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New CalSTRS Pension Law Will Challenge California Schools.pdf

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					AUGUST 12, 2014                                                                                                                                        U.S. PUBLIC FINANCE




SECTOR COMMENT                                    California Schools Face Challenge from New
                                                  CalSTRS Pension Law
Table of Contents:
                                                          On July 1, California Assembly Bill 1469 became effective, which increases the amount
                                                          that the state, school districts and employees must contribute to the severely
THE CALSTRS FUNDING MANDATE IS
AFFORDABLE IN THE NEAR-TERM                  2            underfunded California State Teachers Retirement System’s (CalSTRS, Aa2 stable)
PENSION CONTRIBUTIONS WILL BE                             pension fund. While the state will not provide new revenue sources to fund this
INCREASINGLY BURDENSOME FOR
SCHOOL DISTRICTS AFTER 2017                  2
                                                          mandate, school districts will receive increased funding under the Local Control
CALIFORNIA SCHOOLS FACE                                   Funding Formula (LCFF)1, alleviating potential budgetary pressure over the next three
CHALLENGE FROM NEW CALSTRS                                years. Thereafter, accommodating this mandate will weigh on school district operations,
PENSION LAW                                  3
                                                          highlighting the consequences of years of inadequate contributions to CalSTRS from
SOURCES:                                     4
                                                          districts, employees and the state.

Analyst Contacts:                                 »       Pension contribution increase will be manageable for school districts over the next
                                                          three years. Under the new law, school districts will make pension contributions equal
SAN FRANCISCO                +1.415.274.1708              to 12.58% of payroll in fiscal 2017, up from 8.88% of payroll in fiscal 2015. However,
Eric Hoffmann            +1.415.274.1702
                                                          the state of California will increase funding to school districts under LCFF, alleviating
Senior Vice President                                     the near term financial impact on school districts. The state expects to increase LCFF
eric.hoffmann@moodys.com                                  funding by $5.26 billion from fiscal 2015 to fiscal 2017.
Alexandra Cimmiyotti           +1.415.274.1754
Vice President – Senior Analyst
                                                  »       Pension contribution hikes will grow materially beyond 2017, adding strain on school
alexandra.cimmiyotti@moodys.com                           district budgets. By fiscal 2021, school districts’ pension contributions will be 19.1% of
                                                          their payroll, which is significantly higher than the 8.25% rate they paid in fiscal 2014.
NEW YORK                      +1.212.553.1653
                                                          The additional fixed cost further restricts their already limited financial flexibility.
Naomi Richman                 +1.212.553.0014
Managing Director - Public Finance                »       Despite the rise in contributions, they will still fall short of actuarial requirements, and
naomi.richman@moodys.com                                  the pension plan’s unfunded liability will continue to increase over the next decade.
CHICAGO                       +1.212.553.1653             Only in the final year of the current plan, fiscal 2021, is the projected contribution sized
                                                          to meet the full actuarially required amount. The size of the unfunded liability, and the
Thomas Aaron                   +1.312.706.9967
Assistant Vice President - Analyst
                                                          projected contributions needed to pay it down are also susceptible to weaker-than-
thomas.aaron@moodys.com                                   assumed investment returns on pensions assets.




1
    The LCFF is the funding mechanism for California school districts that is designed to allocate a base grant amount based on average daily attendance while providing
    supplemental and concentration grants to districts with a high percentage of targeted high need students. LCFF includes new funding target levels for education which
    are expected to be reached by fiscal 2021. LCFF is primarily funded from the state general fund and local property taxes.
                                                                                                                                U.S. PUBLIC FINANCE




                                      The CalSTRS funding mandate is affordable in the near-term

                                      The rate increases that CalSTRS is instituting are modest and manageable for school districts over the
                                      next three years. For 2015, school district contributions will increase by only 0.63% of payroll to total
                                      8.88%, which is below the 9.5% that the governor included in the May revised budget. Fiscal 2015
                                      school district budgets would likely have included the higher 9.5%, so the lower adopted rate is budget
                                      positive. Over the next three years, school districts will receive higher LCFF funding from the state
                                      which will more than compensate school districts for their higher pension expenses. School districts’
                                      pension contributions will amount to only 25% of the projected increase in LCFF funding over the
                                      next three years. Employers, consisting mostly of school districts, will contribute $1.29 billion more
                                      toward the CalSTRS pension plan, but LCFF funding will increase by $5.26 billion through fiscal
                                      2017.

                                      School districts will not be able to use all of the added LCFF revenue to fund their general operations,
                                      including pension contributions, because some of these revenues include concentration and
                                      supplemental grants that school districts cannot easily appropriate for general operations. The grants
                                      provide additional funding to support English learners, foster youth development and help students in
                                      poverty. Some school districts could mitigate their added pension burden by strategically allocating
                                      these grant funds where possible. School districts have discretion on how concentration and
                                      supplemental grants are spent, which includes funding salary-related expenses. But the state requires a
                                      link between the use of the grant funds and the increased services to the targeted students.


                                      Pension contributions will be increasingly burdensome for school districts after
                                      2017

                                      Managing rising pension costs will prove challenging over time because CalSTRS rate increases are
                                      back-loaded (see Exhibit 1). School districts face future budgetary stress not only from rising pension
                                      costs but from salary and benefit expenditures and programmatic priorities. Further, school districts
                                      have minimal revenue flexibility. Their funding almost comes entirely from the state under LCFF and
                                      districts are severely limited in their ability to raise additional revenues. Rising pensions costs will
                                      pressure financial operations and may cause a deterioration in credit quality for some school districts.
                                      Moody’s rates a total of 334 school districts with over $48 billion in debt outstanding and a median
                                      rating of Aa3.

                                      EXHIBIT 1
                                      CalSTRS Contribution Rate Increases to Require An Additional 11% of Payroll by 2021
                                                         Annual Cost   Annual % of Payroll
                                                    10                                                                                         12%
                                                    9
                                                                                                                                               10%
                                                    8
                                                    7
                                                                                                                                               8%
                                                    6
                                       $ Billions




                                                    5                                                                                          6%
                                                    4
                                                                                                                                               4%
                                                    3
                                                    2
                                                                                                                                               2%
This publication does not announce                   1
a credit rating action. For any                     0                                                                                          0%
credit ratings referenced in this
publication, please see the ratings
tab on the issuer/entity page on      Source: CalSTRS
www.moodys.com for the most
updated credit rating action
information and rating history.


2      AUGUST 12, 2014                                                   SECTOR COMMENT: CALIFORNIA SCHOOLS FACE CHALLENGE FROM NEW CALSTRS PENSION LAW
                                                                                                                              U.S. PUBLIC FINANCE




                      Over the next three years, the CalSTRS contribution rate will increase by 4.33% of payroll, to 12.58%
                      in total, which most district budgets should be able to absorb. However, contribution rates will
                      increase by another 6.52% of payroll, to almost $6 billion in aggregate, by fiscal 2021. As a result,
                      CalSTRS pension contributions will reach close to 9% of total school district budgets by fiscal 2021,
                      on average. In comparison, CalSTRS pension contributions represented 3.83% of the average district’s
                      fiscal 2014 budget.2

                      In addition to CalSTRS, school districts also participate in the California Public Employees
                      Retirement System (CalPERS, Aa2 stable), which has enacted a series of contribution rate increases for
                      participating employers in recent years as well. The increase in CalPERS contribution requirements are
                      not as material to district budgets as the CalSTRS mandate, but combined pension contribution
                      requirements to CalSTRS and CalPERS are projected to reach 11.66% of school district budgets, on
                      average, by fiscal 2021.3


                      California Schools Face Challenge from New CalSTRS Pension Law

                      School districts will shoulder most of the increase in the CalSTRS pension contributions. In aggregate,
                      annual CalSTRS contribution by school districts will increase to almost $6.0 billion from $2.2 billion
                      over the next seven years under the legislation. The new law aims to fully fund the CalSTRS pension
                      plan by 2046 (see Exhibit 2). The plan’s reported unfunded liability was nearly $74 billion as of June
                      30, 2013, or approximately $185 billion per our adjustments. The funded ratio is weak at 67%. Much
                      of the CalSTRS funding gap is related to reduced contributions and benefit enhancements that were
                      enacted around 2000 when the system was fully funded.

                      EXHIBIT 2
                      New Contributions Won’t Fully Fund CalSTRS Pension Plan Until 2046
                                           Actual            Assembly Bill 1469       No Action         Fully Funded
                         120%

                         100%

                          80%

                          60%

                          40%

                          20%

                            0%




                      Source: California Department of Finance


                      CalSTRS funding challenges are driven by years of contribution shortfalls. Unlike CalPERS, CalSTRS
                      cannot unilaterally increase contribution rates from the state or participating schools. Instead, the state
                      legislature must enact any changes to contributions. Under AB 1469, CalSTRS can increase the
                      employer rate after fiscal 2021 by up to 1% of payroll annually, if necessary, to reach full funding by
                      2046. Contributions to CalSTRS have fallen well below actuarial standards for years, a trend that AB
                      1469 will only gradually address. Should CalSTRS face larger unfunded liabilities in the future than it
                      currently projects, the state would have to act again in order to increase contributions to actuarially
                      sound levels.




3   AUGUST 12, 2014                                                    SECTOR COMMENT: CALIFORNIA SCHOOLS FACE CHALLENGE FROM NEW CALSTRS PENSION LAW
                                                                                                                  U.S. PUBLIC FINANCE




                      Sources:
                      2
                          School Services of California, Inc. CA School Finance and Management Conference 2014-15

                      3
                          School Services of California, Inc. An Overview of the 2014-15 May Revision Workshop




4   AUGUST 12, 2014                                        SECTOR COMMENT: CALIFORNIA SCHOOLS FACE CHALLENGE FROM NEW CALSTRS PENSION LAW
                                                                                                                                                                          U.S. PUBLIC FINANCE




    Report Number: 174261



    Author                                                                                            Production Associate
    Alexandra Cimmiyotti                                                                              Amanda Kissoon




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5        AUGUST 12, 2014                                                                          SECTOR COMMENT: CALIFORNIA SCHOOLS FACE CHALLENGE FROM NEW CALSTRS PENSION LAW

				
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