February 2, 2016

A Review of the CalSTRS Funding Plan


This post is the eighth in a series looking at the implementation of the CalSTRS funding plan. Below, we offer some concluding thoughts.

Summary of Findings. We acknowledge that there may be other views concerning the Legislature's intent about details of the CalSTRS funding plan. That being said, the funding plan has been implemented differently than we understood it when the Legislature passed the law. As implemented, the abstract calculation central to the funding plan has decreased the state’s share of CalSTRS’ unfunded liabilities from $20 billion to $15 billion. Meanwhile, that calculation, coupled with CalSTRS’ treatment of the higher teacher contributions required by the funding law, have increased the school and community college district share from $47 billion to $58 billion. These changes have occurred only one year into the 30-plus year funding plan and without any significant change in CalSTRS’ overall funding situation. Moreover, the plan may fall short of the Legislature’s and the administration’s key goal of “shared responsibility” because there is a good chance that the state will not pay more under the funding plan than it would have anyway under prior law.

On the other hand, the plan also potentially exposes the state to larger unfunded liabilities than we thought possible when the Legislature passed the law. Over the long term, if investments consistently underperform assumptions—or if CalSTRS reduces its investment return assumption—the state’s share of the unfunded liability could increase substantially and state contributions could be several billion dollars higher by the 2040s. As implemented, districts would be largely insulated from large unfunded liabilities under these bad investment scenarios. While there are pros and cons to the implementation—both from the perspective of the state and districts—we are unsure that these are the outcomes the Legislature intended when it passed the CalSTRS funding plan into law.

Complexity a Big Problem. Perhaps more important than the issues raised above is the staggering complexity of CalSTRS’ policy that implements the funding law. The policy employs an abstract calculation that estimates what CalSTRS’ unfunded liabilities would be today had the state’s elected leaders made different decisions about teacher pensions in the past. Requiring estimates of multiple theoretical investment portfolios, CalSTRS’ consulting actuary has described the policy as probably the most difficult thing he has ever had to explain to a pension board. In our view, CalSTRS now has become one of the most complex programs in state government. Such complexity dramatically limits the ability of everyone to effectively oversee such a public program.

Tweaks to Funding Law May Be Necessary to Realize Legislative Intent.  We think some simple tweaks to the funding law could bring the plan back in line with the Legislature’s intent. The Legislature has many options for how it can change the law. For example, abandoning the plan’s abstract calculation and instead adopting a proportional sharing approach would eliminate the plan’s current feature that has shifted part of the state’s share of the unfunded liability to districts. If the Legislature chooses to keep the calculation, limiting the amount by which state rates can decrease in a single year—that is, eliminating the “express elevator” feature—would increase the chances that the state shares in the responsibility of addressing this very difficult problem. Similarly, allowing state rates to increase by more than the current 0.5 percentage point maximum could keep districts from having to pay for part of the state’s share following bad investment years.

Suggest Legislature Prioritize Simplicity. If the Legislature chooses to make changes to the funding law, we urge it to prioritize simplicity by abandoning the abstract calculation central to the funding plan. Simplicity will help lawmakers and the public understand what exactly is happening at CalSTRS. We advise the Legislature that if it allows the abstract calculation to remain in place, the funding plan may become less and less comprehensible with each passing year.

Addressing CalSTRS’ Unfunded Liabilities Will Continue to Be Challenging. No matter what the Legislature decides, tackling this very difficult issue will continue to require billions of dollars in contribution rates above what the state, districts, and teachers will make to CalSTRS this year. The basic structure of the plan—full funding in 30 years—is still the right approach. However, we think tweaks to the funding law could help ensure the plan’s long-term viability.