LAO Pans Governor Brown’s Plan To Have CalPERS Study Hybrid Pensions

In defined contribution plans, employers do not incur unfunded pension liabilities, since the contribution portion is defined rather than the output or the benefit.  There is an advantage, thus, to the employer but it increases the risk to the employee.

The Governor’s proposal raises problems with a conflict of interest, as well as the fact that CalPERS is heavily dominated by employee interests.

The Legislative Analyst’s Office has come out uncharacteristically strongly against this plan. 

They recommend, “Recommend that if the Legislature appropriates $1.5 million from the General Fund, as proposed by the Governor, to ‘study and identify alternatives for hybrid pension systems’ for public employees, that it reject the Governor’s plan to have CalPERS be the entity that conducts this study.”

They write, “Given CalPERS’ independent fiduciary and rate setting roles under our Constitution, placing it in this role of advising the Governor as he develops a pension policy proposal would be inappropriate.”

Indeed they argue, ” We have no idea what the Governor is contemplating in his hybrid proposal or whether the study to be funded from this money would have any value at all. This proposal is uncommonly amorphous and inscrutable compared to the typical state budget proposal.”

While recognizing that such a plan would require considerable staff support time and expertise, they note, “Notwithstanding our doubts about the study’s value, should the Legislature choose to fund all or part of the Governor’s request, we strongly urge it to prevent the administration from using CalPERS to lead the study effort. This is not meant as a condemnation of the considerable skills and abilities of CalPERS staff.”

They argue their recommendation is “intended to preserve CalPERS’ hard-won and important independence.”

As they point out, CalPERS interests are not necessarily in line with other pension systems. 

The LAO writes, “CalPERS is California’s largest public pension system, but there are dozens of others too: for teachers, for University of California employees, county and city systems for other public employees, and others. The interests of these systems clearly are not always the same.”

Moreover, in some respects some of “these systems can be viewed as competitors to enroll public employees and serve public employers in some lines of business.”

The effort is also duplicative, as CalPERS is already required to analyze all bills that affect its pension funds.

In addition, CalPERS opposes 401(k)s which would be the key part of a hybrid plan.

“In its role promoting the interests of its members, CalPERS seemingly has been skeptical of defined contribution plans, which are, naturally, a key element of any hybrid plan,” writes the LAO.

They cite an article from just two days ago in which  CalPERS officials were said to “now see the fund playing a leadership role in the national debate over whether to overhaul public pensions and replace them with 401(k)-style plans popular in the private sector, a change CalPERS opposes.”

As the LAO points out, “Some might debate whether or not that is an appropriate role for CalPERS to be playing. Nevertheless, this gives rise to a perception–and perhaps the reality–that CalPERS is opposed or resistant to the very idea of hybrid plans that include 401(k)-style plans as a major element. Given this perception, it seems odd that the state would spend $1.5 million to fund a CalPERS study on that very topic.”

“Public pensions clearly are very controversial right now,” the LAO writes.  “The choices involved in developing a hybrid plan, however–while immensely controversial–are not fundamentally that complicated.”

They elaborate, “First, one developing a hybrid plan must decide if the overall employee and employer contributions to a hybrid plan will be less than, the same as, or more than ‘normal cost’ contributions–annual contributions to cover the cost of pension benefits accrued each year–to existing pension plans. Second, one must decide what portion of those combined contributions will come from employees and employers, respectively. Third, one must decide what portion of the benefits will be ‘defined benefit’ and which will be ‘defined contribution,’ thereby deciding what degree of financial risk will be placed on the public employee in future years during retirement and what elements of risk will continue to be borne by the employer.”

In their final analysis the LAO recommends, “The Legislature reject this request for funding. Alternatively, if it wishes to provide the administration with some such funding, perhaps the amount could be lowered. In any event, actuaries, legal experts, and other policy experts independent of CalPERS and other California public pension systems should be utilized in this study.”

While we are skeptical of a hybrid plan and support defined benefit contributions with many reforms, we agree with the LAO’s analysis that this is a strange choice that represents a conflict of interest – particularly a conflict of stated interests.

If the plan is to be evaluated, it should be done so by a truly independent body.

Nevertheless, we think the move to a hybrid plan is ill-considered.  The typical employee in the state of California is not a drain on resources.  Unfunded liabilities are a real problem, particularly at the local level, but they can easily be addressed through increased contributions from employees and governments as well as more conservative investment return projections.

The idea of a 401(k) goes against the notion that public employees, by virtue of their taking less salary than other employees, should have a set retirement that they can count on.  A 401(k) introduces much more risk, even if ameliorated somewhat by a hybrid plan.

—David M. Greenwald reporting