LAO Report on Higher Ed Contains Significant Pension Recommendations

The state’s Legislative Analyst has released a lengthyreport on funding higher education which covers UC, CSU, and the communitycolleges (as well as CalGrants).  Thereport is essentially a response to the governor’s January budget proposal withregard to higher ed.

Generally, the report tends to disagree with the governor’sapproach which the Legislative Analyst views as giving too much autonomy to UCand the other segments with regard to enrollment and other matters.  On the other hand, it documents the trendtowards reduced state funding and thus seems to continue the pay-less/say-moreapproach which is odd on its face.

The Legislative Analyst does raise questions about thetrigger cuts proposed by the governor in case his tax initiative does not passin November.

There is a lengthy section on pension matters, especiallyfor UC which has not received explicit state funding for its pension for overtwo decades and which has had to divert other funding to deal with resumedpension contributions.  The report seemsto favor some state funding for the UC pension and – significantly - does notcondition it on UC being covered by the statewide plan proposed by thegovernor.  That is a step in the rightdirection if followed by the legislature in the final budget.  The report favors somewhat less of a pensioncontribution than UC has requested.  However,establishing the principle of some state responsibility would be an advance.

Excerpts from the pension portion are below:

Retirement Costs

The Governor proposes major changes to the way in which some retirementcosts are funded for higher education. For CSU, the Governor proposes to nolonger make base adjustments to reflect changing retirement costs. For UC, theGovernor proposes (1) a $90 million base augmentation that could be used forpension costs or other purposes, and (2) no out–year adjustments for retirementcosts. The budget proposes no changes to the way retirement is funded for CCC.

Background

CSU Pension Benefits. CSU employees are members of theCalifornia Public Employees Retirement System (CalPERS)—the same retirementsystem to which most state employees belong. Funding for this system comes fromboth employer contributions and employee contributions. Each year, as is thecase with other state departments, CSU's employer contributions to CalPERS arecharged against its main General Fund appropriation. The employer contributionis based on a percent of employee salaries and wages that is determined byCalPERS and specified in the annual budget act. The Governor's budget annuallyadjusts CSU's main appropriation to reflect any estimated changes in theemployer contribution. For example, the Governor's budget reduces CSU's mainappropriation by $38 million due to a lower employer rate and lower payrollcosts in the current year. The CSU is expected to contribute $404 million toCalPERS in 2012–13.
UC Pension Benefits. Employees of UC (and Hastings) aremembers of the University of California Retirement Plan (UCRP). This retirementplan is separate from CalPERS and under the control of UC. Prior to 1990, thestate adjusted UC's General Fund appropriation to reflect increases anddecreases in the employer's share of retirement contributions for state–fundedUC employees. Starting in 1990, however, UC halted both employer and employeecontributions to UCRP because the pension plan had become"superfunded." Specifically, the plan at that time was enjoyingexceptionally strong investment returns, resulting in assets that exceededliabilities by more than 50 percent. This "funding holiday" lastednearly 20 years until the plan's assets had declined considerably andcontributions once again became necessary. In April 2010, both UC and itsemployees resumed contributions to the plan. The state, however, has notprovided UC with any additional funding specifically for that purpose.

Governor Proposes New Approach To Funding Retirement Costs

The Governor proposes two major changes related to funding for universityretirement plans:

• A $90 million base budget augmentation for UC that, according to the administration, "can be used to address costs related to retirement program contributions." The administration emphasizes that this funding is not being provided specifically to fund costs for UCRP. Rather, UC could use it for any purpose related to its state–related programs—including, but not limited to, UCRP.
• A new policy that the segments' budgets no longer be adjusted for changes in retirement costs in the future. Instead, state–related retirement costs would be funded entirely from the segments' unrestricted base appropriations.

Unclear Which Retirement Costs Are Affected. The Governor'sproposed language refers simply to "retirement costs." At the timethis analysis was prepared, the administration had not provided sufficientclarity on whether this would include costs for retiree health and dentalbenefits. For example, funding for CSU's retiree health care costs arecurrently bundled together with funding for other CalPERS retiree health carecosts. Since the administration has not yet indicated how it would split outfunding for CSU, we are unsure whether the proposal applies to these costs. Theadministration also was unable to provide information regarding base fundingfor retiree health costs for UC. For these reasons, our budget analysis onlyfocuses on funding for pension costs for UC and CSU.

UC Proposal Has More Merit,But Raises Several Questions

The request for pension–related funding for UC is more difficult andcomplicated than that for CSU. This is because (1) the state currently is notproviding any pension–related funding to UC, and (2) UC has full control overits pension system. To address the Governor's proposal, the Legislature shouldconsider the following questions:

• What is the main justification for the state to provide funding for UC's retirement costs? In other words, why is funding for these costs a state responsibility?
• Given that UC controls its own pension plan, are UC's pension benefits reasonable? How do they compare to the pension benefits the state provides state employees?
• How much funding should the state provide UC in 2012–13? More specifically, what methodology or calculations support the request for $90 million?
• Finally, should the state lock in the pension amount provided UC at the 2012–13 contribution level or provide UC with budget adjustments for pension costs in future years? …

Pension Costs Should Be Funded as Part of Workload Budget. Thestate currently provides funding for pension–related costs for all other stateagencies as part of a normal, workload budget. In other words, the stateprovides funding to state agencies for the salaries and benefits (includingpension benefits) related to their budgeted positions. Given that the stateprovides UC with funding for the salaries and benefits of some of itsemployees, it would make sense from a standard, workload budgeting perspectiveto also provide funding related to pension costs. As noted earlier, the statedid provide such pension–related funding to UC for many years prior to thepension holiday that began in 1990. (As we discuss in the nearby text box, thestate has repeatedly deferred a final budget increase for pension costs sincethat time.) Given that the university has had to restart its contributions toits pension plan in recent years, we find justification in its request that thestate also resume providing pension–related funding.
UC Pension Benefits Similar to State Employee Pension Benefits. Althoughthe state does not control UC's pension system, actions taken to date by theRegents have largely mirrored recent changes to state employee pensionbenefits. For example, the Regents have taken action to reduce pension costs inthe long term by increasing the minimum retirement age for new employees. Inaddition, …the Regents have approved increases to employee contribution ratesthat are beginning to bring them in line with state employee contributionrates, which are now generally 8 percent. (Some of UC's proposed employeecontribution increases are still subject to collective bargaining.) Additionalcontribution increases beyond July 2013 will also likely be necessary to reducethe plan's significant unfunded liability that has accrued due to thedecades–long pension funding holiday and recent market downturns.

UC's Estimate of State's Share of 2012–13 PensionCosts Is Overstated. The $90 million that UC requested from theadministration is only a fraction of the $255.6 million that UC estimates to bethe state's share for 2012–13. The UC states it requested the lower amount inrecognition of the state's severe fiscal shortfall. The university furtherindicates that it will likely seek the full amount of what it estimates to bethe state's share (which it calculates could rise to roughly $450 million) infuture years...

We find two issues that the Legislature should carefully consider withrespect to how the university has estimated the state's share of UC retirementcosts.

• First, we find that the request for $90 million in 2012–13 is overstated. …UC's estimate of the state's share of its 2012–13 retirement cost increase totals about $78 million. The UC appears to be requesting a greater amount because it believes that the state should provide contributions to account not only for incremental retirement costs in 2012–13, but also for part of the cost increases in the two prior years. We take a different view. The UC has managed—by both redirecting internal resources as well as increasing student tuition—to fund all of its employer contributions in both 2010–11 and 2011–12. If the Legislature were to provide funding related to prior years, the funding would in effect free up existing UC base funding for other purposes. In our view, given the state's fiscal shortfall, such an augmentation would be unwise.
• Second, the university's calculation of the state's share of retirement contributions includes employer costs related to tuition–funded salaries. From a workload budgeting standpoint, the state portion of retirement costs should only be related to state–funded payroll costs. Given, however, that the Governor's budget assumes no increases for tuition in 2012–13, the Legislature may wish to consider providing the funding for pension costs related to tuition–funded salaries in 2012–13. In future years, higher pension costs—just like any other UC cost—presumably would be covered by the General Fund and tuition fees in proportion to their current funding levels.

Timing Not Right to Lock In Base Funding for Pensions. Aswith the CSU proposal, now would be a poor time to choose to lock in a basefunding level for UC pensions, given that the Governor is separately proposingto modify public employee pensions to reduce costs in the long run. Inaddition, as noted earlier, UC intends to increase its employer contributionsover the next few years, although it has not yet reached agreement with all ofits union–represented employees on the employee contribution rate. In our view,the Legislature should carefully evaluate future requests from UC for pensionfunding on a year–by–year basis in the context of the university's currentpension benefit and contribution structure. In the long term, however, it couldmake sense to expect UC to fund its pension costs out of its base budget, giventhat the university's retirement system is separate from the state's. Thiscould only work once a reasonable funding level has been identified andcontribution amounts have stabilized.

Recommendations

…Recommend Restarting Budget Adjustments for UC. Asdiscussed above, we find that there is sufficient justification on a workloadbudget basis to provide UC with an augmentation that the university could useto address its pension costs. We recommend, however, that the Legislature onlyprovide funding for the incremental change in 2012–13 in UC's pension costs forstate– and tuition–funded employees—which we estimate to be $78 million. Thiswould mean reducing the Governor's request for $90 million in General Fundsupport by $12 million. In addition, we recommend that the Legislature adoptintent language in the budget specifying that in the future funding for UCretirement costs (1) shall be determined annually by the Legislature, (2) shallbe contingent on such factors as the comparability of UC's pension benefits andcontributions to those of state employees, and (3) shall not necessarilyinclude funding for tuition–supported employee pension costs or pension costsincurred prior to 2012–13.

The full report is at http://lao.ca.gov/analysis/2012/highered/higher-ed-020812.pdf

A video presentation of the report highlights is availablebelow: