Commentary: Underfunded pensions must be dealt with
I recently read a claim that underfunded pension obligations for city employees were imaginary.
Consider the following hypothetical, which is analogous to what’s facing thousands of public employees in the California Public Employee Retirement System (CalPERS), including those in Costa Mesa, who are looking forward to retiring in the coming years.
A recently hired 35-year-old accountant has been told by his physician that he will slowly lose his eyesight over the next 30 years. At that time he will no longer be able to see adequately to function as an accountant and support himself and his wife.
Knowing that he has no other significant source of retirement income, the accountant begins to plan ahead. He and his employer agree to a contract with a pension manager (Calvin Purrs) to establish a 30-year retirement savings plan. The plan must provide him with a modest income of $28,800 per year ($2,400 per month).
They calculate that the combined savings contribution by the accountant and the employer will need to be $284 per month. They assume a 7.5% annual rate of return on the savings. (This is a high rate of return, and some think too optimistic, but it is about what CalPERS is currently assuming.)
They adhere to the savings plan for the first 10 years, and it gets a little more than the targeted 7.5% rate of return.
However, because the previous 10 years had been so good, they discontinue contributing to the savings program for years 11 to 15. Fortunately, they do continue to get the high rate of return on all the previous year’s savings.
Then, even though they restart contributions to the savings program, the bad news hits: The economy is slowing, and the rate of return has fallen to 1%. Worse yet, the rate of return stays at this low level for the next five years (16 to 20).
The accountant now realizes that his retirement savings plan is underfunded. He understands that in order to meet his retirement income goal he must work with his employer and Calvin Purrs to find a way to get more money into his savings plan as soon as possible.
In other words, at the 20-year mark, what has been created by the suspension of contributions and the weak economy is an unfunded liability to his account of about $60,000 (about half due to the weak economy).
If no supplemental contributions are made, the original 30-year goal of accumulating about $400,000 will be missed, and the underfunding will grow to about $90,000.
The accountant fears that at the end of his 30-year savings program he will be unemployed, blind and unable to live on the $600 lower projected monthly income.
Similar events have contributed to the real-life problems that many California cities, including Costa Mesa, are facing in order to deal with underfunded city employee pensions.
Let’s not be fooled into thinking that if a debt is not current then it is not owed or that underfunded pension liabilities are imaginary. Cities like Irvine, Laguna Hills and Huntington Beach have not been fooled and have implemented plans to make supplemental contributions to CalPERS to address the problem of underfunded pensions.
Underfunded pension liabilities are real, and many other city councils, and all those involved in the retirement system, will need to muster the financial and political will to deal with them.
CHARLES MOONEY lives in Costa Mesa.