VII. CLIMBING OUT
returns and discount rates has two adverse effects. First, it likely leads pension governing boards to set unrealistically high discount rates since those rates understate liabilities. Second, governing boards (and pension fund mangers) must undertake ever riskier investments to meet those high discount rates. Since virtually all public systems provide benefits that are viewed as guaranteed, beneficiaries bear virtually none of the risk. Pension systems perform well, and beneficiaries are guaranteed benefits. If systems perform poorly, beneficiaries are guaranteed the same benefits. Regardless of whether pension boards make good investments—or bad ones—beneficiaries remain protected. But governments and taxpayers who provide revenues are not protected. A hybrid system, such as that proposed by Governor Brown, would re-establish a balance. Equal contributions by employers and employees, including contributions for unfunded liabilities, would also appropriately share the risk between beneficiaries, sponsoring government employers, and taxpayers. Finally, pension boards require significant reforms. As discussed earlier, remarkably, there are no requirements for technical expertise on the CalPERS, CalSTRS, or UCRP governing boards. Future reforms should require that a majority of members possess minimum educational levels (such as degrees in accounting, economics, investment management, etc.) and/or professional expertise in these fields. Perhaps the best example of successful, appropriate reform exists in San Jose, where city leaders restructured both pension boards to require a majority of members with at least 12 years of relevant experience, in addition to a professional degree. Public employee pension boards should include representatives from active workers and retirees. However, the majority positions should not include members with direct financial interests in benefit levels and/or contribution rates. As one example of the current problem, consider a current employee serving as a board member who votes to set discount rates, which in turn affect employer and employee contribution requirements. That member receives a direct benefit from keeping discount rates high and member contribution rates low, knowing that any future shortfall to provide his/her guaranteed benefit will almost certainly be made up by future workers or increased employer contributions.
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Proposals for Reform This section summarizes recent proposals from Governor Jerry Brown and from California Pension Reform (CPR), which is considering placing a pension reform measure on the 2012 General Election ballot. Governor Brown’s Twelve-Point Plan In October, Governor Brown proposed a “twelve-point” pension reform plan to “provide a fair but sustainable income security plan.”165 It is his intention that the reform plan apply to all new state, local, school, and other public employees and to current employees as permitted by law.166 The governor’s twelve points167 can be grouped into three broad areas: • Benefit reductions • Contribution increases • Governance. Despite the positive elements, Governor Brown’s proposal provides only modest cost savings.168 For example, the proposed ban on pension holidays is a worthwhile policy shift, as is a prohibition on retroactive pension increases. But given that pension holidays and retroactive increases are highly unlikely considering the financial status of public pension systems, they do not reduce existing or future liabilities. Adding public members to the CalPERS Board of Administration is an appropriate, if insufficient, policy shift, but it also does not result in cost savings. Moreover, the addition of only two “independent” members to the current 13-member board is unlikely to have any appreciable effect.169 Two measures, the mandatory use of three-year average salaries to determine retirement payments and the limitation of that salary to an employee’s base rate (i.e., base salary without add-ons, such a uniform allowance, K-9 duty, etc.), 165 Office of Governor Jerry Brown, “Governor Brown Unveils Pension Reform Plan,” Oct. 27, 2011, retrieved from http://gov.ca.gov/video. php?id=44, Nov. 1, 2011. 166 Office of Governor Jerry Brown, “Twelve-Point Pension Reform Plan,” Oct. 27, 2011, http://gov.ca.gov/docs/Twelve_Point_Pension_ Reform_10.27.11.pdf, retrieved Oct. 27, 2011. 167 One measure deals with health care costs and is excluded from this discussion. 168 The Governor’s staff argues strongly that vested rights limitations restrict the opportunities for savings. 169 The Governor and his staff have indicated that the addition of these two independent members is only a start.