for the state to provide funding for UC’s retirement costs? In other words, why is funding for these costs a state responsibility?
• Given that UC controls its own pension plan, are UC’s pension benefits reasonable? How do they compare to the pension benefits the state provides state employees?
• How much funding should the state provide UC in 2012–13? More specifically, what methodology or calculations support the request for $90 million?
• Finally, should the state lock in the pension amount provided UC at the 2012–13 contribution level or provide UC with budget adjustments for pension costs in future years? …

Pension Costs Should Be Funded as Part of Workload Budget. The state currently provides funding for pension–related costs for all other state agencies as part of a normal, workload budget. In other words, the state provides funding to state agencies for the salaries and benefits (including pension benefits) related to their budgeted positions. Given that the state provides UC wi
th funding for the salaries and benefits of some of its employees, it would make sense from a standard, workload budgeting perspective to also provide funding related to pension costs. As noted earlier, the state did provide such pension–related funding to UC for many years prior to the pension holiday that began in 1990. (As we discuss in the nearby text box, the state has repeatedly deferred a final budget increase for pension costs since that time.) Given that the university has had to restart its contributions to its pension plan in recent years, we find justification in its request that the state also resume providing pension–related funding.
UC Pension Benefits Similar to State Employee Pension Benefits. Although the state does not control UC’s pension system, actions taken to date by the Regents have largely mirrored recent changes to state employee pension benefits. For example, the Regents have taken action to reduce pension costs in the long term by increasing the minimum retirement age for new employees. In addition, …the Regents have approved increases to employee contribution rates that are beginning to bring them in line with state employee contribution rates, which are now generally 8 percent. (Some of UC’s proposed employee contribution increases are still subject to collective bargaining.) Additional contribution increases beyond July 2013 will also likely be necessary to reduce the plan’s significant unfunded liability that has accrued due to the decades–long pension funding holiday and recent market downturns.

We find two issues that the Legislature should carefully consider with respect to how the university has estimated the state’s share of UC retirement costs.

• First, we find that the request for $90 million in 2012–13 is overstated. …UC’s estimate of the state’s share of its 2012–13 retirement cost increase totals about $78 million. The UC appears to be requesting a greater amount because it believes that the state should provide contributions to account not only for incremental retirement costs in 2012–13, but also for part of the cost increases in the two prior years. We take a different view. The UC has managed—by both redirecting internal resources as well as increasing student tuition—to fund all of its employer contributions in both 2010–11 and 2011–12. If the Legislature were to provide funding related to prior years, the funding would in effect free up existing UC base funding for other purposes. In our view, given the state’s fiscal shortfall, such an augmentation would be unwise.
• Second, the university’s calculation of the state’s share of retirement contributions includes employer costs related to tuition–funded salaries. From a workload budgeting standpoint, the state portion of retirement costs should only be related to state–funded payroll costs. Given, however, that the Governor’s budget assumes no increases for tuition in 2012–13, the Legislature may wish to consider providing the funding for pension costs related to tuition–funded salaries in 2012–13. In future years, higher pension costs—just like any other UC cost—presumably would be covered by the General Fund and tuition fees in proportion to their current funding levels.

Timing Not Right to Lock In Base Funding for Pensions. As with the CSU proposal, now would be a poor time to choose to lock in a base funding level for UC pensions, given that the Governor is separately proposing to modify public employee pensions to reduce costs in the long run. In addition, as noted earlier, UC intends to increase its employer contributions over the next few years, although it has not yet reached agreement with all of its union–represented employees on the employee contribution rate. In our view, the Legislature should carefully evaluate future requests from UC for pension funding on a year–by–year basis in the context of the university’s current pension benefit and contribution structure. In the long term, however, it could make sense to expect UC to fund its pension costs out of its base budget, given that the university’s retirement system is separate from the state’s. This could only work once a reasonable funding level has been identified and contribution amounts have stabilized.

Recommendations

…Recommend Restarting Budget Adjustments for UC. As discussed above, we find that there is sufficient justification on a workload budget basis to provide UC with an augmentation that the university could use to address its pension costs. We recommend, however, that the Legislature only provide funding for the incremental change in 2012–13 in UC’s pension costs for state– and tuition–funded employees—which we estimate to be $78 million. This would mean reducing the Governor’s request for $90 million in General Fund support by $12 million. In addition, we recommend that the Legislature adopt intent language in the budget specifying that in the future funding for UC retirement costs (1) shall be determined annually by the Legislature, (2) shall be contingent on such factors as the comparability of UC’s pension benefits and contributions to those of state employees, and (3) shall not necessarily include funding for tuition–supported employee pension costs or pension costs incurred prior to 2012–13.