UCRP: Real Questions, False Answers

 Introduction by Michael Meranze

With  the Regents set to take up the UCRP task force report -- and to consider the Senate's Dissenting Statement  as well as a new UCOP Response to the Dissenting Statement --it is more important than ever that the entire university community have the information necessary to debate, and the influence to effect, the future of employee retirement.  To that end, Onuttom Narayan, Professor of Physics at UCSC, has examined the logic and calculations of the different proposed solutions to the UCRP funding problems.  His analysis appears below, and it concludes that neither of the options that the Task Force proposes (what they term A & B) will, in fact, solve the funding problem.  Instead, they will only put off a solution for a decade. By that point, unless UC is able to make dramatically larger contributions from an as yet unknown source, either employee contributions will increase substantially or benefits will be further reduced. What the options will accomplish, however, is to diminish employee retirement in the meantime, and to erode the defined benefit system at the heart of the UC retirement system.  Moreover, they will do so in a way that is inequitable—favoring those at the top end of the pay scale.  Unfortunately, while the Senate representatives' preferred proposal (Option C) will preserve the present system with small changes, it will not solve the larger funding issues either, and will require employee contributions that are unlikely to be acceptable to all employee groups.  Narayan suggests that some immediate changes may help, along with a more searching examination of the way that UCRP is managed, not to mention more equitable solutions to sharing the burdens of change.   Please do read his analysis and as always comments are more than welcome.


COMMENTS ABOUT THE REPORT OF THE POST-EMPLOYMENT BENEFITS TASK FORCE

Onuttom Narayan

Summary: The PEB Task Force recommendations for UCRP rely on implausibly high contributions from the University in about 10 years. Accepting these recommendations will result in a second crisis after the University and its employees have sunk more money into UCRP, which is especially unfair for junior faculty. Despite claims in the Task Force Report, there is no good reason to expect that the return on investments will be 7.5% or to believe that we are doing as well as we should; even small changes in these will have a big impact on UCRP. Because the University's proposed contributions and return on investments are so speculative, it is impossible to be sure that the modest savings achieved by downgrading the UCRP structure are really necessary.

Even if one accepts that the University's proposed contributions to UCRP are neither less nor more than what is possible, the two-tier Integrated Pension Plan proposed by the Task Force is flawed: it is illogical, creates instability, and is biased towards high-wage employees. Uniform employee contributions and maximum age factor, similar to the present UCRP, should continue. A maximum age factor of 2.25% is both adequate and affordable; the 2.5% sought in the Dissenting Opinion is unrealistic. Reversing some other recommended changes (paying for survivor benefits from the first dollar, etc.) and increasing the HAPC window from 3 to 5 years may be appropriate.

I. The restructuring is insufficient and will precipitate a crisis in the future:

The PEB Task Force assumes that employer contributions towards UCRP will reach more than 20% of payroll in 2018-19. This is utterly unrealistic. The Task Force Report practically acknowledges as much (page 82):
“The Task Force Finance recommendations reduce the University contribution to a maximum of 23% over time. While that number poses a frightening challenge to the University operating budget, it represents the collective best efforts of the Task Force...”
Past promises of imminent large salary increases show that the University's hopes of better financial times to come are generally overoptimistic, and even if State funding does increase, there are other claims (e.g. salaries) on the money. Adopting the PEB Task Force's plan will reveal another crisis in 5-7 years time, after more employee (and employer) money has been sunk into the pension plan. This is particularly unfair to younger employees; in a Defined Benefit Plan, benefits accrue disproportionately towards the end of one's career, and therefore there is an implicit assumption that the plan is stable. Since the Task Force Report does not guarantee that employees will only pay their share of the normal cost of their pension plan with the University shouldering the burden of the deficit, and the University certainly does not guarantee this, if the dreams of 20% employer contributions fail, there is nothing to prevent the University from raising employee contributions far beyond this share.

Moreover, there are no grounds to assume that the 7.5% assumed rate of return on UCRP investments is realistic. Every per-cent shortfall in this target increases the plan normal cost by approximately five per cent. Although the Task Force Report states (page 23) that the fund has returned 8.97% on average over the last 20 years, this ignores the major restructuring of the Treasurer's office around 1999; a ten year window would reveal a much worse performance. Moreover, as the UCFW report of March 2009 correctly points out, average returns over 10 years reveal almost nothing about what should be expected. There is no persuasive evidence that a 7.5% rate of return is a reasonable expectation.

Therefore
• the University, in consultation with the committees of the Senate, must identify big cost cuts right now, including “the sale of University property and the privatization/monetization of housing and parking structures and possible workforce reductions” (page 80).
• capital projects and new schools should be frozen to the extent they do not improve the University's financial position; just being part of the University's “strategic plan” is too vague to justify a $8 billion 5-year capital plan (page 71).
• Pension Obligation Bonds for the state share of employer contributions should be considered more seriously.
• the possibility that the UCRP fund could achieve returns that are better than planned through a combination of a different distribution of the investment portfolio and different management at the Treasurer's office should be looked into. The March 2009 UCFW Report uses wrong statistical arguments to claim that comparisons between funds are meaningless and evidence that UCRP has been underperforming other funds during the last decade should be ignored.
• a guarantee should be obtained from the University that employees will only have to pay for their share of the normal cost of their pension plan, and that the University will deal with the deficit and its consequences (including the loss of 7.5% returns on the deficit).
• Only after all this will one know whether the pension plan restructuring recommended by the Task Force is necessary; the restructuring covers only 10% of the gap over the next 10 years (page 82), and with such speculative projections for contributions and return on investments, it is impossible to say if this 10% is unavoidable.

Despite these criticisms, Section II will assume that reducing the employer's normal cost of UCRP to 8-9% is essential, and ask whether it is accomplished optimally by the Task Force.


II. The Integrated Pension Plan is fundamentally flawed:

It is illogical. The main selling point for the integrated plan seems to be that, when combined with Social Security, post-retirement income is an almost constant percentage of HAPC. But this uniform output is achieved with a grossly non-uniform input: 9.7 % of income below $60K, 15.7% between $60K and $105K (where many faculty are) and 9.5% above $105K. Why is this equitable?

It is unstable. Social Security Covered Compensation (SSCC) is approximately $60K in 2010, but it is adjusted upward each year. If someone's salary does not keep up near the end of their career, they could pay in to UCRP at a high percentage and get out the low-tier pension. (Social Security is not based on HAPC, so it would not jump to compensate for the drop in pension.) For the first time in our history,we would have a pension where one would not be able to plan ahead for an assured age factor. Assured benefits are the raison d'etre of a defined benefit plan.

It is inflexible. The plan assumes that everyone with income above the SSCC will want to contribute more in exchange for a higher post-retirement income. But some people may need money now, when their salaries are low and obligations are many. Why not leave it to individual employees to decide?

It is unfair The Integrated Pension Plan Option B calls for contributions from employees and the University adding up to 13% for low wage employees, in return for a 2% maximum age factor. But as discussed in Section IV, a uniform maximum age factor of 2% would have a normal cost of only 12.1%. Effectively, the employer contribution of 9% is disproportionately allocated to high wage employees, resulting in an employee normal contribution of 4% instead of 3.1%. The same is true for Option A. More subtly, employees whose salary jumps near the end of their careers (e.g. by taking up administrative appointments) would, in addition to a higher HAPC, now obtain a better age factor for which they will have contributed very little.

Therefore
• A uniform maximum age factor of 2.25%, which can be achieved with employee and employer contributions of 4.8% and 9% (the same total normal cost as Option B) is much more preferable. Post-retirement replacement income including Social Security would be 80% even for high wage employees, which the Task Force Report states is adequate; anyone who wants more can save in their 403(b) and 457 plans.
• Option C, advocated in the Dissenting Opinion, would result in an employee contribution of at least 6.1% (more if the University contribution is not 9%) which is likely to be unaffordable for low-wage workers. Pushing for this to be analyzed will force us to fall back on Option A or B at the last moment, just before the Regents' decision.
• Other changes recommended by the Task Force (retirees paying for survivor benefits from the first dollar, no inactive COLAs etc.) collectively reduce the normal cost by little, and there are good arguments against each of them. These should be considered individually and not be implemented unless the resultant cost savings are significant.
• Changing the 3 year HAPC window to five years should be considered; a brief window of prosperity should not create an expectation of a permanent increase in living standards.
• The recommendation on page 44 to establish a work-around for the Internal Revenue Code §401.a.17 limit of $245K (and to continue the work-around for IRC §415.m) is inappropriate.
• The recommendation to explore a partly employer-funded DC option on top of UCRP for clinical enterprises should not be pursued unless it is verified that such a DC option could not end up unexpectedly creating liability for the University or have an indirect impact on UCRP.