The Terminator Of Public Pensions?

Schwarzenegger's tough goal: Privatizing part of the state's retirement system

In his 30-year acting career, Arnold Schwarzenegger has battled sorcerers, interplanetary villains, and molten cyborgs. Now California's 57-year-old governor is taking on his toughest opponent yet: the Golden State's 3 million government workers. The state's share of their retirement costs now tops $2 billion a year -- and makes up a healthy chunk of California's $8 billion budget deficit.

To trim that, Schwarzenegger, like George W. Bush, wants to take a page from Corporate America's pension playbook and privatize part of the state's retirement system. Under his plan, state and local government workers hired after June, 2007, would no longer get guaranteed annual pensions when they retire. Instead they would be put in privately managed, 401(k)-like accounts, to which the state would contribute an amount equaling up to 6% of their salaries. The job of managing those funds would fall to the workers, resulting in cost savings and budgeting predictability for the state, says Keith Richman, the Republican assemblyman who sponsored the plan.

BROAD APPEAL

Schwarzenegger's gambit may have an audience outside the Golden State. Already, six states -- Florida, Montana, North Dakota, Ohio, South Carolina, and Washington -- have optional private accounts. And legislation has been introduced in 10 more.

America's public pension systems could use some reform. The 127 largest state and local plans are $200 billion short of the funds they need to pay beneficiaries, according to the National Association of State Retirement Administrators. That has forced some states to cut services or borrow heavily to pay pensioners.

An aging population, mediocre investment returns, and delays by cash-strapped states in making contributions are partly to blame for the shortfalls. But promises of rich benefits to workers by lawmakers and other officials have made the situation worse. In California, recent changes allow state highway patrollers to retire at age 51 with an inflation-indexed pension that could be as much as 90% of their highest annual salary.

Still, the track record of the handful of states that have introduced private plans has been mixed. A study of Nebraska's system -- which has offered private accounts to some workers for decades -- found that employees using the accounts chose cautious investment options and earned just 6% a year on their money, vs. 11% for the state's traditional funds managed by professionals. Nor do private accounts immediately solve the problem of rising costs: Michigan introduced private accounts for new employees in 1997, yet pension costs have yet to fall because the state must still make substantial payments into the old plan.

Critics of privately managed accounts also warn that creating a two-tiered system could hinder recruitment of new workers, who often choose jobs in the public sector for less pay but higher benefits. And public pension funds argue that their large size makes them more cost-effective managers than private firms. The giant California Public Employees' Retirement System says its annual management costs are just 0.18% of assets -- about one-sixth of what a typical mutual fund charges.

Perhaps just as significant, under the governor's plan, CalPERS, a longtime champion of shareholders' rights, would gradually die off along with its existing members. "I'm not against pension reform," says Alberto Torrico, a Democrat and chairman of the California State Assembly's pension committee. "But there are other things we can do to reduce costs, like cracking down on unnecessary disability payments."

The public sector is far behind Corporate America in introducing private accounts largely because of the objections of unions that view them as a reduction in benefits. Their protests killed similar legislation in the California Senate nine years ago. The governor vows to take his proposal directly to the voters in a referendum. After all, a popular uprising put him in office in the first place.

By Christopher Palmeri in Los Angeles and Nanette Byrnes in New York

    Before it's here, it's on the Bloomberg Terminal.
    LEARN MORE