California, along with many other states, has unfunded public pension obligations that it hasn’t the remotest possibility of being able to meet. A Stanford study last April determined California’s unfunded pension liabilities to be $500 billion. That’s right, California owes half a trillion dollars and it hasn’t a clue where the money will come from.
This sorry state of affairs is due to multiple factors. California public pension funds have been mismanaged for years and have used unrealistic estimates of future growth to pretend everything was fine, only to frantically revise those estimates when the inevitable reality pie hit them in the face. The stock market slump caused further damage to the funds. Incredibly, public pension liabilities are not even included in the state budget. Instead, they’ve been ignored and pushed to the side in hopes that perhaps a magic fairy will soon sprinkle pixie dust on the funds and then all will be well. That must be what legislators and fund administrators have been hoping for, because how else can one explain their deliberate and willful myopia and belief that if they ignore the problem long enough, it will fix itself? That game is now over. The magic fairy has announced she will not be coming to California and that the state will have to deal with the public pension shortfall all on its own.
Last year, Utah switched from defined benefit to defined contribution pension for its public employees after State Senator Dan Liljenquist determined their public pensions were nearing insolvency and spearheaded pension reform. A defined benefit plan is what California public employees have now. It specifies the amount of monthly benefits upon retirement. Investments made by the pension fund are assumed to be able to keep up with the amount owed, even though this clearly has not happened in reality. By contrast, a defined contribution plan specifies how much the employee and employer will contribute. The amount of future benefits is not guaranteed. However, employees control their own plan, can invest it however they want, can take it with them if they leave, and crucially perhaps, the state cannot attempt to loot it to pay for current obligations.
Under the Utah plan, new hires have a defined contribution plan with the state contributing a generous 10% of pay. They can also choose a defined benefit plan, but the state contribution remains the same at 10% and is not open-ended. This guarantees that Utah knows precisely how much it will have to pay. Even a stock market crash can’t force them to pay more, as happens in California now where CalPERS can mandate that the State of California fund their shortfall. Last year that was $3.2 billion. By contrast, Utah’s plan is eventually expected to cut their pension costs in half.
For better or worse, defined contribution plans for state employees are probably going to be adopted widely. Wyoming may be next and other states are interested too. A big problem with such plans is that it shifts the burden of investing wisely from a pension fund to the employee. But many employees have no expertise in investing and could easily make blunders. Of course a cynic might snarkily say they couldn’t do much worse than some of the public pension funds.
All of this also applies to municipalities, and that’s where the financial implosions and resultant bankruptcies will hit first. Some cities almost certainly will be filing for bankruptcy soon, and when that happens, public pension plans will be reworked. In fact, bankruptcy judges may have the power to break existing defined benefit plans and convert them to defined contribution. States can’t file bankruptcy under existing law, but that could be changing too.