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Out of Control Policy Blog Archives: 9.1.13–9.7.13

Study: Public Pensions Nationwide Underfunded By $4.1 Trillion

State Budget Solutions (SBS) has released a comprehensive review of state-level public employee pension plans in all 50 states and their funding levels.  Based on annual financial reports and actuarial valuations, the SBS examined “over 250 state-level defined benefit pension plans” with a combined $2.6 trillion in assets and evaluated their funding level based on a “fair-market valuation.” SBS determined that state-level public pension plans have a $4.1 trillion unfunded liability, nearly four times as large as the $1 trillion that pension systems officially report.

The SBS study is the latest report demonstrating how large the problem of underfunded public employee pension systems is and how flawed government accounting measures have understated the scope of the problem.

A defined benefit pension plan is a retirement plan based typically on a set formula, generally multiplying credited years of service by final average salary by a retirement factor (1-3%, generally) to yield the pension that a retired public employee will receive for life. Defined benefit pension plans are heavily dependant on employer and employee contributions, as well as careful investments, to sustain them long-term.

Most public pension systems assume a long-term investment return of around 8%. Based on such assumptions, state (and municipal) governments set contribution rates for government employers and employees. Higher investment return assumptions allow government agencies and employees to contribute less than may be necessary to fund pension systems. These rates also allow governments to assume a higher level of funding and a lower level of liabilities, thereby keeping contribution rates lower than may be necessary.

Based on the government-set investment assumptions, all state pension systems combined are 73% funded. In dollar amounts, state pension systems currently have $2.6 trillion in assets with obligations of $3.55 trillion. In other words, state pension systems are making $1 trillion more in promises than they can actually pay for.

As troubling as this shortfall is, the unfunded liability grows even further when alternative investment return assumptions are used.

While state pension systems generally assume around an 8% return on investments over 30-years, the SBS study assumes a drastically lower investment return of 3.225%, the 15-year Treasure bond yield as of August 21, 2013. Under this assumption, state-level public pension funding drops from 73% to 39%, meaning that the pension systems only have 39 cents for every dollar that they are promising in pension benefits.  With $2.6 trillion in assets up against $6.7 trillion in liabilities, the per capita unfunded liability works out to $13,145.

According to SBS, the most poorly funded systems are:

  • Illinois (24%). Assets of $91 billion, liabilities of $378.5 billion.
  • Connecticut (25%). Assets of $25 billion, liabilities of $102 billion.
  • Kentucky (27%). Assets of $26 billion, liabiities of $97 billion.
  • Kansas (29%).  Assets of $13.3 billion, liabilities of $46 billion.
  • Mississippi (30%). Assets of $20.4 billion, liabilities of $69.2 billion.
  • New Hampshire (30%). Assets of $5.8 billion, liabilities of $19.75 billion.
  • Alaska (30%). Assets of $10.25 billion, liabilities of $34 billion.

The five most well funded states are:

  • Wisconsin (57%). Assets of $79.9 billion, liabilities of $138.7 billion.
  • North Carolina (54%). Assets of $78.4 billion, liabilities of $145.4 billion.
  • South Dakota (52%). Assets of $7.9 billion, liabilities of $15.1 billion.
  • Tennessee (50%). Assets of $36.7 billion, liabilities of $73.3 billion.
  • Washington (49%). Assets of $60.8 billion, liabilities of $124.9 billion.

The SBS study is the most recent study to evaluate alternative investment assumptions and the consequent impact on unfunded liabilities.  While critics may charge that the 3.225% investment assumption is too low, the SBS study is hardly the first to consider the possibility that the 7-8% 30-year investment returns are far too high.

In fact, there is reason to believe that the 7-8% rates are unreasonably high. For one, the Moody’s has recently pushed for something similar to the SBS study, which is using assumptions more in line with long-term bond yields. The Government Accounting Standards Board similarly revised pension accounting standards and for investment assumptions outlined a “blended rate” to reflect “the expected return for the portion of liabilities that are projected to be covered by plan assets and the return on high-grade municipal bonds,” according to a Boston College study based on the revised standards.  Applying the “blended rate” to state pension systems in 2010, the funding rate would have dropped from the then-76% funding level to 57%. Under this system,

Several others have been conducted challenging the prevailing investment assumptions:

  • In 2009, researchers at Boston College reviewed 129 state and local pension systems. Combined, these systems had assets of $2.7 trillion and liabilities of $3.4 trillion. Under a “risk-free” discount rate of 5%, the liabilities for these systems would have grown to  $4.9 trillion, yielding an unfunded liability of $2.2 trillion.
  • In 2011, the Stanford Institute for Economic Policy Research (SIEPR) calculated changes in the unfunded liability for California state pension systems using different discount rates. While using a 7.75% discount rate kept CalPERS  and CalSTRS 73.5% and 75.3% funded, respectively, using a discount rate of 4.5% reduced funding ratios to 45.1% and 47.6%. In dollar amounts, this amounts to a combined unfunded liability of $469 billion compared to $136 billion.
  • In June 2013, Moody’s argued that pension accounting should use investment assumptions closer to bond yields, which, for the purposes of its paper, was between 5-6%.  Using these figures, the 73% funding level for pensions plunge to 48%. In dollar amounts, this represents an unfunded liability of over $2.5 trillion.

What this all translates to, potentially, is a need for higher contributions to the pension system. Pragmatically, this can come in the form of higher contributions by public employees coupled with untold billions of dollars combined in annual increases to current funding. In other words even greater diversion of tax dollars that could be going to services could instead go towards making pensions sustainable.

Naturally, when one steps back and realizes that these programs are not sustainable, and that the amount of money necessary to keep them operating as such far exceeds any benefit pensions bring to society, considering common sense alternatives becomes an obviously viable option. One idea that comes to mind is switching to 401(k)-style retirement plans, something that the private sector largely shifted to decades ago.

The rising costs to taxpayers and the smoke-and-mirrors accounting practices that obscure the realities that pension systems are operating with threaten the long-term stability of government and, by extension, pensions. Taxpayers are being mislead as to the true cost of the tab they’ll be expected to pickup, and public employees are being sold retirement schemes that may not be around for them when it is there time to retire. Or even worse, governments and related pension systems may just go bankrupt and hurt everyone involved.

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CSLB Sting Operations Continue To Defy Common Sense

Since July 30th, the Contractor State License Board (CSLB) has conducted at least four sting operations in Napa, Hanford, and Roseville, California. The CSLB, which refers to itself as “as one of the leading consumer protection agencies in the United States,” conducts sting operations on a weekly basis aimed at unlicensed contractors and licensed contractors who bid on projects they aren’t licensed to work on.

The most recent stings resulted in the arrests of 34 unlicensed contractors, all of whom given notices to appear (NTAs) in court for unlicensed contracting. Most were also charged with “illegal advertising,” and some for requesting an “excessive down payment. Most of the unlicensed contractors were busted for being willing to do landscaping or painting, but unwilling to abide by the onerous and excessive licensing requirements established by the CSLB.

Several licensed contractors were also busted in the sting operations for “using a business name not listed with CSLB, failing to include license numbers in advertisements, and submitting a bid for work outside the job classification.” For example, one licensed electrician was busted because he “submitted a bid for painting.” The licensed contractors caught in the sting face possible administrative citations, which can range from fines to suspended licenses.

The CSLB’s Statewide Investigative Fraud Team (SWIFT) partners with local police departments and district attorney’s to set up To-Catch-A-Predator-style sting operations. Members of SWIFT pose as homeowners seeking various home improvement projects and contact unlicensed contractors through online boards as Craigslist or business cards. Unlicensed contractors who arrive at the home are then arrested and charged with various misdemeanors.

Unlicensed contractors who advertise through the Internet face fines of between $700 and $1000 for the misdemeanor crime of “advertising by unlicensed person.” For bidding on projects above $500 without a license, unlicensed contractors can face up to six months imprisonment and/or a fine of $5000 for a first time offense. Subsequent convictions face steeper punishments, with a third conviction potentially resulting in  “imprisonment in a county jail for not more than one year or less than 90 days.”

In California, aspiring contractors must meet the following requirements:

To apply for a contractor’s license, individuals must have more than $2,500 worth of operating capital (defined as assets minus liabilities), submit an application along with $300, as well as at least four years of experience. To meet this four-year requirement, individuals may take three years of schooling, followed by one year of work experience under the supervision of a CSLB-approved contractor. Once applicants meet this requirement, they must submit fingerprints for a background check. Applicants must disclose any criminal history, even if the record was sealed, expunged or reduced; failure to do this is grounds for being rejected at this stage. Applicants then must take two exams: a Law and Business examination, and an exam covering the specific classification being applied for...This is just the licensing part, and speaks to no other regulations, insurances, permits and certifications they may need.

Not surprisingly, many Californians simply refuse to abide by licensing requirements that the state sets. As an indication of this, there have been over 300 arrests of unlicensed contractors in California so far this year.

These licensing requirements are justified by the government on the basis that government licensing of (presently 300,000) contractors is necessary to protect the health and safety of consumers. Considering that issues such as fraud or harm caused by negligence are already crimes, the regulatory scheme of occupational licensing is a preemptive one. However, considering that the targets of these sting operations are generally people willing to work on fairly low risk home improvement projects, such as house painting or landscaping, the necessity of government regulation is difficult to discern.

Cases of actual harm, such as fraud and negligent work, are distinct from being willing and able to work on a project without government permission. Blanket criminalization of economic activity wrongly punishes individuals who may be just as competent and professional as those who had the resources to navigate and fulfill regulatory obligations. Consequently, it limits competition and therefore the freedom of choice of consumers.

Even more ridiculous is the idea that homeowners aren't capable of assessing the quality and competence of someone they're willing to pay thousands of dollars to work on their home. If an individual is willing to hire someone to work on a project who doesn't have a license or certification, but offers a lower price than those that do, they should be allowed to make that choice.  There isn't any need for government to step in and criminalize any component of that decision making process.

For more on Reason's work on occupational licensing, click here.

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Ventura County Makes Small Step Towards Pension Reform

The State Employees International Union (SEIU) 721 and the County of Ventura have agreed to a three-year contract that includes reform to public employee pensions. The SEIU 721 represents over half of all public employees in Ventura County, approximately 4,600 of 8,100 public employees. Agreed upon reforms include a phasing out of pension pick-ups and thus having public employees represented by the SEIU pay more into their pensions.

Ventura County is one of 20 counties in California that operates its own retirement system through the Ventura County Employees’ Retirement Association (VCERA). Under an assumed 30-year investment return of 7.75%, the VCERA currently faces a $1 billion unfunded liability and as of June 2012 the pension system was 73-77% funded.

The County has experienced rising pension costs, taking up increasing portions of the county budget. According to the Stanford Institute for Economic Policy Research (SIEPR), Ventura County spending on pensions has sharply increased in the last decade. Through 2004, Ventura County devoted less than 1% of its annual budgets towards pension contributions. By 2011, Ventura County contributions to the pension system took up 16.9 percent of the budget. The latest figures from June 2012 indicate that Ventura County spent $140 million on “employer contributions.” Money that could have gone towards services or, better yet, saved, increasingly goes towards funding public pensions.

One significant change in the SEIU agreement is the phasing out of pension pickups in July 2014. Like other pension systems, the VCERA is funded through employer and employee contributions. An actuary sets the contribution rates as a percentage of an employees’ income. On average, Ventura County employees are supposed to contribute 8.53% of their salaries towards their pensions.

Among SEIU-represented employees, those hired before June 27, 2010 have had 1% of their required 8.41% of salary pension contribution "picked up" by the County. In other words, taxpayers made the payments on their behalf. Most public employees in Ventura County have received pension pickups, with safety employees historically receiving the most generous pickups through labor negotiations.  

Between 2011 and 2012, for all public employees in Ventura County, taxpayers spent $11.3 million making pension contributions on behalf of public employees. The SEIU agreement is likely to save taxpayers at least a portion of that when the pickups for the 4,600 represented employees are terminated in 2014.

While the agreement to have the pension pickup eliminated is a significant step, the SEIU contract has a number of not-so-good concessions. All public employees represented by the SEIU, for example, will receive a $750 one-time payment later this month. In addition, over the next two years, public employees will receive a 3% across the board pay increase in addition to a 1% pay increase to “offset” the eliminated 1% pension pickup.

Simple changes such as eliminating pension pickups aside, several costly issues remain to be addressed by Ventura County.

Firstly, the rising unfunded liability needs to be directly addressed. Until last year, the VCERA assumed an 8% investment return over 30-years, an expectation that exceeded private sector assumptions and the VCERAs own investment experience. According to SIEPR, using a "risk-free" discount rate of 5% instead of 8%, VCERA’s unfunded liability grows to nearly $3 billion, and the funded ratio drops to 50%. VCERA’s actual investment returns, between 2003 and 2012, averaged less than 6%. In light of these realities, the Board of Supervisors reduced the 30-year investment return assumptions to 7.75% just last year, a step that has subsequently led to higher County contributions to the pension system and an increase in the unfunded liability.

There has also been a problem with employees approaching retirement engaging in "pension spiking" in order to boost their final salary in order to receive a bigger pension. Cashing in unused vacation and sick pay, for example, artificially boosts the “final average salary” used to calculate the pensions public employees will receive for life.

Of the 148 public employees who retired between December 31, 2005 and June 20, 2011 with the largest pensions, 124 retirees played the system to receive pensions larger than their final year base pay. The highest earning pensioner, a former fire department employee, earned $86,711 in their final year working before retirement. Absurdly, that employee now draws an annual pension of $159,598. Nearly all of the 148 highest paid pensioners were "safety employees," working either in law enforcement or in the fire department. Ventura County still allows for pay in addition to the base pay of an employee to be used in pension calculations.

Contract negotiations between Ventura County and other unions are ongoing. Tackling the unfunded liability is a necessity, both for taxpayers who are paying the bills and public employees who are basing their life plans on the assumption that the promises made to them will be fulfilled. At some point, Ventura County will need to do more than short-term measures that fail to address the long-term sustainability of the pension program.

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California’s AB 917 Puts Charter Schools in Jeopardy

A bill requiring charter school supporters to seek consent from both unionized school employees and teachers before establishing charter schools recently passed the California state Assembly, creating a potential roadblock to future charter school expansion.

Currently, to create a new charter school at least 50 percent of parents expecting to enroll their children in the school or 50 percent of teachers expecting to work at the school must approve the charter petition. To convert an existing public school to a charter school, at least half the teachers working at the school must sign the petition.

Under the new bill, at least 50 percent of teachers and school staff, including custodians and cafeteria workers, will need to support both the conversion of public to charter schools and the establishment of new charter schools in order for either process to occur.

Proponents of the bill claim that it is important for every individual involved in school operation to have a say in crucial decisions. The bill's author, Assemblyman Steven Bradford, D-Gardena, said it would allow "employees who play a vital role in the education of our kids, whether they're in the classroom or not, to have a voice in whether we convert or create a new charter school."  

Republicans and democrats alike, however, believe the bill will stymie the creation of charter schools by creating potential gridlock among school employees. Teachers often lead efforts to convert schools to charters in order to bypass red tape that prevents them from optimally educating their students. Lower-level employees such as custodians and bus drivers will be unmotivated by such concerns, making them less likely to approve drastic and potentially inconvenient changes to their workplace structure.

Even Governor Brown is unlikely to support the bill. He vetoed a nearly indistinguishable bill in 2011, writing in his veto message that "this bill would unnecessarily complicate an already difficult charter school petition process."

Unsurprisingly, the Service Employees International Union, the California Federation of Teachers, and the California School Employees Association all support the bill. Teachers unions have generally failed to organize non-union charter school employees, so the next step is to limit charter school expansion altogether. Thus, the bill is simply a way for teachers unions to advance their agenda, under the guise of benevolence and inclusion. 


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Bullying: A Flawed Solution to a Misunderstood Problem

In 2010, Rutgers University Student Tyler Clementi committed suicide after his roommate filmed him kissing another man. The same year, 15-year-old Phoebe Prince killed herself after being bullied by a group of high school classmates. These highly publicized tragedies are part of a nationwide panic surrounding the supposed "bullying epidemic," and the resultant crusade to legislate it out of existence.

Both state and local governments have implemented measures that attempt to combat bullying. After Tyler Clementi's death, the New Jersey State legislature passed the "Anti-Bullying Bill of Rights," considered the toughest anti-bullying legislation in the nation, requiring schools to implement comprehensive anti-bullying programs, increase staff training, and comply with strict deadlines for reporting bullying.

California state law also includes a number of recently passed anti-bullying, harassment, and discrimination measures. The School Safety Violence Prevention Strategy Program awards grants to local educational agencies serving any combination of students from kindergarten to seventh grade that best meet school safety criteria, including discrimination, harassment, and school-related crime-assessment policies. The California Safe Place to Learn Act, enacted in 2007, outlines the State's responsibilities to keep schools safe and combat bias and harassment in schools by requiring that the California Department of Education annually assess whether LEAs have complied with existing anti-discrimination and harassment laws. Compliance entails both a policy that prohibits discrimination based on a student's actual or perceived characteristics (or discrimination based on association with a person or persons who posses any of these actual or perceived characteristics) and a method of receiving and responding to complaints of this type of discrimination.

Assembly Bill 9, passed in 2011, expands the reach of the Safe Place to Learn Act to apply to intimidation and bullying in addition to discrimination. The Bill includes an enumeration of the minimum standards of the complaint-response process, which is as follows: (1) immediate intervention if school personnel witness acts of discrimination, intimidation, bullying, or harassment, when safe to do so; (2) a timeline to investigate and resolve complaints; (3) an appeal process for the complainant; and (4) complaint forms that are translated, as appropriate.

President Obama endorses the anti-bullying efforts and considers bullying a significant problem in the United States, stating in a recorded message that "for a long time bullying was treated as an unavoidable part of growing up, but more and more we are seeing how harmful it can be for our kids...Putting a stop to bullying is a responsibility we all share."

But is bullying truly ravaging America's schools to an extent that necessitates such widespread government intervention? While it is a reprehensible practice that deserves the attention of a nation, the numbers suggest that bullying as a whole is actually declining in the U.S. The National Center for Education Statistics reports that between 1995 and 2009, the percentage of students who were "afraid of attack or harm at school" declined from 12 to 4 percent, while the victimization rate decreased fivefold. NCES also reported that the number of students being bullied has remained fairly constant over the years: 28 percent of students ages 12-18 reported being bullied in 2005; the percentage rose to 32 percent in 2007, but dropped back down to 28 by 2009 and remained constant through 2011 (the most recent year for which data is available). This data is hardly suggestive of an epidemic.

Even if bullying were running rampant, legislation remains a problematic solution to the problem. To start, much of the anti-bullying legislation-though well intentioned-contains broad definitions of bullying that result in curtailed First Amendment rights and undeservedly draconian punishments. For example, a Maryland elementary school student was suspended for nibbling a pop-tart into the shape of a pistol and waving it around, while two Florida middle-schoolers received day-long suspensions for daring to publicly hug on school grounds. Free speech has come under siege as well. In a Wisconsin High School, for example, the school paper published side by side student opinion articles, one advocating for adoption by same-sex couples and one opposing same-sex parenting on religious grounds. While the opposing view is widely considered an offensive and bigoted position, the article was a legitimate expression of the author's right to free speech. The school labeled the article as "bullying", however, issuing a public apology and assuring that they would take measures to prevent future potentially offensive opinions from being proliferated in their school paper. It seems, then, that claims of bullying have become vehicles for censorship and the limitation of rights.

In addition, anti-bullying legislation is poorly enforced and ineffective. In California, a recently released report by the state auditor revealed that state and local educational agencies throughout the state blatantly neglect to enforce and evaluate anti-bullying and other protective programs. After investigating the LEAs compliance with anti-bullying and harassment legislation, the auditors found that while most local educational agencies have implemented policies that comply with state law, they do little to evaluate the effectiveness of these programs. In fact, 55 percent of schools reported that they do not formally evaluate the effectiveness of their anti-bullying programs.

This type of neglect prevails on the state level as well. The California Department of Education did not collect data from 2008-09 to 2010-11 through its federal monitoring program to confirm that school districts had set up procedures to both prevent and report bullying. The department's data collection system was not updated to collect bullying information until 2012, a full four years after the Safe Place to Learn Act required department oversight of district anti-bullying programs. Additionally, the auditors found that the department failed to meet the 60-day legal requirement to resolve appeals in 11 out of the 18 appeals they reviewed.

The auditors also found that most of the complaint-resolution processes --the proactive arms of anti-bullying policies- are riddled with weaknesses that render them effectively impotent. Each LEA encourages that complainants address their grievances in an early and informal manner at the school site level or through the use of an alternative complaint process. In this way most complaints bypass the existing formal complaint resolution processes and instead fall under the jurisdiction of potentially biased school staff. In fact, the auditors found that one local educational agency in particular failed to ensure the complainant's right to an unbiased decision by regularly allowing site administrators named as parties to the complaint to conduct the investigations of the very same complaints.

Bullying does exist in schools in the United States, and administrators, teachers, parents, students, and private organizations should actively pursue its elimination. However, the nation needs to stop devoting its money, time, and personnel to programs and legislation that combat an imagined epidemic, especially when these measures are ineffective and lead to violations of rights. 


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