By JOE NATION
Joe Nation represented Sonoma and Marin counties in the state Assembly from 2000 to 2006. He is now a lecturer in public policy at the Stanford Institute for Economic Policy Research.
Earlier this year, the Stanford Institute for Economic Policy Research issued “Going for Broke: Reforming California’s Public Employee Pension Systems.” That policy report identified a $425 billion funding shortfall for three state pension systems: California Public Employees’ Retirement System, California State Teachers’ Retirement System and the University of California Retirement System. The study also identified policies that could prevent future shortfalls.
Last week, I authored a second institute report that examined the funding status of independent, or local, pension systems. These include public employee pension systems operated by cities and special districts and those operating under the County Employees’ Retirement Law of 1937, including the Sonoma County Employees’ Retirement System (SCERA).
These reports are not intended to question the benefits owed to current public employees. With literally every member of my immediate family in public service (from school librarians to firefighters), I believe that those employees are owed what we have promised them. But those commitments to public employees will be worth little if the pension systems supporting them collapse.
These payments to public employees are guaranteed based on case law that guarantees these pension payments as equivalent to compensation. As such, we need to discount the value of future payments at risk-free rates.
Use of this risk-free rate does not imply that pension systems should invest only in risk-free assets. Rather, they should invest long-term in a diversified portfolio, but they should at the same time realistically estimate the commitments they owe. That can only be achieved by using a risk-free rate for future liabilities.
Using that approach and a recent discount rate of 4 percent (similar to the 3.49 percent rate for 10-year U.S. Treasury rates), these independent pension systems in California faced a nearly $200 billion shortfall in 2008, the last year for which data are available.
Based on 2008 data, Sonoma County’s system faced a funding shortfall of $2.1 billion over the next 18-year period.
SCERA’s funded status, measured by assets divided by liabilities, is 43 percent, indicating that SCERA has only 43 cents on every dollar that it owes. Based on subsequent data published in 2009, Sonoma County’s retirement system is unfunded by $2.3 billion, despite having reported an increase in assets. (That increase between 2008 and 2009 seems awkward since other systems reported sharp drops resulting from the financial crisis. For example, San Mateo County’s fund reported an asset drop of 14 percent, San Joaquin County 10 percent, and Santa Barbara County 10 percent).
SCERA’s 2009 funded ratio is estimated at only 40 percent.
In addition to pension obligations, associated local governments face funding challenges for Other Post Employment Benefits, which are typically dominated by health care costs. Sonoma County reported a $259 million unfunded liability for OPEB in 2008, but this is undoubtedly less than what is actually owed since virtually all governments use optimistic assumptions about health care cost increases. For example, most, like Sonoma County, assume medical inflation rates of only 5 percent by 2014. Much higher rates are more likely.
This most recent Stanford study estimated the share of payroll required by Sonoma County to meet its on-going and unfunded pension and OPEB costs. Assuming an 18-year period (the approximate number of years workers receive benefits), the county will need to dedicate 50 to 55 percent of payroll to fully fund its pension and OPEB accounts. That figure is slightly better than the average for all systems examined. But it suggests that other critical county functions will have to be dropped or cut severely because of its pension problems.
Recent reform at the state level, enacted as part of the current state budget agreement, and recent election results provide some possible avenues for reform at the local level. That reform is likely to include increased transparency, reductions in benefits, increased employee contributions and further restrictions on pension spiking. In order to fully meet its commitments, the Sonoma County Employees’ Retirement System and other independent systems will need to explore all of those options.