1. $5.7 billion in contributions for 2012-13.
The annual contributions to the California Teacher Retirement System will cost employees ($2.1b), districts ($2.2b), and the State ($1.4b) a total of $5.7 billion for the 2012-13 fiscal year. Employees contribute 8% of their pay to the retirement fund; districts contribute 8.5% of their payroll to the fund, and; the State pays about 5% of teacher payroll.
The LAO points out that these current ratio of contributions in addition to the annual rate of investment returns is insufficient to solve the long term liability.
2. Retirement liability twice as much as Governor’s “Wall of Debt” in the Budget.
The estimated $70 billion in unfunded liabilities is twice as much as the Governor’s “Wall of Debt” which he estimates is $30 billion. The CalSTRS liability is also the single largest retirement liability facing the state.
LAO believes the retirement liabilities are more important than the budget’s “wall of debt”
The state makes regular payments on some items in the wall of debt (such as deﬁcit ﬁnancing bonds), and it can make payments on the school and community college elements of the wall of debt from funds guaranteed annually by Proposition 98. The state, however, has much more ﬂexibility in determining how to repay other items in the wall of debt, which tend to grow more slowly than CalSTRS’ unfunded liabilities. Accordingly, adopting a plan to address these unfunded liabilities might be considered a greater priority than repaying these other items in the wall of debt.
Without any policy changes, all assets will be depleted by 2044.
3. CalSTRS and other retirement obligations grow faster than other State debt.
The state’s retirement obligations generally grow faster than infrastructure and budgetary obligations. Left unaddressed, CalSTRS’ unfunded liabilities, for example, tend to grow at something like the system’s assumed annual rate ofinvestment return—currently 7.5 percent. This is because each year the state delays action on the unfunded liability,the state loses another 7.5 percent return under the actuarial assumptions, an amount that compounds over time. In addition, CalSTRS’ unfunded liabilities are also affectedby market conditions. For example, a change in the stockmarket decreases (or increases) the Defined Benefit Program’s assets and can cause a commensurate change in CalSTRS’unfunded liabilities.
4. The longer we wait to solve the problem, the worse it will get.
Investment returns compound over time. Therefore, the longer it takes for the state to increase contributions to the CalSTRS system, the more costly it generally will be to erase the unfunded liability. Similarly, the smaller the increase in contributions inthe near term, the less the investment gains over the long term.Waiting to address the funding problem would leave the system with fewer assets in the meantime—making it much more vulnerable to sharp, future declines in the stock market. If CalSTRS’ assets were depleted, beneﬁts would have to bepaid on a pay-as-you-go basis.
Pay-as-you-go is also more costly:
In general, because investment returns compound over time, prefunding pension beneﬁts is signiﬁcantly less costly than funding beneﬁts on a pay-as-you-go basis. To illustrate, the normal cost of current hires under the Defined Benefit Program—that is, the amount actuaries estimate is needed to be paid now to cover the cost of future beneﬁts earned this year by these teachers—is 15.9 percent ofteacher payroll. CalSTRS currently estimates that the annual cost of providing beneﬁts under a pay-as-you-go method couldbe about 50 percent of teacher payroll.
5. Full funding through investment returns is unlikely.
The analysis shows that CalSTRS investments average annual returns of 7.5%. To fully fund CalSTRS for the next 30 years, the LAO estimates investments would need an average annual return of 10% or more, which they conclude is highly unlikely.
6. The solutions are as ugly as the problem.
The state has limited options based on case law. CalSTRS only gives one plausible option on the issue of increasing teacher contributions: a 2.6% increase in contribution in exchange for vesting a program that adjusts pension amounts by 2%.
Reducing benefits to future teachers would not fully solve the issue unless the benefits were dramatically cut on these teachers. The LAO points out that the new teachers would be a minority of the System members and may not be enough to close the gap.
The only real solution is that the State or the districts will have to contribute increased amounts to the System. This option would be seen as very unpopular to voters who would see reductions in other program priorities or tax increases.
LAO recommendations on how to solve this unfunded liabilities can be viewed on pages 11-13 in their report below: