George Diehr presents…
Up for
the CSU
And Our

CalPERS Board of
13 members set policy for…
Ensuring a secure retirement
Investing for optimum risk adjusted return
Negotiating for quality health care at reasonable cost

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Traditional Defined Benefit (DB) Pension Systems
Each party contributes to the retirement fund; the employee contribution is almost always fixed—i.e., does not vary from one year to the next.
The retirement benefit is guaranteed, and is usually based on age, “final” salary, and years of service: e.g., “2% @ 55” (see example).
The money is managed in a pool to reduce overhead.
Investment risk is the responsibility of the employer.
Risks are spread over time.
Often provide inflation protection and disability and death benefits.
Have some degree of “portability” depending on reciprocal agreements with other public agencies.

Example CalPERS Pension Benefit
Common plan: State Miscellaneous, 2% at age 55
Assume 30 years of service, age 63 at retirement and final salary of $6,000 per month.
“Standard” retirement benefit is almost 75% (=30 years times age factor of 2.5%) of final salary.
Pension = 75% * ($6,000 - $133) = $4,400.
Formula: Yrs * Age Factor * (Highest Salary - $133)

DC Plans—401(k), 403(b): Characteristics
Employee usually responsible for investment.
Employer typically provides some contribution, possibly on a matching basis.
Investment management costs are generally higher.
Often vest faster than DB plans; employee owns the investment.
In general, feature better portability than DB.
“Actuarial” and “market” risks fall to employee.
Lack explicit inflation protection.
No disability or death benefits.
Make excellent supplements to DB plans.

DC Plans: Think You (or Your Broker) Can Beat the Market (& CalPERS)?
“Fund managers lagged behind market indexes in ’04,” San Diego Union-Tribune, 1/23/05
“Fund managers lagged indexes in 8 of 9 … investment categories… ”
“The S&P 1500 … outperformed 51.4% of actively managed domestic equity funds.”
“Expenses also dragged down total returns… Fees for managed funds tend to be much higher [than indexed funds], sometimes upward of an entire percentage point…”

“Equivalent” Defined Contribution Plan
Under optimistic assumptions, what percent of salary must be saved to purchase an annuity equivalent to the DB pension of $4,400/month?
Assume: starting salary $1,388, increasing 5%/year for 30 years (=$4,400); 8% investment return.
22 year life expectancy at age 63 (IRS standard, male).
Need fund of $716,000 at retirement; return of 4.8%. See
Requires contribution of over 21% of salary.
AND: no benefit to survivor, no inflation protection, no death or disability benefit.

Three Proposals That Attack Fundamental Retirement Security
A budget proposal that shifts more of the costs onto employees: employees share in the investment risk.
Legislation that ends the current defined benefit system for new employees;
A ballot initiative that ends the DB plan.

BUDGET Proposal
Most common CalPERS Plan: employer contribution = 17%; the employee contribution fixed at 5%.
The budget proposal:  equal sharing of the contribution by the state and employees means employee contribution would more than double to 11%—effectively, a 6% pay cut.
$469 million in pension contributions would be shifted to K-14 teachers for the 2005-’06 fiscal year.
And more: state contribution to health care premium frozen, …

Assemblymember Dr. Keith Richman proposes elimination of a defined-benefit plan for ALL PUBLIC employees
The proposed amendment to the state constitution known as ACA5, would put all new employees into a “defined contribution” plan--e.g., 401(k).
All investment risk would be placed on the individual.
Employer contribution would be limited to 6% for most plans.

Legislation, continued
Richman’s plan would require use of private money managers—e.g., CalPERS could not manage the DC plan. (This provision may have been dropped.)
Richman’s staff may be developing a separate bill that would create plans that would have a dollar-for-dollar match on up to 10% of employee pay. (P&I, 12/6/2004)
The DC plan would eliminate disability retirements and death benefits provided by DB plans.
A DC plan would provide no protection against inflation.

Effects of Richman’s DC Plan
Would eliminate disability retirement and death benefits even for survivors of police and firefighters hurt or killed in the line of duty.
Might require use of private money managers like Charles Schwab—e.g., CalPERS could not manage the DC plan.
Richman’s staff is developing a separate bill that would create plans that would have a dollar-for-dollar match on up to 10% of employee pay. (P&I, 12/6/2004) [See “Backpedaling”]
A DC plan would not protect against inflation.

The Howard Jarvis Taxpayers Association wants to break the promise of a defined-benefit pension.
Their purpose is to hinder/obstruct the right of employees to bargain over wages and benefits by using the ballot to end our retirement system.
It is like having voters approve every contract we negotiate.

Other Notes and Comments: Backpedaling?
Tom Campbell, Director, State Department of Finance, presentation to CalPERS board, 2/15/05:
Fundamental goal is that employees, not taxpayers, bear market risk.
CalPERS could manage DC plan, continue corporate governance activism.
Nothing set in stone—other than that the retirement plan cannot be DB.
When asked if market forces might result in salary increases that would offset reductions in retirement benefits and, therefore, result in no savings to the state, Mr. Campbell said YES.

Will Killing the DB Save Money?
Letter to Bill Lockyer, Attorney General, from Legislative Analyst & Campbell, 2/11/2005:
“Offsetting Employee Compensation in Other Areas. Reduction in retirement compensation … could lead to increases in other types of employee compensation. For instance, in order to attract and retain employees, some governments might need to increase salaries to compensate for lower retirement benefits. Over time, these types of increased public employer costs could offset a significant portion of the retirement savings.”

More Attacks…
At a recent legislative hearing (Feb. 14 or 15), Senator Tom McClintock expressed his intent to freeze DB benefits at current levels for all employees.
He was not persuaded that laws and cases have held that this cannot be done.
Point is: We can expect every effort will be made to reduce benefits or shift costs to CURRENT employees—YOU!

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Comments/Notes on Pension Reform
Pensions & Investments, 1/10/05
All public defined benefit plans in the state would be closed to new employees [starting 7/1/2007] although existing employees could continue to participate. It also would transform every public fund in California run by a state agency — including cities, counties, utility districts and possibly the $39 billion University of California Retirement Plan [into defined contribution plans].
The governor favors Mr. Richman’s proposal, which, under a new revision, would cap employer contributions between 6% or 9% of pay for most government employees. [6% for almost all CSU employees]
According to the CalPERS data, administrative costs of defined contribution plans are typically 1-2% of assets, vs. 0.18% for CalPERS, the nation’s largest defined benefit plan.
CalPERS’ research also shows that 80 cents of each $1 in a defined benefit plan is paid out in benefits, vs. 50 cents in a defined contribution plan. For benefit payments to be the same, contributions would have to increase substantially, according to the National Conference on Public Employee Retirement Systems, Washington.

Comments/Notes continued
Some union leaders suggested the governor’s defined contribution proposal piggybacks on President Bush’s plan to privatize Social Security. “This is the California version of Social Security privatization,” Carroll Wills, spokesman for California Professional Firefighters.
Others suggest a backlash toward CalPERS for its activist corporate governance positions.
… opponents of a shift to public defined contribution plans worry that participants are not prepared to manage their own retirement assets.  “You’re putting so much risk of the stock market onto each individual person, they become in danger of losing retirement protections,” Art Pulaski, executive secretary, California Labor Federation, AFL-CIO.
“It’s a hard thing to make the public understand about our pension systems, and why we need them,” Fred Nesbitt, executive director of NCPERS.
"There's an old saying, so goes California, so goes the rest of the nation.  That's exactly what they're worried about.  You talk about pensions.  What do you think, it's just about California?  No.  If California's pension system goes, now it will go like an avalanche.” Orange County Register, January 25, 2005

Myths: Exploding Pension Costs, Extravagent Benefits
During the 1970s and 80s, employer contribution rates exceeded current rates.
The state and public agencies enjoyed dramatically reduced contributions during the market boom.
Had agencies banked contribution savings, the situation today would be quite different.
Average pension is only $1,669/month.

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Experience in Other States
Florida: DC alternative established in 2002. State contributes 9% of salary. 5% of existing employees transferred; 19% of new employees. Mgmt cost for DC plan: 1.7%.
Michigan: Since March 1997, new employees have DC (only) plan. 40% of assets are in plan’s default money market fund.
Nebraska: After 20 years of DC plan, state converted back to DB. DC returns were 6-7%; DB plan returned 11%.

The Social Security “Crisis”
“The net PV of the shortfall in revenues over the next 75 years is $3.7 trillion [assuming a very cautious 1.6% growth rate of U.S. economy], only about 1/3rd of the NPV of the Bush tax cuts of 2001 and 2003.” Laura D’Andrea Tyson, Dean, London Business School, Business Week, 1/17/05.
“It really is that stark: Any [stock market] growth projection that would permit the stock returns the privatizers need to make their schemes work would put Social Security solidly in the black.” Paul Krugman, NY Times, 2/2/05.

Cost of “Saving” Social Security
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What Can We Do To Protect The Promise of Retirement Security?
CFA is part of the Pension Protection Coalition.
CFA is working with SEIU on the Secure Retirement Campaign.
As individuals, we must persuade the voters that it is not in the state’s interest to eliminate the DB pension for public employees.
Diehr will be visiting most CSU campuses to explain the threats of budget changes and legislation.

Be Informed.  Get Involved.
Resources & Contacts:
George Diehr:
AFL-CIO Center for Working Capital: