School health benefits

A disaster in the making

By Peter Schrag, Sacramento Bee Columnist, March 30, 2005

While the governor and other pension privatizers are warning ominously that California's retirees are about to eat up the state budget, a related but larger and more imminent fiscal hazard is looming over many of California's largest school districts.

Put most simply, those districts have collectively piled up an estimated $17 billion in unfunded health benefit liabilities for retired teachers and other school employees, present and future. Many districts try hard not to even think about it. Some may not know how deep they're in the hole.

In the coming years, those liabilities are likely to consume an increasing share of the funding for regular school programs - forcing up class size, and forcing further cuts in counselors, libraries, arts, music and other offerings.

Thomas Henry, the executive director of FCMAT, the state's Fiscal Crisis and Management Assistance Team, which was created to help the growing roster of California's financially troubled school systems, calls it the most serious fiscal problem he's seen in 30 years: "the tomato that ate New York." The official champion on the list is the Los Angeles Unified School District with some $5 billion in unfunded liabilities - essentially the amount that would be required in a fund that would pay the lifetime health benefits that the district is currently committed to.

That $5 billion is the equivalent of about 80 percent of the district's annual operating budget. To properly fund it, said Paul Warren at the Legislative Analyst's Office, the district ought to be setting aside a half-billion dollars a year.

But Los Angeles is hardly alone. According to Henry, some 80 large districts are committed to lifetime benefits for retirees and, in some cases, for their spouses, among them San Francisco, West Contra Costa County, Sacramento ($345 million) and the fiscally troubled Fresno Unified School District, whose unfunded liability runs to a whopping $1.2 billion.

In addition, there are countless other districts that have contractual obligations to retirees until they reach age 65 or 70. Some districts, in order to attract staff in economically lean times, promised new employees with longtime service elsewhere full health benefits after their first year in the new system.

The actuarial and legal history here is complicated. Until the mid-1980s, health benefits, even gold-plated ones like Sacramento's that included cosmetic surgery (a benefit since dropped) and no copays, weren't a huge issue since average per-capita health benefits seemed manageable. But with escalating health costs and new accounting rules, it's becoming harder to avoid.

Nor is it hard to explain how districts made those commitments. With the straitened budgets in the years after passage of Proposition 13, school districts, like other California government agencies, negotiated generous long-term benefits in lieu of increased pay schedules that they felt they couldn't afford. Few suspected that the cost of those health benefits, which seemed modest at the time, would balloon in the coming decades. Most probably wouldn't have cared if they had suspected it.

Some districts, Elk Grove among them, have created funds to cover retiree health benefits. A few, which have such funds, have since raided them to cover other costs. Most have simply been paying the premiums out of their current operating budgets.

But as costs continue to climb, both because of escalating health care expenses and the growing rolls of retirees - retirees who live longer - those costs, as Sacramento County Superintendent Dave Gordon points out, will consume more and more of the money that had been going to the regular school program. For the 400 California school districts - 40 percent of all districts - whose enrollment and state revenues are declining, that's going to be a particularly severe problem. Warren calls it a disaster in the making.

The only way to resolve the crisis, says Henry, is for districts to "stop the hemorrhaging" - meaning to renegotiate contracts so at least prospective employees don't get the full lifetime coverage that current employees (and current retirees) are getting. At the moment no one at the state level - or in many cases even at the district level - even knows how large the liability really is.

Both FCMAT and the legislative analyst are issuing pointed warnings and advice. "The size of retiree health benefit liabilities," says the LAO in its analysis of the governor's budget, "is so large that unless steps are soon taken to address the issue, it seems likely that districts will eventually seek financial assistance from the state."

New accounting rules imposed by GASB, the private but powerful Governmental Accounting Standards Board, that will be phased in beginning in 2006-07 will require districts to record the full cost of funding post-retirement health benefits as part of current expenditures.

But beyond the obvious need for better accounting and reporting, there's a more immediate and depressing prospect: No matter what happens, schooling for millions of California kids in the coming years is likely to get leaner, not richer.

Hearings sought on unfunded benefits

By David M. Drucker, Los Angeles Daily News, April 14, 2005

With California school districts unable to fund $17 billion in health benefits to retired employees, Republican legislators asked Democratic leaders on Wednesday to convene hearings on the issue. Referring to the Los Angeles Unified School District's $5 billion unfunded liability, six Republicans -- including the Senate and Assembly GOP leaders and Sen. George Runner, R-Lancaster -- asked for a legislative panel to investigate the problem.

"It is evident that our state school system is now facing a fiscal catastrophe as never seen before. The Legislature must act now to investigate the depth of the unfunded liability crisis," Republicans wrote in a letter to Assembly Speaker Fabian Nuñez, D-Los Angeles, and Senate President pro tem Don Perata, D-Oakland.

The request emanates from a recent report by the nonpartisan Legislative Analyst's Office, which found that the state's school districts owe $17 billion in health care benefits for retirees that they don't currently have the money to pay -- also called an "unfunded liability."

According to the report, LAUSD's $5 billion unfunded liability equals 80 percent of its general operating budget.

Republicans say many school districts are unaware of their liability, and cite that as one of the reasons for the investigation.

LAUSD Superintendent Roy Romer was unavailable for comment.

But Vivian Castro, the district's director of legislative and government affairs, said the district would welcome the hearings. She noted, however, that providing generous health benefits is one of the key ways to attract highly qualified teachers.

"What we've heard so far is an explanation of the problem. I don't know that anyone has offered a viable solution," she said. "It's very difficult to say that's a benefit we will no longer provide."

Runner said the hearings are needed to expose the crisis and prevent school districts that are not yet in trouble from negotiating retirement deals similar to the agreement LAUSD cut with its employees.

"It's worthy of a discussion that talks about how big this problem is so other school districts don't get sucked into this problem."

CalSTRS funding gap increases

A report notes a need for more current income or changes in benefits

By Gilbert Chan, Sacramento Bee, May 30, 2005

The California State Teachers' Retirement System learned in a new report that the gap is widening between what the pension fund must pay future retirees and what assets the fund will have.

The day of reckoning is about 20 years away, but the fund's trustees must either begin feathering the nest now or cut back on benefits for new hires. Current teachers won't see their pension benefits reduced, because the payments are guaranteed by law.

CalSTRS trustees face the daunting task of erasing the shortfall at a time when Gov. Arnold Schwarzenegger has expressed his desire to reduce the state's obligation to public pension funds by ending guaranteed pensions for new teachers and other public employees.

The fund's projected long-term shortfall has increased to $24.2 billion, up $1.05 billion from the last year's actuarial report by the consulting firm Milliman. CalSTRS trustees will review the report Thursday.

Although the nation's third-largest public pension fund saw its assets grow faster than liabilities last year, it remains underfunded. As of June 30, 2004, CalSTRS had enough assets to cover 83 percent of the pension obligation to current employees.

"The impact of the losses is playing itself out," said Ed Derman, CalSTRS deputy chief executive officer.

As they did a year ago, consultants are warning that CalSTRS needs to generate more revenue to meet pension obligations over the long haul. The options include reducing benefits for newly hired teachers, selling pension obligation bonds or boosting contributions from the state or school districts.

"It is very much a concern. It is an issue that we need to address," said Carolyn Widener, chairwoman of the $124 billion fund with 755,000 members.

But Widener and other trustees have said the fund doesn't need to panic, and they point out that CalSTRS is in better shape than in the 1980s and early '90s when the plan was funded between 41 percent and 76 percent.

Nationally, other public pensions have narrowed their shortfalls because of a rebounding stock market.

But most remain underfunded, according to a Wilshire Associates study released this spring. On average, 64 plans were 83 percent funded, up from 77 percent the year before, the firm said.

Unlike private plans, public funds are not required by law to be 100 percent funded.

Experts say there is no rule of thumb to determine the health of state retirement systems.

"I've been seeing other funding ratios tick up. We have turned the corner," said Keith Brainard, research director for the National Association of State Retirement Administrators.

Roz Hewsenian, a managing director at Wilshire, said the Wall Street upswing since 2003 is a positive sign for underfunded pensions.

"Things will get better. As long as people mind their p's and q's, they'll ride it out," Hewsenian said. "We went through that in '73 and '74. Pension funds got healthy."

But CalSTRS officials and experts aren't counting on Wall Street to pull underfunded plans out of the financial hole. Instead, consultants suggest raising contribution rates.

By law, the Legislature must approve any changes to CalSTRS contributions made by teachers, school districts and the state.

Currently, teachers contribute 8 percent of their annual payroll, while school districts put in 8.25 percent and the state adds 2 percent.

To bridge CalSTRS' gap, consultants estimate the combined contribution rate must grow by as much as 4.56 percentage points. This figure has increased along with the shortfall.

Any proposals will likely spark debate as teachers cope with rising expenses such as health care and the state and school districts deal with shortfalls of their own.

"It is important for us to be very deliberate about it and really take our time and consider every possibility," Widener said.

Philip Glasgo, a finance professor at Xavier University in Ohio, said pension funds can't afford to wait too long.

"If you start to deal with it now, it will never reach a crisis," he said.

Schwarzenegger and other governors have questioned increasing state pension burdens in recent years.

This month, the Alaska Legislature approved the switch to 401(k)-style accounts for future state workers. Schwarzenegger abandoned an effort to make such a switch this year but has vowed to pursue the issue next year.

"The forces for eliminating (traditional) plans are still out there," Brainard said.

CalSTRS trustees tackle shortage

Pension system will work on plugging a $24.2 billion gap in commitments

By Gilbert Chan, Sacramento Bee, June 3, 2005

Saying the financial gap will only grow wider in the future, trustees of the California State Teachers' Retirement System agreed Thursday to start mapping out strategy to tackle a $24.2 billion shortage. The move comes after a consultant warned that the shortfall could balloon to more than $200 billion in the next three decades if CalSTRS doesn't tackle the issue in the coming years.

"The longer we wait, the more expensive it gets," said Jim Zerio, a representative for CalSTRS trustee and state Treasurer Phil Angelides. Next month, trustees of the nation's third largest public pension fund will review ways other retirement systems are tackling their shortages.

By the fall, the board plans to outline a strategy that could include seeking higher contributions from the state or school districts or reducing benefits for newly hired teachers.

CalSTRS officials said Thursday that the gap won't vanish even if Gov. Arnold Schwarzenegger is successful in his plan to end traditional pensions.

Schwarzenegger and other Republican leaders advocate replacing guaranteed pensions with self-directed 401(k)-style investment accounts for future public employees, including teachers. They cite a growing pension obligation burden on the state and local governments.

For CalSTRS, any changes to the current retirement plan require approval of the Legislature and Schwarzenegger.

"We don't need to panic," said Nick Smith, a CalSTRS representative for state Controller Steve Westly. "But we do need to act. There's a problem we all need to solve."

A year ago, trustees first learned that a string of stock market losses and subpar investment returns in recent years had left the giant fund billions of dollars short to pay benefits for retirees over the long haul. After reviewing options to erase the shortfall, the board opted to call for another actuarial study.

The latest report, presented Thursday to trustees, found little has changed 12 months later. The shortfall increased $1.05 billion to $24.2 billion. But CalSTRS' assets grew faster than liabilities because of smaller wage increases. As of June 30, 2004, the fund had enough assets to cover 83 percent of future benefits, compared with 82 percent the previous year.

"You're a little better off than expected," said Mark Johnson, national pension director for Milliman, the CalSTRS consulting firm that prepared the report. "You're in a little better-funded position."

Still, he warned trustees they can't sit idle.

"You don't need to panic," Johnson said. "But you need to address the issue. If you ignore it … you're going to be in deep trouble."

Officials point out that the $124 billion fund has enough money to pay benefits for 20 years. Moreover, retiree benefits aren't in jeopardy because they are guaranteed by law.

But like most pension funds across the country, CalSTRS isn't projected to generate enough income from investments or employee and employer contributions to meet long-term pension obligations.

Milliman estimates that CalSTRS, which has 755,000 members, needs to boost contributions by as much as 4.56 percent. Currently, teachers contribute 8 percent of their annual payroll, school districts 8.25 percent and the state about 2 percent.

Without any increase, the shortfall would skyrocket to $217 billion in 30 years.

Johnson and CalSTRS investment officials aren't counting on Wall Street returns to bail out the fund. CalSTRS targets an 8 percent annual investment return as the benchmark for keeping the plan fully funded. To wipe out the shortfall, the fund would need to generate a 9.1 percent annual return for 30 years.

"It's not likely you're going to invest out (of the hole). It's not a chance you want to take," Johnson said.

In other action Thursday, trustees voted 8-1 to back an Assembly resolution aimed at pressuring companies to protest human-rights abuses in Sudan. Trustee Jerilyn Harris dissented, saying enforcing the measure would divert time from CalSTRS investment officials.

Last month, the California Public Employees' Retirement System endorsed the measure by Assemblyman Mervyn Dymally, D-Compton. The resolution urges the two funds to encourage companies to avoid activities that promote human rights abuses in conflict-torn Sudan.

Hard choices face CalSTRS

Pension The challenge: How to fill a $24 billion pension gap

By Gilbert Chan, Sacramento Bee, December 10, 2005

WEIGHING THE OPTIONS

• Pension obligation bonds. Trustees must figure out whether the state can sell these bonds without voter approval. Local school districts could issue the bonds and use the proceeds to cover any future increase in pension contributions.
• Increase the amortization period to up to 40 years, from 30 years. While this reduces the annual costs, the overall bill to provide benefits would be larger.
• Base pensions on highest compensation over three straight years, compared with 12 consecutive months. This would reduce monthly benefits by $134.
• Take out a career factor used to calculate benefits, which would result in a loss of $378 a month in benefits for each teacher.
• Reduce age calculations for teachers who are 60 years old and older, which would result in a loss of $504 a month in benefits for each teacher.
• No longer allow unused sick leave in the retirement formula, which would cut benefits by $146 a month for each teacher.
• Drop a 2 percent teacher contribution to a supplemental benefit, which would drop benefits by $81 a month for each teacher.
• Reduce or drop the employer contribution to the supplemental benefit for teachers working extra duties. Cut: $54 a month.
• Eliminate the annual 2 percent inflation adjustment. This could affect current teachers, cutting benefits by $93 a month in the first year.
• Incorporate the state's annual payment for a special account to offset inflation for older retirees into the regular pension fund. This year, the state payment is $581 million.
• Don't extend Medicare premium payments for teachers who retire after July 1, 2006. This would increase each teacher's health costs by $393 a month.
• Impose employer contribution for teachers who work after retirement. The total annual cost to districts would be $15 million.

Schools face ‘death spiral'

Districts must choose between students' needs, teachers' benefits

USA Today Editorial, February 16, 2005

Until last week, Los Angeles school officials had thought their unfunded health care obligation for retirees was $5 billion. Then they scrubbed the numbers. The new estimate: $10 billion. That's bad news for taxpayers who will foot the bill and for children whose education will be limited by the cost.

At least Los Angeles' school leaders are trying to calculate their future debts. Most school districts have no idea what they owe retired or soon-to-retire teachers. Instead, nearly all plod along with annual budgets, signing labor agreements that ignore exploding long-term liabilities.

Thanks to generous contracts negotiated years ago, when health care costs were largely an afterthought, tens of thousands of teachers about to retire have been promised lifetime benefits for themselves and spouses, something available to very few of the taxpayers who pay the cost.

As health care costs soar, these contracts represent financial time bombs. They will leave schools with less money to hire teachers, less money for raises — less money for everything. The health care squeeze is “the single most important issue facing districts nationwide,” Tom Henry, a financial adviser to California schools, told USA TODAY.

New federal accounting rules are forcing them to do just that — ensuring that thousands of communities will receive the kind of news Los Angeles is getting.

School boards will pretend they are shocked: Who knew? The teachers' unions will claim they did nothing wrong. Politicians and taxpayers will demand accountability.

Unless or until there's a national solution to soaring health care costs (don't hold your breath), maintaining high quality of schools will involve taxpayers digging deeper, teachers being willing to make concessions, or possibly districts following the lead of companies that have filed for bankruptcy protection to shed pension obligations.

The teachers argue that in many cases, health care deals were offered in lieu of salary increases. They have a point, but the teachers are not blameless. Many contracts were negotiated with school boards elected with union backing.

In some school districts, teachers might have to start or increase medical co-pays. In others, they'll have to lose their district-provided coverage when they turn 65 and become eligible for Medicare.

Doing nothing threatens to send many school districts into what Henry describes as “a death spiral.” Already, health care benefits are smacking against budgets. Los Angeles sets aside $1,000 of its $5,500-per-student budget to cover health care costs for current and retired teachers. To cover the newly estimated $10 billion liability would require $2,087 per student.

The health care situation facing school systems mirrors the squeeze facing public and private employers more generally, as well as the financial strains on Social Security and Medicare as the baby boomers retire.

In all these cases, the sooner action is taken to bring promised benefits in line with revenue, the less painful the solution will have to be. That's a lesson schools can teach the rest of the nation.

CalSTRS funds gap lowered

A 12.3 percent investment gain reduces the pension shortfall from $24.15 billion to $20.3 billion, an actuarial report finds

By Gilbert Chan, Sacramento Bee, April 3, 2006

Investment gains are helping to offset a long-term gap in teacher pensions, a new actuarial report shows, but the trustees of the California State Teachers' Retirement System still have some work cut out for them. The greatest challenge will be resolving different opinions on how to fund the potential shortfall.

As a group, trustees of the $141.8 billion California State Teachers' Retirement System favor asking California educators, their employers and the state to dig deeper to pay the difference, according to a staff survey.

Advocates for teachers and school administrators, however, are greeting the idea of raising everyone's contributions with a tepid response.

Instead, these groups are pushing for the state to foot most of the bill and supporting the sale of pension obligation bonds. They also balk at imposing a two-tier benefit plan for future teachers.

"Having good benefits and job security is what keeps people in education," said Arlene Pavey, president of the retiree affiliate of the California Teachers Association. "We don't have Social Security. That's why preservation (of benefits) is important. They don't want any decreases."

The funding gap, which stood at $24.15 billion for 2004, now is projected to be $20.3 billion - thanks in part to a hefty 12.3 percent investment gain in 2004-05 and a continued recovery from the stunning stock market losses in the early 2000s, said Milliman, the fund's independent actuary. The firm will outline its report to the 12-member CalSTRS board next Friday.

"We're headed in the right direction. It relieves a little of the pressure," said Carolyn Widener, CalSTRS chairwoman. "We can take our time looking at ... scenarios. We're very reluctant to create a different tier of benefits. The responsible thing is to look at adjusting contributions very gradually."

The Milliman report said the fund had enough assets last year to cover 86 percent of benefits over the long run - an improvement from 83 percent in 2004.

While CalSTRS points out the fund has enough assets to pay benefits for six decades, trustees want to keep the gap from widening. If left unchecked, the shortfall could grow to $170 billion over the next 30 years as more baby boomers retire.

CalSTRS is among the 80 percent of major U.S. public pensions that are underfunded, according to a 2005 survey by Wilshire Associates, a Los Angeles investment consulting firm.

Some pension programs such as the California Public Employees' Retirement System have raised employer contributions to improve their funding level.

But CalSTRS has no authority to increase contributions or unilaterally cut most benefit programs.

The Legislature must approve any changes.

Currently, teachers contribute 8 percent of pay to their pension, while school districts put in 8.25 percent of payroll and the state pays about 2 percent.

Each percentage point increase would cost an extra $40 a month for teachers, $250 million a year for school districts and $220 million for the state, officials estimate.

Milliman said the fund needs to boost rates by another 3.75 percent to become fully funded.

On Friday, trustees will review a series of proposals to tackle the shortfall. By June, the board will decide which approach to take and begin preparing a legislative proposal to be introduced in early 2007.

Some options:

• Increase contribution rates for teachers, school districts and the state and shift a special supplemental benefit fund to the regular pension program. School districts would be required to make pension payments for teachers who return to work after retirement. A majority of trustees polled in the past month favor this strategy.
• Take several steps in a more aggressive approach. Raise contribution payments and allow a Medicare premium payment program to expire. Then impose a two-tier program for future educators that would eliminate an annual 2 percent cost-of-living adjustment, and end or alter various salary, age and years of service formulas used to calculate final benefits.

Some groups such as the Faculty Association of California Community Colleges have called on trustees to back the sale of pension obligation bonds and amortizing the unfunded liability over a 35-year or 40-year period instead of the current practice of 30 years.

Educators have voiced unified opposition to a two-tiered benefit plan.

"It's very important to have equity," said Jennifer Baker, an association official. "We don't want to have a reduction in benefits."