Demographic Changes Threaten Pensions

New report: There eventually will be more retirees collecting pension checks than there will be employees paying into the system

In a 2011 profile about California's ongoing fiscal mess, Vanity Fair interviewed San Jose's then-Mayor Chuck Reed, a progressive Democrat who has for years been warning about coming cuts in public services if the state's pension systems don't get benefit levels under control. Reed did the math and the picture wasn't pretty.

"By 2014, Reed had calculated, a city of a million people, the 10th-largest city in the United States, would be serviced by 1,600 public workers," according to the piece. "The problem was going to grow worse until, as he put it, 'you get to one.' A single employee to service the entire city, presumably with a focus on paying pensions."

Pension activists still refer to Reed's "joke," but it wasn't really a joke and it's certainly not funny. Defenders of the current pension system accused Reed and the state's pension reformers of overstating the problem.

But while San Jose and other cities will never literally reach a single employee who sits in the room mailing out pension checks, the trajectory is headed in that troubling direction. One city manager even quipped to a newspaper a few years ago that cities are becoming pension providers that offer a few public services on the side.

Now even the California Public Employees' Retirement System, the nation's largest pension fund and one of the state's most adamant opponents of pension reform, released a report in November that bolster's Reed's case. Its key finding: There eventually will be more retirees collecting pension checks than there will be employees paying into the system. This is a nationwide trend in public-pension systems, and one that's tough to ignore.

"A pension plan in its infancy will have a very high ratio of active to retired members," according to the report. "(T)he ratio for CalPERS has dropped from just above two (active members) to just below 1.5 over a 10-year period. … (T)hese ratios are also expected to continue dropping over the next decades until they reach a floor somewhere between 0.6 and 0.8."

That means more people will be receiving money from the system than putting it into it, thus challenging CalPERS' ability to fund retirement promises. It could lead to a further reliance on risky Wall Street investments to make up for the shortfalls and continued increases in the contribution rates CalPERS assesses to participating agencies. Cities will be pushed to raise local taxes or cut back services.

Local agencies already are reeling from recent rate hikes. "For many plans, the contribution rates have never been as high as they are now," according to the CalPERS report. These agencies already pay 30 percent to more than 50 percent of each employee's salary into the retirement system. This is a big chunk of cash.

Public employees receive defined-benefit pensions guaranteeing them a payout based on a formula. The agencies they work for contribute into a pension fund, which invests the money. The funds, such as CalPERS, predict a rate of return. Higher returns on these investments reduce the size of the debt, whereas poor returns create a bigger "unfunded liability" problem.

"This is just another indicator about the unsustainability of the pension promise," said Dan Pellessier, president of California Pension Reform. This information doesn't change the size of the liabilities, he notes. But it does affect the money flowing into the system to pay off those liabilities. There will be fewer active employees to help CalPERS dig out of its hole.

"CalPERS is finally demonstrating some fiduciary responsibility in better describing the magnitude of its problem," Pellessier added. Nevertheless, the big question is what the agency plans to do about it. CalPERS has been meeting its investment targets, yet these and other demographic changes point to deep trouble any way.

Legislative leaders are unlikely to tackle this issue when they return to the Capitol given their political leanings. For years, it's been easy for them to depict Reed's and other reformers' warnings as hyperbole, but it's going to be much harder for them to ignore CalPERS' latest findings.