Opinion By Jon Coupal – August 9, 2023

Last week, this column addressed the dilemma facing the California Public Employees’ Retirement System (CalPERS) and the California California State Teachers Retirement System (CalSTRS), California’s biggest public pension retirement funds, involving “Environmental, Social, and Governance” principles.

Depending on how it is interpreted, “ESG investing” can simply mean evaluating investments in a broad manner “to assess potential risks.”

Where ESG principles get problematic is when they are used to push a progressive political agenda at the expense of maximizing returns. This occurs when activists seek prohibitions against investing in fossil fuels, firearms, or in companies located in nations that have met with their disfavor for political or policy reasons, irrespective of the positive performance of the companies.

For current retirees and employees, there is little opportunity to influence the investment decisions of CalPERS and STRS. Some of the board members are elected by participants in the system but most are subject to the political pressures of the day.

What politicians in California and elsewhere ignore is a simple way to avoid the entire ESG quagmire as well as many other problems inherent in California’s “defined benefit” retirement plans. That is to begin shifting to “defined contribution” plans that reduce the risks to the state and taxpayers and which frequently produce better returns for the employees. In defined contribution plans, the employee’s benefit is equal to his or her own contributions, plus those of the employer, plus whatever earnings the investments accrue.

Defined contribution plans come in many flavors, but they have one common element important to taxpayers. That is, the financial obligation of the employer (paid for with taxpayer dollars) is complete at the end of each pay period.

Another big advantage to defined contribution plans is their portability, especially in a changing workforce where employees change jobs frequently.

In a comprehensive policy paper published in 2020 by the Reason Foundation, “Defined Contribution Plans: Best Practices in Design and Utilization,” the authors contend that, “When structured properly, [defined contribution] retirement plans—plans with individually controlled investment accounts with contributions made by both employers and employees—can offer governments an approach to retirement plan design that garners retirement security for employees while actively working. Defined contribution plans accomplish this by modernizing the retirement option set and managing employers’ financial risks that are inherent in traditional pension plans.”

In California, the political power of public-sector labor renders the full adoption of defined contribution plans to replace CalPERS and CalSTERs extremely unlikely. In 2005, progressive outrage at then-Gov. Arnold Schwarzenegger forced him to drop his proposal before it even got started. But now, with economic realities setting in, it might stand a better chance, especially if offered only to new hires or as part of a “hybrid” system of combined defined benefit and defined contribution elements.

Defined contribution plans are becoming increasingly popular in other jurisdictions. Both Michigan and Alaska offer state employees defined contribution plans only.  For the sake of the state’s financial health, and to limit the risks to taxpayers, the shift to a defined contribution plan should be the cornerstone of California’s public employee retirement systems. It’s time to take the off-ramp from defined benefit pension plans.

Jon Coupal is president of the Howard Jarvis Taxpayers Association.