Author: Ed Mendel

Reporter Ed Mendel covered the Capitol in Sacramento for nearly three decades, most recently for the San Diego Union-Tribune. More stories are at Calpensions.com.

One of the two initiatives filed by a pension reform group last week would cap state and local government spending on retirement benefits for most new hires at 11 percent of pay, much like a Utah pension reform five years ago.

A co-author said the cap is “dramatically different” from the other initiative: a simplified version of a requirement that voters approve pensions for new hires, originally filed in June, that was rewritten in an attempt to clearly exempt current workers.

The leaders of the bipartisan coalition, former San Jose Mayor Chuck Reed and former San Diego City Councilman Carl DeMaio, said the original “voter empowerment” initiative was given a biased ballot summary that made voter approval unlikely.

By filing two initiatives, the group hopes to get at least one acceptable ballot summary from Attorney General Kamala Harris, a U.S. Senate candidate said by the reformers to be an ally of public employee unions opposed to their measures.

The reformers need a ballot summary that polls well enough to attract major campaign donors. DeMaio has estimated that $2.5 million to $3.5 million will be needed to gather the voter signatures required (585,407) to place a state constitutional amendment on the November 2016 ballot.

The original initiative requiring voter approval of pensions for new employees, and allowing employers to pay only half of their retirement benefit costs, might for many result in 401(k)-style investment plans, which would not require voter approval.

The new initiative limiting employer retirement payments for new hires to 11 percent of “base compensation” (13 percent for police and firefighters) would allow, for example, bargaining for pensions, 401(k)-style plans, or a combination of the two.

Voter approval would only be needed to lift the employer cap on payments or, as in the original initiative, lift a requirement that government employers pay no more than half the total cost of retirement benefits for new employees.

“It just focuses on the costs in the simplest way possible,” Reed told reporters last week, “because the cost is what is driving our concerns about the future of California and the future of municipal government in California. Services are being cut all over the state as a result of these costs.”

One of the half dozen current and former local government officials who signed the initiative filings, Pacific Grove Mayor Bill Kampe, is familiar with a failed attempt to cap pension payments.

Voters in Pacific Grove approved a 10 percent cap on city pension payments to the California Public Employees Retirement System. A superior court judge ruled that Measure R in 2010 violated the “vested rights” of current workers.

DeMaio told reporters last week the coalition looked at the Utah reform, led by former state Sen. Dan Liljenquist in 2010, that capped government retirement costs for new hires at 10 percent of pay.

New Utah employees choose between a 401(k)-style individual investment plan, now widespread in the private sector, and a “hybrid” that combines individual investments with a smaller pension, similar in concept to the plan for federal workers.

DeMaio said the coalition chose a “different approach” that allows state and government to “develop a variety of pension programs” that do not exceed the cap on employer costs, unless lifted by voters.

“In this case we looked at Bureau of Labor Statistics data on retirement costs for employers in the state of California and county by county,” DeMaio said, “and we believe that the cap that we have established is very reasonable.”

Dan Pellissier, a coalition consultant, said the initiative caps have room for the Brown pension reform requiring new hires to pay half the “normal” cost of their pension, which does not include the “unfunded liability” or debt from previous years.

The Utah reform, unlike the coalition cap, provides Social Security, 6.2 percent of pay each from employers and employees. The Utah contribution to a 401(k)-style plan, 10 percent of pay, is well above the average Utah company contribution, 3 percent of pay.

In California, reforms are limited by the “California rule,” a series of state court decisions widely believed to mean the pension offered on the date of hire becomes a “vested right,” protected by contract law, that can only be cut if offset by a new benefit.

The rule prevents the one thing, allowed in private-sector pensions, that the watchdog Little Hoover Commission and others say could quickly lower costs: cutting the pensions current workers earn in the future, while protecting amounts already earned.

Most California reforms, like Gov. Brown’s in 2012, are limited to new hires. That can take decades to yield significant savings as previously vested workers are slowly replaced, doing little meanwhile to reduce massive pension “unfunded liabilities” or debt.

Only 11 other states have the “California rule.” But reformers seldom push an initiative directly challenging the rule, apparently fearing a lack of support among voters and, even if approved, a costly and uncertain court battle.

A labor polling firm found two years ago that “California voters reject the idea of reducing or eliminating retirement benefits for current public employees,” calling it a “visceral negative response,” the Sacramento Bee reported.

Reed filed a lawsuit to change the Harris summary of his previous pension initiative. But last year a judge found the summary was not “false and misleading,” ruling instead that the initiative was indeed an attempt to overturn the “California rule.”

The opening phrases of the Harris summary of Reed’s initiative last year and the coalition initiative filed last June are identical: “Eliminates constitutional protections for vested pension and retiree healthcare benefits for current public employees . . .”

A statewide poll issued by the Public Policy Institute of California last month found that 72 percent of likely voters say public pension costs are a problem and 70 percent say voters should make decisions about retirement benefits.

As in previous PPIC polls, 70 percent favor giving new government employees a 401(k)-style plan rather than a pension. The change has strong bipartisan support: Republicans 74 percent, independents 69 percent, and Democrats 65 percent.

So, why aren’t the reformers proposing a direct switch to 401(k) plans for new hires?

Reed said not everyone in the broad coalition wants to eliminate public pensions. And like DeMaio, he said the coalition wants to let local governments and voters make the decisions.

“Since most of us are from local government, we don’t like the state telling us what to do,” Reed said.

A coalition of public employee unions, Californians for Retirement Security, issued a statement after the two initiatives were filed last week.

“It’s clear that the proponents of eliminating retirement security for teachers, firefighters, schoool employees and other public servants are more interested in playing politics and rewarding Wall Street than providing the retirement security all Californians deserve,” said Dave Low, the chairman.

“Their new proposals would ultimately do what their previous failed attempts would have done: create billions of dollars in costs for the state’s pension systems, jeopardize the ability to attract and retain teachers, police officers and other public employees and jeopardize a secure retirement for hard-working middle class families.”

Reporter Ed Mendel covered the Capitol in Sacramento for nearly three decades, most recently for the San Diego Union-Tribune. More stories are at Calpensions.com.

A bill sent to California Gov. Jerry Brown this month would exempt new hires from his reform requiring them to pay half the normal cost of their pensions, if they work for any of the 22 cities and one county that have special property taxes to pay pensions.

The pursuit of an unlikely exemption may be an early sign of the resistance facing government employers that try to impose the 50 percent normal cost share on current workers, as allowed by the reform through the bargaining process beginning in 2018.

One of the backers of the bill that would exempt new hires of pension-tax cities, the Peace Officers Research Association of California, mentions the potential change for current workers in a statement supporting SB 292.

“A section in the PEPRA (Public Employees Pension Reform Act) calls for all new employees, and by 2018 most current employees, to contribute 50 percent of their ‘normal cost,’” said the association’s statement.

The normal cost covers the estimate of the pension earned in a year. But it does not cover the debt or “unfunded liability” from previous years such as investment earnings shortfalls, longer life spans, and workforce changes.

So, it’s the government employer and taxpayers, not the employee, who bear nearly all of the pension risk and often most of the pension cost.

A police or firefighter, for example, might be contributing 10 to 12 percent of pay to their pension, roughly half the normal cost, while the employer contributes several times as much, reaching 60 percent of pay or more in some deeply under-funded plans.

The pension reform Brown pushed through the Legislature three years ago (UC and independent big-city pensions are excluded) requires new hires to contribute 50 percent of the normal cost, if they are not under a contract specifying a contribution rate.

To allow time for labor contracts to expire, the reform set a date of 2018 to begin allowing employers, when good faith bargaining fails, to impose a 50 percent normal cost contribution on workers hired before the reform took effect.

The reform (AB 340 in 2012) also put a cap on the contribution that can be imposed: 8 percent of pay for most workers, 12 percent of pay for police and firefighters, and 11 percent of pay for other safety workers.

There is no cap on contributions agreed to through bargaining. The reform said equal cost sharing of the total normal cost “shall be the standard.” But it does not appear to be required for workers hired before the legislation took effect.

For new hires, the reform bans payment of the employee contribution by the employer, known as the “pension pickup” or more formally the “employer paid member contribution.”

The pension pickup, often obtained through bargaining, has been widespread. It counts as pay on which pensions are based, has some tax advantages, and the employer is sometimes reimbursed by employees.

The bill labor groups sent to Brown this month would allow the pension pickup to continue in cities and counties where voters approved a property tax to help pay pension costs, prior to the passage of the landmark Proposition 13 property-tax cut in 1978.

In legislative analyses of the bill, the statements from the co-sponsors, the Peace Officers Research Association of California and the California Professional Firefighters, have two main points.

1) If the pension tax can no longer be used to pay the employer and employee pension contribution, money from the general fund and other sources will have to make the pension payments, straining budgets.

2) Banning the use of the tax to pay employee pension contributions conflicts with the will of the voters, some expressed in long-standing local measures approved in the 1920s.

Last week, the sponsors of the measure could not provide examples of pension property taxes, said to be capped in a range from 0.05 to 0.45 percent, that specifically direct the revenue to employee contributions rather than pension costs in general.

The only specific example of a pension tax in the legislative analyses of the bill is a statement from the city of Oxnard opposing the bill. Its pension tax falls short of covering safety pension costs, requiring “several million dollars” from the general fund.

“Thus, if these new employees are exempted from the 50 percent employee contribution requirement of PEPRA, the costs for the pension contribution no longer required by the employee would place an additional burden upon the city’s general fund,” Oxnard said.

The pension-tax exemption bill, SB 292, made the selective hit list of a Los Angeles Times editorial vigorously titled “Gov. Brown, veto these 5 bills!” and published yesterday (Sept. 27).

“Proponents of the bill, which was sponsored by lobbyists for police and firefighters, argue that cities with this sort of levy should be exempt because their voters wanted to pay for pensions through special taxes,” said the Times.

“But it’s far from clear that these voters, some casting ballots as far back as the 1930s, intended to cover the employees’ share of the cost of future pension plans with different benefits.

“In any case, we believe it would be unfair to the state’s other local agencies to exempt a few cities from this important reform simply because of how they’ve paid for previous pension plans.”

Last year, a bill was introduced, AB 837, that would have exempted seven judges from PEPRA, lowering their pension contribution from the 15 percent of pay for new hires to the 8 percent of pay for judges in office before the reform took effect.

The seven judges thought they had a strong argument for fairness. They were elected in 2012 after holding jobs in the private sector, but did not take office until after the reform took effect on Jan. 1, 2013.

Other judges elected in 2012, who also did not take office until 2013, already were in a public pension system because they had been in government jobs. They paid the same lower contribution as judges in office before the reform took effect.

Three of the seven judges from the private sector appeared before a legislative committee to argue the case for fairness. On their recent salary of $181,292, lowering their pension contribution from 15 to 8 percent of pay would save each judge $12,690 a year.

The judges bill passed the Legislature on a strong bipartisan vote, Senate 31-to-2 and Assembly 69-to-6. The pension-tax bill passed the Democratic-controlled Legislature on a more partisan vote, Senate 27-to12 and Assembly 48-to-25.

“This measure creates an exemption to the California Public Employees’ Pension Reform Act of 2013,” Brown said in his judges bill veto message. “I am unwilling to begin chipping away at these reforms.”

Reporter Ed Mendel covered the Capitol in Sacramento for nearly three decades, most recently for the San Diego Union-Tribune. More stories are at Calpensions.com.

After the CalPERS staff gave the board a correction last week for providing misinformation about private equity fees, the board member who has been grilling staff on the issue walked out of a private staff meeting because he was not allowed to record it.

The nation’s largest public pension system, one of the first to invest in private equity firms and their lucrative leveraged buyouts, expected to be a leader again this year by launching a new fee tracking system after three years of development.

But when a question from board member J.J. Jelincic in April revealed that CalPERS did not know the amount of “carried interest” earned by its private equity firms, there was a small wave of criticism in the national media.

In the traditional “2 and 20” fee structure, the private equity firm gets to keep 20 percent of the profit after earnings reach a basic amount. This performance incentive is called the “carried interest,” a term said to date back to 16th Century sea voyages.

At a board meeting last month, Jelincic questioned staff at length about the 2 percent management fee. At one point the investment committee chairman, Henry Jones, threatened to rule him out of order.

After the meeting, Jelincic wrote a letter to Anne Stausboll, CalPERS chief executive officer, complaining that the private equity staff he questioned, Real Desrochers and Christine Gogan, gave inaccurate, evasive and condescending responses.

“Staff is perpetuating the talking points and mythology of PE fund managers, who are continuously — and largely successfully — trying to convince the limited partners (CalPERS and other institutional investors) that they receive a more favorable deal than they actually do,” Jelincic said.

His letter included an excerpt of his questions to the staff pointing out that a key reply by Desrochers was incorrect. Ted Eliopoulos, CalPERS chief investment officer, read a correction to the board last week.

“We were asked if a management fee is $100 and the fee to the portfolio company is $50 and there is a 100 percent offset to the limited partner, will the general partner (the private equity firm) ultimately collect $100,” said Eliopoulos. “The answer is ‘yes.’ We should have answered ‘yes’ instead of ‘no.’”

The Desrochers error and the Jelincic letter led to another small wave of criticism in the national media, notably in the Financial Times and Fortune magazine. CalPERS responded with a “For the Record” defense of its private equity investments, averaging 12.3 percent returns over the last 20 years.

Jelincic said in his letter to Stausboll that the staff should acknowledge a “breach of decorum” not only for being condescending and wrong, but also for “a general posture of implying that my questions about these topics were irrelevant, ill-informed, or silly.”

In a reply to the letter, Jones, the committee chairman, said he did not agree there had been a “breach of decorum” and would schedule a private meeting of Jelincic and top staff and consultants to get answers to his questions about private equity fees.

Jelincic said he walked out of the meeting last week after being told he could not record it. The former leader of the largest state worker union is a long-time CalPERS investment office employee, sometimes said to be at odds with top staff.

He has been on leave since 2010, when he was elected to the board by CalPERS members. After a sexual harassment reprimand was upheld, his fellow board members voted in 2011 to censure him, adding a six-month suspension of several board duties.

One thing that helped move private equity fees into the spotlight is financial reform legislation, the Dodd-Frank act in 2010, pushed through Congress with support from CalPERS and other public pension funds.

Private equity firms had generally been unregulated. The new law required firms with $150 million or more in assets under management to register as investment advisers, bringing an initial review of 150 firms by the Securities and Exchange Commission.

“In some instances, investors’ pockets are being picked,” Andrew Bowden, an SEC official, told the New York Times in May last year. “These investors may be sophisticated and they may be capable of protecting themselves, but much of what we’re uncovering is undetectable by even the most sophisticated investor.”

A Times report last October found, among other things, that CalPERS and other investors are on the hook for the uninsured part of a $115 million lawsuit settlement by the Carlyle Group for colluding to suppress the share prices of targeted companies.

Another force that has helped make private equity fees an issue is Yves Smith (the pen name of Susan Webber), who launched the “Naked Capitalism” website in 2006. She is mentioned in the national media stories this month and the Times report last October.

Smith published a 10-part series on CalPERS private equity fees, from Aug. 30 to Sept. 16, prompted by video of the board meeting last month when Jelincic questioned the two CalPERS private equity officials.

Her arguments often are supported or accompanied by comments she received from private equity experts, including Leon Shahinian, a former CalPERS private equity officer, and Michael Flaherman, a former CalPERS investment committee chairman.

“Thus the concerns we have raised about CalPERS’ program, that private equity has over the last decade persistently not generated enough in the way of performance to justify the risks, that private equity firms charge indefensibly high fees (and worse, CalPERS and other investors are ignorant of the full amount they are paying), and that SEC officials have determined many private equity general partners are stealing from investors, are all hazards to taxpayers’ health,” Smith said in her Sept. 16 post.

Smith said in a footnote to her Aug. 30 post that, to CalPERS credit, even though she lost a lawsuit to get CalPERS private equity data, CalPERS gave her the data anyway, which took six months of “often heated exchange” with CalPERS lawyers.

“If CalPERS continues to be unwilling to grapple with what the public can now see are both a huge expertise gap in private equity and a propensity to side with private equity general partners over its beneficiaries’ interests, the organization will lose its power in the wider world,” Smith said in the Aug. 30 post.

“Indeed, one can sense that is already starting to occur. Needless to say, we at Naked Capitalism do not want that to happen.”

This fall, CalPERS expects its new Private Equity and Accounting Reporting Solution to issue the first report of carried interest paid to private equity firms. About $30 billion of the $293 billion portfolio is in 700 private equity funds.

“In November, we are planning an educational session for the board on private equity that will be presented by staff and invited industry experts,” Eliopoulos told the CalPERS board last week. “This will be concurrent with our annual review of our private equity program.

“It’s important that we don’t let the recent attention on our presentation eclipse CalPERS long-standing commitment to financial transparency and reporting, and in particular, the significant steps we have taken recently to address what has been a challenge for the entire industry.”

 

Photo by  rocor via Flickr CC License

Reporter Ed Mendel covered the Capitol in Sacramento for nearly three decades, most recently for the San Diego Union-Tribune. More stories are at Calpensions.com.

A Moraga-Orinda fire chief drew national attention six years ago for retiring at age 50 with a pension much larger than his base pay. He went back to work as chief the following Monday, hired as a consultant with full salary.

“People point to me as a poster child for pension spiking, but I did not negotiate these rules,” Peter Nowicki told the Wall Street Journal.

Last week, the Contra Costa County pension board, following a review by its law firm, voted to reduce Nowicki’s initial pension, $240,923, to an amount, $172,818, that is below his final base pay, $193,281 — a cut of $68,105 or 28 percent.

The board also voted to recover a $617,458 pension overpayment to Nowicki during the last six years, including cost-of-living adjustments and interest. An actuarial estimate of the future pension system savings from the pension cut is $1,289,331.

The review found that Nowicki, with two amendments to his contract, inflated or “spiked” the final pay used to calculate his pension, mainly by cashing out unused vacation time with smaller amounts from holiday, terminal and retroactive base pay.

Pay deals were negotiated behind closed doors and benefits were retroactive, the review said, raising questions about legality. But the board acted under a state law authorizing pension cuts when an employee improperly increases final pay.

“It seemed to us that under the circumstances presented to this board that constituted improper behavior,” said Harvey Leiderman, the board’s attorney. “I’m not calling it illegal behavior. But I’m saying it is improper behavior, in our opinion.”

The review was prompted by anti-spiking bills that became part of broad pension reform legislation three years ago. Reports by the Contra Costa Times of Nowicki’s pension and similar pensions in the San Ramon fire district were cited.

Nowicki told the board last week that when he became chief in 2006, he had a “gentlemen’s agreement” with the former fire chief and a board director that he would be “made whole” later, rather than get annual pay raises like his predecessor.

His pension was little more than he would have received by remaining a battalion chief, Nowicki said, and lacking an assistant he was usually unable to take time off. A rare vacation was marred by the need to write a response to a consolidation proposal.

A skeptical pension board mentioned the lack of a written agreement, “self-dealing,” and email that undermined Nowicki’s statement that he had not yet decided to retire when obtaining the second contract amendment enabling a large vacation cash out.

“I think the fact that the employer (Moraga-Orinda fire district) isn’t here today speaks volumes,” said board member Scott Gordon. “I think the fact that Meyers-Nave (Moraga-Orinda legal counsel) isn’t here today speaks volumes.”

An email that Nowicki sent to fire department employees announcing his retirement (three days after approval of the second contract amendment) refers to a pension formula, “3 at 50,” that some say is too costly and may be “unsustainable.”

The formula was negotiated by the Highway Patrol union and placed in CalPERS-sponsored legislation, SB 400 in 1999, that gave state workers a large retroactive pension increase.

Under the Highway Patrol formula, the pension is 3 percent of final pay for each year worked at age 50, a big increase from the previous “2 at 50” formula. The “3 at 50” formula has since been widely adopted by local police and firefighters.

“As you are all aware, the 3 percent at 50 retirement system very much dictates when an employee will discontinue employment,” Nowicki said in an email dated Dec.13, 2008. “The decision is predominantly based upon a fiscal plateau, at which point the employee then loses income by coming to work.

“I’m very fortunate to be a part of such a lucrative system, yet I philosophically find it to be very troubling at the same time. The ability to retire at the age of 50 is certainly a nice option, but I do not believe that workers should be ‘put to pasture’ due simply to a lack of any other viable alternative.

“That concept is akin to the government paying farmers not to grow crops — I never understood that practice either. Nonetheless, I’ve reached that financial plateau and it’s no longer economically feasible to continue in my current capacity.

“For that reason, my retirement will become effective on January 30, 2009. But before everyone starts to help me pack and shows me the on-ramp to the freeway … my retirement will be in ‘status’ only.

“The Board of Directors and myself have been entertaining discussions on my continued service to the District as a contract employee. Should that come to fruition, it would be nothing more than a ‘paper conversion’ and a seamless transition to a new classification.

“So, in essence, this message is most likely much ado about nothing. I’ll keep you informed as this matter evolves.”

Nowicki’s email (review, exhibit 16) did not say that he had taken unusual steps three days earlier to boost his pension well above his base pay. Nor did it mention that he had not worked long enough to maximize his pension under the “3 at 50” formula.

He was credited with 28.3 years of service, giving him 85 percent of final pay. If he had worked less than two more years he would have had 30 years of service, reaching the cap of 90 percent of final pay under the “3 at 50” formula.

At the Contra Costa County Employees Retirement Association board hearing last week, Nowicki said he was told at the pension system’s retirement workshops he could make full use of allowed pension enhancements, including cashing out vacation time.

“My counselor, Marge Rosenberg, sat with me in this building and twice went over the numbers with me and congratulated me on what a well-deserved job, or well-deserved method, of making it through my career and having this final outcome in my retirement,” he said.

Nowicki said it was from Rosenberg that he first learned he could return to his job after retiring and receiving a pension. “Double-dippers” or “retired annuitants” can cut employer costs because they do not earn additional retirement benefits.

“I made my life decisions based on what I was told my retirement was going to be,” Nowicki said. “And again, the Reed document (Reed Smith law firm) condemns me for having used what calculations were put on a piece of paper and given to me.”

Contra Costa is one of 20 county retirement systems operating under a 1937 act. Spiking is a particular issue for them because of a 1997 state Supreme Court ruling in a Ventura case expanding pensionable pay to vacation time and dozens of other items.

In 1993 the giant California Public Employees Retirement System had sponsored anti-spiking legislation for its members, SB 53, that limits the use of supplemental pay and created a screening unit.

But similar legislation in 1994 for the 20 county systems, SB 2003, failed to pass.

A long-sought CalSTRS rate increase, more than doubling the bite from school districts, is the reason given last week for a proposal to increase the lump-sum death benefit, unchanged in the last 13 years.

The CalSTRS board, unlike most California public pensions, lacks the power to raise employer rates, needing legislation instead. But the board is authorized to make annual increases in the lump-sum death benefit to keep pace with inflation.

Because the system is underfunded, the CalSTRS board has made no inflation adjustment in the death benefit since 2002. The board was told that it could have increased the death benefit by about 34.7 percent during the period.

One level of coverage with a payment of $6,163 would have increased to $8,299, the payment for another from $24,652 to $33,196. The long-term CalSTRS actuarial obligation would have increased by $238 million.

Now the big phased-in rate increase enacted last year for school districts, with smaller increases for teachers and the state, allows the California State Teachers Retirement System to project reaching a funding level of 100 percent by 2046.

Last week the staff, responding to an earlier board request, recommended a plan to resume death benefit inflation adjustments, but only in years with better-than-expected investment returns.

The funding level could not drop below the path to full funding scheduled in the rate hike legislation. For example, the schedule expects 64.5 percent funding this year, and the latest funding level as of last year is 68.5 percent.

If the board had approved the plan, the death benefit could have been increased enough to drop the funding level back to 64.5 percent. But action was delayed until next April, mainly due to opposition from Gov. Brown’s appointees on the board.

The issue is not likely to go away. A retired school administrator, Dave Davini, told the board CalSTRS members would like some assurance that the board will continue to try to restore the original purchasing power of the death benefit if funding is available.

“What members are interested in is enhancing that benefit and keeping that benefit as the legislation originally intended,” Davini said.

The lump-sum benefit is regarded as a “vested right” that cannot be cut if increased. Pension boards also have a fiduciary duty under the state constitution (labor-backed Proposition 162 in 1992) to give member benefits priority over taxpayer costs.

Using a temporary funding “surplus” to pay for increased benefits or cuts in employer rates is a long-standing practice in the management of California’s public pension funds.

Twenty county retirement systems operate under a 1937 act that allows “excess” earnings, amounts exceeding 1 percent of total assets, to be diverted for retiree bonuses, retiree health care or lowering employer contributions.

Some city retirement systems allow a “13th check” bonus for retirees, if investment earnings exceed the annual forecast. In San Jose, the bonus check was eliminated by a pension reform approved by voters three years ago.

Two CalPERS funds that used “excess” earnings to maintain pension purchasing power, the Extraordinary Performance Dividend Account and the Investment Dividend Disbursement Account, were replaced by a different program in 1991.

As its funding soared to 138 percent during a boom in the late 1990s, CalPERS cut employer rates to near zero and sponsored a retroactive pension increase, SB 400 in 1999, telling legislators the surplus and “superior” earnings would cover the cost.

Under a lesser-known bill, AB 1509 in 2000, a quarter of the teacher contribution to CalSTRS (2 percent of pay from the total of 8 percent) was diverted for a decade into a new individual investment account with a guaranteed minimum return.

The Legislature was told, in an echo of the CalPERS claim for SB 400, that a decade-long diversion of a quarter of the teacher contribution would have “no effect to the solvency of STRS” and the cost would be absorbed by a funding surplus.

The CalSTRS individual investment account created by the bill, the Defined Benefit Supplement, and a similar account for part-time teachers, the Cash Balance Benefit, can be awarded additional earnings credit if there is “excess” funding.

After an analysis of the impact on long-term funding, the CalSTRS board last April adopted a tighter policy for awarding additional credit to the two individual investment accounts.

Last week, the board decided to get a similar actuarial analysis of the long-term funding impact before considering an increase in the death benefit next April, a move suggested by a Brown representative.

“I recognize the issue you have raised about constituents and the concern that it hasn’t been raised in a long time,” Eraina Ortega of Brown’s finance department said during the board discussion.

“I completely respect and understand that view,” she said. “But it feels to me that our primary concern ought to be the funding status overall before we consider any benefit changes.”

Paul Rosenstiel, a Brown appointee, reminded his colleagues that CalSTRS is considering shifting up to 12 percent of its portfolio, about $20 billion, to investments with less risk of big losses that could lower the funding level.

“Our investment consultants are saying we can move (the funding level) in the wrong direction and not be able to recover,” Rosenstiel said. “That’s what they told us yesterday.”

Controller Betty Yee and Treasurer John Chiang’s representative, Grant Boyken, agreed with the proposal to get an actuarial analysis of death benefit increases under the current policy that uses the consumer price index as a guide.

A CalSTRS staff survey of death benefits provided by 22 retirement systems throughout the nation, including one in Canada, found that CalSTRS is among the more generous.

Most of the retirement systems offer some form of continuing income to the survivors of retirees. Fewer provide income to the survivors of active workers. CalSTRS does both.

“In addition, only slightly more than half of the plans investigated provide a one-time lump-sum death benefit, other than the return of contributions and interest in the member’s account, to survivors of members who die while in active service and less than half provide a similar benefit to members who die after retiring,” said the staff report.

The standard lump-sum death benefit for members of the California Public Employees Retirement System is the return of contributions with interest.

Reporter Ed Mendel covered the Capitol in Sacramento for nearly three decades, most recently for the San Diego Union-Tribune. More stories are at Calpensions.com.

 

Photo by TaxCredits.net

Reporter Ed Mendel covered the Capitol in Sacramento for nearly three decades, most recently for the San Diego Union-Tribune. More stories are at Calpensions.com.

Bankrupt San Bernardino approved a plan last week to disband the city fire department and annex the city to a large county fire district. Part of the expected savings is $2.7 million a year from avoiding future CalPERS rate increases.

City firefighters now in CalPERS would be transferred to the San Benardino County Employees Retirement System. And the county system is said to face lower rate increases, because it has more quickly paid down pension debt.

Getting CalPERS-related savings would be a welcome change for the struggling city.

After an emergency bankruptcy filing in August 2012, San Bernardino skipped its California Public Employees Retirement System payments until the following July, saying it was in danger of not making payroll.

The unprecedented failure to make payments required by law gave CalPERS grounds to terminate its contract with the city. But CalPERS opted for an all-out legal battle occupying much of the first two years of the San Bernardino bankruptcy.

A sketchy city operating plan in 2012 proposed a “fresh start” that would “reamortize CalPERS liability over 30 years,” perhaps in a way that would “realize value of $1.3 million per year starting fiscal year 2014.”

What emerged from mediation in June last year was a San Bernardino agreement to repay the $13.5 million skipped payment with interest and penalties. A $1.5 million payment in May last year is being followed by monthly payments of $602,580 for two years.

The interest in the payment totaling $16 million is based on the CalPERS investment earnings forecast, 7.5 percent. When the city plan to exit bankruptcy is approved or denied, the city will pay a $2 million penalty in five annual installments.

Now a key part of the San Bernardino recovery plan is outsourcing fire services, approved by the city council on a 4-to-3 vote last week. Moving fire services to the county includes a property parcel tax increase of $143 a year.

Opposition came from opponents of the parcel tax and supporters of a fire department established in 1878. Unlike other unions, firefighters did not agree to a 10 percent pay cut and to forego merit raises, instead filing several lawsuits against the city.

Paul Glassman, the city’s bankruptcy attorney, warned the council that rejection of the outsourcing plan could lead to U.S. Bankruptcy Judge Meredith Jury and creditors losing confidence in the will of the city to make difficult decisions needed for recovery.

“This in turn could jeopardize the city’s plan of (debt) adjustment and could lead to dismissal of the bankruptcy case and loss of the protection from creditor lawsuits and seizure of assets,” Glassman said. “This would have a catastrophic effect on the city such that it could not continue as a viable ongoing entity.”

The San Bernardino County Fire Department, with 930 employees and 56 fire stations, serves the unincorporated area and seven cities including Fontana, a San Bernardino neighbor with nearly as much population, 203,000 compared to 213,000.

The county would take over the 10 current San Bernardino fire stations and offer similar jobs to all of the 100 or more city firefighters and possibly most support personnel. Firefighters on duty at all times, 41, would be more than current staffing, 38.

Annual fire service costs would be lower. But more importantly, the $143 parcel tax increase would reduce the allocation of city property tax needed for fire services, yielding $7 million or more of the new city revenue called for in the recovery plan.

“You’re not solvent now,” Andrew Belknap of Managing Partners consultants reminded the council as he presented the plan to outsource fire services. “This would be an $11 million contribution to solvency.”

Few details about how $2.7 million in pension costs would be saved, or how the pension savings fit into the city budget forecasts, were in the agenda packet for the council meeting last week.

“Annexing to County Fire for fire services will save the City an additional estimated $2,700,000 per year in pension costs, based on a recent actuarial analysis provided by a separate consultant to the City,” said a Citygate consultant report.

Mayor Carey Davis, puzzled about the $2.7 million pension savings, asked Stewart Gary of Citygate for an explanation. He later raised the issue with Belknap and later still with Michael Busch of Urban Futures Inc. consultants.

“Maybe I’ll understand it for the third time,” Davis told Busch.

A final explanation of the $2.7 million pension savings was volunteered by Gregory Devereaux, San Bernardino County chief executive officer, who prefaced his remarks with the hope that he would not be adding to the confusion.

“Part of the savings that we are discussing is avoided cost,” he said. “You heard much earlier in the evening that SBCERA absorbed the shortfall for the deficiency much more quickly than PERS.

“What’s going to happen in PERS over the next few years are significant rate increases. So the savings that is being discussed is the difference between if you stay in PERS with city fire, you’re PERS rates are going to go up at a much more rapid rate than the SBCERA rates.”

In the latest reports, the CalPERS San Bernardino safety plan for police and firefighters had 73 percent of the projected assets needed to fund future pension obligations. SBCERA was 80 percent funded.

The report for the CalPERS San Bernardino safety plan, which is for the year ending June 30, 2013, shows the employer rate was 23 percent of pay in 2010, set at 38.8 percent of pay for this fiscal year, and is estimated to increase to 49.3 percent by 2020-21.

If firefighters withdraw from the CalPERS safety plan, Busch said, the city will over time pay off their share of the plan’s “unfunded liability,” about $2.3 million. This “legacy cost” is included in the estimate of $2.7 million in pension savings.

Gov. Brown signed a bill last month, AB 868, that some think enables transfers of employees from CalPERS to county retirement systems. Belknap said the transfer also can be done through existing “reciprocity” agreements.

“These transactions are not that uncommon,” he said. “This happens with some regularity. So we know how to do it.”

The consultants and the city manager, Alan Parker, did not recommend a bid for fire services from a private firm, Centerra, citing uncertainty about mutual aid agreements with neighboring fire departments and lack of experience with large service areas.

The council vote authorized staff to negotiate the terms of annexation with the county and the county fire district as well as an interim contract for county fire services. Both would be brought back to the council for approval.

An annexation agreement will need the approval of the Local Agency Formation Commission. The city hopes to be annexed into the county fire district by next July. Waste management and other city services also would be outsourced under the recovery plan.

 

Photo by  Pete Zarria via Flickr CC License

Reporter Ed Mendel covered the Capitol in Sacramento for nearly three decades, most recently for the San Diego Union-Tribune. More stories are at Calpensions.com.

CalPERS took another step last week toward a gradual long-term rate hike, a move to lower the risk of big investment losses as the maturing pension system enters a new era.

Retirees are beginning to outnumber active workers. Pension payments to retirees are no longer covered by employer-employee contributions and investment income. Now “negative cash flow” forces the sale of some investments to cover annual pension costs.

The new need to routinely sell some investments (see two charts at bottom) is one of the reasons the California Public Employees Retirement System is expected to have even more difficulty recovering from investment losses in the future.

After a loss of $100 billion in the recent recession, the CalPERS funding level dropped from 100 percent in 2007 to 61 percent in 2009. It has not recovered, despite a major bull market in which the S&P 500 index of large stocks tripled.

“Even with the dramatic returns we have seen over the past six years, because the demographics of plans in general have changed and plans are now by and large cash-flow negative, it’s been very challenging to dig out of that hole,” Andrew Junkin, a Wilshire consultant, told the CalPERS board last week.

The funding level of CalPERS in fiscal 2013-14 was 77 percent of the projected assets needed to pay pensions promised in the future. But investment returns last fiscal year were below the forecast, 7.5 percent, causing the funding level to fall again.

“With the estimated 2014-15 investment returns of 2.4 percent, that funded status is expected to drop to a range of 73 to 75 percent,” said Cheryl Eason, the CalPERS chief financial officer.

In a loss equaling the state general fund budget at the time, the CalPERS investment fund dropped from about $260 billion in the fall of 2007 to $160 billion in March 2009, before climbing a little above $300 billion early this month.

CalPERS won’t soon run out of money. Its main fund paid $18 billion last year to 594,842 persons, up from $11 billion to 462,370 in 2007. Employers contributed $8.8 billion and members $3.8 billion, up from $7.2 billion and $3.5 billion in 2007.

Critics say the CalPERS earnings forecast, an average of 7.5 percent a year, is too optimistic and conceals an even larger funding gap. The board is working on a “risk mitigation” strategy that could slowly lower the forecast to 6.5 percent over 20 years.

When the earnings forecast goes down, some of the pension fund can be shifted to less risky bond-like investments. The yield is likely to be lower, but so is the chance of big losses in an economic downturn.

A lower earnings forecast also means that contribution rates are likely to go up, offsetting the lower earnings assumed in the future. That’s what happened when the CalPERS board in 2012 lowered the earnings forecast from 7.75 percent to 7.5 percent.

The CalPERS chief actuary, Alan Milligan, recommended lowering the forecast to 7.25 percent to provide a cushion or “margin for adverse deviation” as in the past. The board phased in the rate increase over two years to ease the impact on employer budgets.

Two more rate increases followed: a change in actuarial method in 2013 and a projection of longer life spans last year. Now a total employer rate increase averaging roughly 50 percent will be phased in by the end of the decade.

Under the proposed “risk mitigation” strategy CalPERS would consider lowering the earnings forecast in good years when the annual investment return is well above the current earnings target of 7.5 percent.

For example, a return of 11.5 percent might cause the board to consider lowering the earnings forecast by 0.05 percent. After a larger return of 17.5 percent, the board might consider lowering the earnings forecast 0.15 percent.

Brown aides urged the CalPERS board to consider using its existing policy to speed up the lowering of the earnings forecast. The rate increase resulting from a lower forecast would be phased in over five years and amortized or paid off over 20 years.

“If the current investment assumption of 7.5 percent is an unacceptable risk today — by the nature of this conversation it seems everyone is more or less in agreement that it is too high — the board should consider lowering it sooner rather than later,” Eric Stern of Brown’s finance department told the board.

Richard Gillihan, a CalPERS board member and director of Brown’s human resources department, said he agreed with the administration position and asked for an explanation of why the existing policy for lowering the forecast is not being used.

“It just seems like it’s too easy to pat ourselves on the back and say, ‘We came up with this plan,’ and then we are not doing anything with it for a few years and then a future board might change it.”

The CalPERS chief actuary, Milligan, said the proposed strategy balances the need to lower investment risk with concern about the impact on the budgets of 3,000 local governments, some in better financial condition than others.

“I would be concerned about the amount of strain we would put on some of our public agency (local government) employers,” Milligan said of dropping the earnings forecast too quickly. “Apparently, it’s not such a concern for the state.”

In the past, CalPERS rate increases only hit employers. But now many employees are included. A pension reform calls for employees to pay half of the pension “normal cost,” which excludes the debt or “unfunded liability” from previous years.

Milligan said the 50-50 split of the normal cost is required for local government, CSU, judicial and legislative employees. But the reform did not require a normal cost split for most state workers. Their rate is set by legislation resulting from bargaining.

In an example, over two or three decades miscellaneous employee rates could increase by a half to 1½ percent of pay and safety rates by 1½ to 3½ percent of pay. The timing would vary among plans, depending on the reform and demographics.

The CalPERS staff recommended a “blended” path with check points, perhaps every four years, when a lower earnings forecast would be considered. Rate increases would be more certain and predictable.

Union representatives argued for a “flexible” path when a lower earnings forecast would only be considered after a year with great investment returns. Rate increases would not be on “autopilot” and would be less likely to happen after a year of bad returns.

A spokeswoman for the League of California Cities told the board cities surveyed split on blended vs. flexible but were in favor of taking action to lower investment risk. A spokesman for special districts said they favored a blended plan.

The CalPERS board, in an 8-to-4 straw vote, directed the staff to prepare a flexible plan for a first reading in October. The final vote on a risk mitigation strategy may be in November.

 

Photo by Steve Rhodes via Flickr CC License

 

Some thought an appeal of a court ruling blocking a key part of a San Jose pension reform could lead to a high court review of the “California rule,” an issue in an initiative ballot summary issued last week by Attorney General Kamala Harris.

But dropping an appeal of the superior court ruling is part of a settlement of union suits against the voter-approved pension reform that, under a San Jose city council agreement last week with police, could soon be implemented by court action.

The “California rule” is a series of state court decisions widely believed to mean that the pension offered on the date of hire becomes a vested right, protected by contract law, that can only be cut if offset by a new benefit of comparable value.

Because of the rule, most cost-cutting pension reforms are limited to new hires, which can take decades to get significant savings. The rule prevents what the watchdog Little Hoover Commission and others say is needed to get immediate savings.

Namely, cut the pensions that current workers will earn in the future, while protecting the pension amounts they have already earned. It’s allowed in private-sector pensions and all but a dozen states that have something like the “California rule.”

A pension reform approved by 69 percent of San Jose voters in 2012, Measure B, used an option to cut pensions current workers earn in the future: contribute up to an additional 16 percent of pay to continue the current pension or switch to a lower pension.

While approving other parts of the measure, Santa Clara County Superior Court Judge Patricia Lucas ruled in December 2013, citing previous “California rule” court decisions, that the option violated the vested rights of current workers.

Former San Jose Mayor Chuck Reed, the Measure B lead author, and others have said the “California rule” decisions made in different circumstances in the distant past, one in 1947, could have a different outcome if reviewed by a high court now.

For example, a legal scholar, Amy Monahan, argued that by imposing a restrictive rule without finding clear evidence of legislative intent to create a contract, California courts broke with traditional contract analysis and infringed on legislative power.

“California courts have held that even though the state can terminate a worker, lower her salary, or reduce her other benefits, the state cannot decrease the worker’s rate of pension accrual as long as she is employed,” Monahan said.

In addition, under the “California rule” a pension increase on the job becomes a vested right that can‘t be cut, even if it’s retroactive (such as SB 400 in 1999), not paid for with employer-employee contributions, and creates an immediate pension debt.

And the “California rule” decisions were made by judges who were in the state pension system. As Orange County unsuccessfully tried to overturn a retroactive increase for deputy sheriffs in 2011, an attorney for the deputies noted the conflict of interest.

“Miriam A. Vogel, a retired Court of Appeal justice, clearly told her former colleagues that the court’s decision would affect every pension in the state of California: “(I)t would affect yours, it would affect mine,” former Orange County Supervisor John Moorlach (now a state senator) wrote in the Orange County Register.

Litigation of Measure B was an issue in the San Jose mayor race last fall. The winner, Sam Liccardo, a Reed ally, said “a mayor who will fully litigate — and implement — Measure B reforms” is needed to solve deep city budget problems.

The loser, Dave Cortese, backed by public employee unions, advocated settling the Measure B lawsuits, warning that pension cuts were causing the city to lose police officers, endangering public safety.

“Public unions assert that pensions are inviolable, but California’s high court has never decided whether future benefits are protected under the state constitution,” a Wall Street Journal editorial said after Liccardo’s victory.

A need to rebuild a police department, which dropped from 1,400 members in 2009 to about 960 last month, was said to be a main driver of the police and firefighter settlement negotiated by new city staff and new union leaders.

Firefighters approved the settlement last month. Police said they would not ratify an 8 percent pay raise unless the city agreed to have a court invalidate Measure B and replace it with the settlement.

The city wanted to wait until the next scheduled election, November 2016, for voter approval. Last Friday the city council agreed to ask the court to make the change. The police union was voting on the package over the weekend.

Liccardo and Reed said in an op-ed article in the San Mercury News on Aug. 7 that the settlement achieves their goals of reducing “unsustainable” retirement benefits, not adding to $3 billion in unfunded retirement debt, and rebuilding the police force.

An independent actuary expects the settlement to cut costs $1.7 billion over the next three decades compared to police and fire benefits in 2012, the two men said. More savings may come from negotiations with nine other city unions.

Lower pensions for new hires, competitive with other cities, are expected to save $1.15 billion over 30 years, cuts in retiree health care $244 million, and the elimination of a “bonus” pension check $270 million.

“The agreement would not include savings contemplated by Measure B’s mandate for employees to pay up to an additional 16 percent of their salaries for pensions,” Liccardo and Reed said in the article.

“We would need to chase those savings down a long and perilous road, however, spending millions in litigation over several years to appeal to the California Supreme Court. If we failed, we’d lose the $1.7 billion in savings achieved by this settlement, not to mention many more longtime employees who would be likely to resign.”

The city reportedly has spent $4 million on Measure B legal fees. The police union president, Paul Kelly, told reporters last week he would have taken the settlement deal four years ago before Measure B.

In the August issue of the San Jose Police Officers Association publication, Vanguard, Kelly said the union had proposed pension reforms saving tens of millions: “Reed preferred to roll the dice, putting forward the disastrous Measure B. He lost.”

Last week Attorney General Kamala Harris issued a ballot summary of a statewide pension initiative proposed by a bipartisan group led by Reed, a Democrat, and former San Diego city councilman Carl DeMaio, a Republican.

The “Voter Empowerment Act of 2016” would require voter approval of pensions for new state and local government employees, government paying more than half the cost of new hire retirement benefits, and any pension increase for current workers.

The first sentence of the Harris summary of the initiative: “Eliminates constitutional protections for vested pension and retiree healthcare benefits for current public employees, including those working in K-12 schools, higher education, hospitals, and police protection, for future work performed.”

Reed and DeMaio say the initiative would not overturn the “California rule” and allow cuts in the pensions current workers earn in the future. Harris agrees with union attorneys who say that door is opened by giving voters the right to set pay and benefits.

Why is overturning the “California rule” an issue? For one thing, hard-hitting opposition television ads could feature police, firefighters and others held in high public regard warning that their promised pensions could be cut.

Reporter Ed Mendel covered the Capitol in Sacramento for nearly three decades, most recently for the San Diego Union-Tribune. More stories are at Calpensions.com

Photo by Joe Gratz via Flickr CC License

The authors of an initiative giving voters the power to decide whether new government employees get pensions said they will “commission a legal review” of the ballot summary issued yesterday by Attorney General Kamala Harris.

Two previous pension reform initiatives were dropped after sponsors said Harris gave them ballot titles and summaries that were inaccurate and misleading, making voter approval unlikely.

The authors of the new initiative, former San Jose Mayor Chuck Reed and former San Diego City Councilman Carl DeMaio, said “politicians and union bosses” opposing the initiative “continue to try to mislead the public on what the initiative does.”

But a news release from the two leaders of a bipartisan group backing the new initiative, which is aimed at the November ballot next year, did not cite a specific problem with the Harris summary of the initiative.

The initiative leaders previously have said they intended to file the initiative early to allow time for a legal challenge of the title and summary, if needed. Polling to see how the title and summary is received by voters also has been mentioned.

“Reed and DeMaio noted that the next step in their campaign will be to commission a legal review (of) the ballot measure ‘Title and Summary’ concocted by state politicians,” said their news release. “Once that review is completed, DeMaio and Reed will kick off their signature drive to qualify the measure.”

A coalition of public employee unions opposed to the initiative gave Harris, who is running for the U.S. Senate next year, some claim to the middle ground on her ballot summary by drawing fire from both sides.

“We strongly disagree with the attorney general’s elimination of the specific mention of teachers, nurses, police and firefighters in the title and summary,” Dave Low, chairman of Californians for Retirement Security, said in a news release. “They are the bulk of the public servants whose retirement security and death and disability benefits would be abolished by this heavy-handed measure.”

The elimination of death and disability benefits was used in television ads a decade ago that helped persuade former Gov. Arnold Schwarzenegger to drop his support for a measure to switch new state and local government employees to 401(k)-style plans.

In an apparent response, the new initiative says it shall not be “interpreted to modify or limit any disability benefits provided for government employees or death benefits for families.”

Reed dropped a different pension reform initiative last year after losing a court battle to change a Harris ballot summary. One of his complaints was that the summary “singles out a few specific public occupations” held in high regard by voters.

The first sentence of the initiative summary last year: “Eliminates constitutional protections for vested pension and retiree healthcare benefits for current public employees, including teachers, nurses, and peace officers, for future work performed.”

Low’s complaint is that the occupations are not specific in the first sentence of the initiative summary this year: “Eliminates constitutional protections for vested pension and retiree healthcare benefits for current public employees, including those working in K-12 schools, higher education, hospitals, and police protection, for future work performed.”

But the new Harris summary repeats what once again may be the main issue. Another of Reed’s complaints last year was that the summary incorrectly said the initiative eliminates the vested pension rights of current workers.

A superior court judge found that the initiative summary was not “false and misleading,” ruling that the previous Reed initiative was an attempt to overturn the “California rule.”

The rule results from a series of state court decisions widely believed to mean that the pension offered on the date of hire becomes a vested right, protected by contract law, that can only be cut if offset by a comparable new benefit.

And it may be important to voters. A labor polling firm found that “California voters reject the idea of reducing or eliminating retirement benefits for current public employees,” calling it a “visceral negative response,“ the Sacramento Bee reported.

Most pension reforms are limited to new hires, which takes years to yield savings. Cutting pensions earned by current workers in the future gets immediate savings, urgently sought by reformers who say pensions are taking money needed for other programs.

Reed and the union coalition have already clashed over whether the new initiative would allow voters to reduce or eliminate pensions earned by current workers in the future, while protecting pensions already earned.

Reed has argued that the new initiative is not intended to overturn the California rule. The union coalition disagrees, pointing to a provision that gives voters the right to determine the “compensation and retirement benefits” of government employees.

The official analysis of the new initiative sent to Harris by nonpartisan Legislative Analyst Mac Taylor and Brown’s finance director, Michael Cohen, said the issue is unclear and could end up in the courts.

“Many of the measure’s provisions could be subject to a variety of legal challenges,” said their initiative analysis. “For instance, it is not clear to what extent allowing voters to use the power of initiative or referendum to determine elements of compensation for existing employees would change governmental employers’ contractual obligations under the California rule.”

The new initiative, the “Voter Empowerment Act of 2016,” would require voter approval of pensions for new state and local government employees hired on or after Jan. 1, 2019.

Some of the other provisions in the initiative require voter approval of a government employer paying more than half the cost of retirement benefits for new employees and voter approval of any pension increase for current employees.

“Costly government pension deals are devastating our public services — and this simple initiative gives voters the ability to stop sweetheart and unsustainable pension deals that politicians concoct behind closed doors with union bosses,” said the Reed-DeMaio news release.

“That’s why the politicians and union bosses oppose this initiative — and why they continue to try to mislead the public on what the initiative does. Despite their attempts to mislead, we are very confident the voters will understand the plain English requirements of this measure and overwhelmingly pass it in November 2016.”

Low’s news release said: “While the (Harris) statement accurately reflects that this Tea Party-backed measure is a back-door way of repealing constitutionally-vested and promised rights to retirement security and health care and breaks contracts negotiated through collective bargaining, it falls far short of describing the chaos and uncertainty that would occur if it were to pass, including the undermining of the financial stability of the state’s major retirement systems.

“The measure also purports to protect death and disability, but contradicts itself by repealing the very structure on which these benefits are provided for police, firefighters and other public workers. This type of extreme measure will be unacceptable to California voters and is doomed to fail.”

Reporter Ed Mendel covered the Capitol in Sacramento for nearly three decades, most recently for the San Diego Union-Tribune. More stories are at Calpensions.com.

 

Photo by Elektra Grey Photography

It may surprise cities that did not switch new hires to 401(k)-style plans because of huge CalPERS termination fees, not to mention the authors of a proposed initiative giving voters power over pensions.

But a CalPERS white paper that surfaced last week describes a “soft freeze” of pension plans that switches new hires to a 401(k)-style investment plan without paying a termination fee.

The March 2011 paper seems to contradict the current California Public Employees Retirement System position: When a pension plan is closed to new members, state law requires that the plan be terminated.

Termination triggers a fee large enough, when conservatively invested in bonds, to pay the pensions promised remaining plan members for decades into the future. The big fee is needed because employers and employees no longer pay into a terminated plan.

In the Stockton bankruptcy, Judge Christopher Klein said a termination fee that boosted the Stockton pension debt or “unfunded liability” from $370 million to $1.6 billion was a “poison pill” if the city tried to move to another pension provider.

One of the co-authors of the proposed “Voter Empowerment” pension initiative, former San Jose Mayor Chuck Reed, has first-hand experience with the big CalPERS termination fee.

The San Jose city council considered switching new council members to a 401(k)-style plan three years ago. But the council made no change after learning the CalPERS termination fee would be $5 million, far above the $900,000 debt or unfunded liability.

Villa Park, with another small plan (30 members, seven active), asked for an estimate to publicize high termination fees. The CalPERS estimate this year was $3.7 million. Canyon Lake and Pacific Grove also balked at high termination fees.

So, why did the CalPERS white paper issued four years ago describe a “soft freeze” that would allow switching new hires to a 401(k)-style plan without terminating the pension plan and triggering a big fee?

A CalPERS spokeswoman said the white paper assumed that the state law covering public pensions, the Public Employees Retirement Law, would be changed to allow a soft freeze without terminating the pension plan.

“The PERL could be changed to permit the soft freeze that is contemplated in the initiative, but the current wording of the initiative does not clarify this,” Amy Morgan, the CalPERS spokeswoman, said via email. “It is this lack of clarity in the initiative that leads to the uncertainty about the consequences of the initiative.”

Among other things, the initiative sponsored by a bipartisan group led by Reed and former San Diego Councilman Carl De Maio requires voter approval of pensions for new hires, government paying more than half of total retirement costs, and termination fees.

The white paper issued in March 2011 was followed in August of that year by a major CalPERS policy change. The investment earnings forecast used to set the termination fee was dropped from 7.75 percent to 3.98 percent, sharply increasing the fee.

The change from the optimistic forecast for the main CalPERS fund, with its diversified portfolio of stocks and other investments, to a less risky and more predictable bond-based forecast was driven by worry that a large plan might be terminated.

CalPERS had been hit by huge recession-era investment losses, about $100 billion, and needed large employer rate increases. There was speculation about possible city bankruptcies, and Stockton and San Bernardino filed the following year.

But no large pension plan has been terminated. The pooled CalPERS fund that pays for the pensions of members in terminated plans, which receive no payments from employers or employees, has a large surplus.

The Terminated Agency Pool had 249 percent of the assets (market value $194 million) needed to pay promised pensions as of June 30, 2013, the latest report said. Annual payments of $4.6 million were going to 684 retirees and beneficiaries of 90 terminated plans.

How important is the termination fee?

It’s the one way, outside of bankruptcy, that the pensions of current workers can be cut. If a terminated plan lacks the assets to cover promised pensions, the CalPERS board has the power under state law to cut the pensions to the level covered by the assets.

The white paper on plan closure was cited by the CalPERS chief executive officer, Anne Stausboll, in a reponse to a request for an analysis of the proposed initiative from the Assembly public retirement committee chairman, Rob Bonta, D-Alameda.

In addition to creating administrative challenges and threatening tax-exempt status and death and disability coverage, Stausboll said, the initiative would abolish the “California Rule” for new hires and possibly current employees.

A series of state court decisions known as the “California rule” are believed to mean that the pension promised on the date of hire becomes a vested right, protected by contract law, that can only be cut if offset by a new benefit of comparable value.

The CalPERS white paper said a “hard freeze” stops future pension earnings for current employees, presumably prohibited by the California rule. A “soft freeze” only closes the pension plan to new employees.

“When a plan administrator closes a defined benefit (pension) plan, often the administrator opens a fixed-rate defined contribution (401k-style) plan,” said the white paper. “The defined benefit plan must be administered until the last participant quits working, retires and dies.”

The white paper lists a number of reasons why staying with pensions is preferable, including lower costs from administering only one plan instead of two plans if new employees are switched to a 401(k)-style plan. A termination fee is not mentioned.

The other large state pension system, the California State Teachers Retirement System, has not had to deal with plan terminations. It has only one plan covering 1,700 employers, mainly school districts but also other education agencies.

In an early analysis of the initiative sent to stakeholders, CalSTRS sees a number of administrative, funding and other problems. The vote on whether to give new hires pensions is assumed to be by each school district or employer jurisdiction, not statewide.

Depending on the vote outcome, CalSTRS said it could be required to administer multiple plans with “inconsistent eligibility requirements, vesting rules, benefit formulas, contribution rates, retirement ages, and beneficiary and survivorship allowances.”

Attorney General Kamala Harris is expected to issue a title and summary for the initiative by tomorrow (Aug. 11). Two previous pension initiatives were dropped after the sponsors said Harris gave them inaccurate and misleading summaries, making voter approval unlikely.

Reporter Ed Mendel covered the Capitol in Sacramento for nearly three decades, most recently for the San Diego Union-Tribune. More stories are at Calpensions.com.