Author: Ed Mendel

Ed Mendel is a reporter who covered the capital for nearly three decades, most recently for the San Diego Union-Tribune. More of his stories are at CalPensions.com

A state attempt to create a retirement savings plan for 6 million private-sector California workers not offered one on the job, Secure Choice, got a boost last week during the White House Conference on Aging.

President Obama said he has directed his labor department to propose rules showing states how to create what in California could be an “automatic IRA,” a payroll deduction that puts money into a tax-deferred savings plan unless workers opt out.

The rules are expected to answer a key question: Is Secure Choice exempt from a federal retirement law, ERISA, that not only has employer administrative costs but may also expose employers to liability for failed investments and other problems?

An ERISA exemption is one of several limits California legislation placed on Secure Choice: No state budget for development ($1 million was donated), self-sustaining when operating, IRS tax approval, and legislative approval of the final savings plan.

The payroll deduction, believed to be an important way to increase retirement savings, is intended to be a supplement for Social Security. Nearly half of California workers are said to be on track to retire with incomes below $22,000 a year.

Obama said Congress ignored repeated calls for an automatic IRA. Taking alternative action, he said the new labor rules will encourage a handful of states that have enacted new retirement savings plans and 20 other states considering similar plans.

In May, the President received a letter from 26 U.S. senators urging clarification of federal labor and tax laws hampering states trying to develop retirement savings plans. California and Massachusetts were mentioned.

“A major cause of the retirement crisis is that almost half of employees work for an employer that does not sponsor a retirement plan,” the senators said in the letter. “Employees without access to a plan at the workplace are much less likely to save.”

In March, state Senate President Pro Tempore, Kevin De Leon, D-Los Angeles, the author of Secure Choice (SB 1234 in 2012) and state Treasurer John Chiang, whose office houses Secure Choice, met with Obama administration officials to discuss the bill.

“President Obama’s action removes the most significant barrier to state action across the country,” De Leon said in a news release last week. “California, and states that follow our lead, will now be able to ensure tens of millions of hard-working men and women will have a shot at retiring with dignity.”

Chiang’s response was more cautious last week as he gave a previously scheduled update of Secure Choice to his fellow members of the California Public Employees Retirement System.

“It’s a major development,” Chiang told the CalPERS board. “It’s hopeful. At least we know we are going to have some rules.”

Obama called on his labor secretary, Tom Perez, to propose the new rules by the end of the year. Chiang said Secure Choice hoped to be ready to take a plan to the Legislature by the end of the year, but could act quickly if the rules allow the plan.

With the $1 million in donations, half from the Laura and John Arnold Foundation, a market analysis and plan design is being prepared by Overture Financial and others under a $500,000 contract. K&L Gates has a $275,000 legal services contract.

In a blog post last week, Secretary Perez said a number of states have asked for clarity about whether their retirement savings plans would be “preempted or nullified” by ERISA, the federal Retirement Income Security Act.

“Although the federal courts, not the Department of Labor, are the ultimate arbiter on that question, the department can try to help reduce the risk of litigation challenges to state retirement savings initiatives,” Perez said.

The President told the aging conference last week that Social Security, the basic federal retirement system that would be supplemented by the savings plan, is not in “crisis” as often claimed by those who want to cut the program.

Social Security, like Medicare, is “facing challenges” because of the “demographic trends” of the Baby Boomers, he said. A population bulge turning 65 at the rate of a quarter million a month also is expected to have a longer life span.

“Number one, we have to keep Social Security strong, protecting its future solvency,” Obama said without mentioning specific solutions. “And I think there are ways, creative ways that people are talking about to protect its future solvency.”

In a presentation to the CalPERS board last week, a UC Davis economist, Ann Huff Stevens, said the Social Security “trust fund” now covering a funding gap is widely expected to drop to zero around 2035-40. (see graph above)

If a solution is not enacted before then, payments presumably would be reduced to the amount covered by annual Social Security tax revenue from employers and employees, currently 6.2 percent of pay from each each.

Huff Stevens said Social Security funding gaps have been closed in the past. In 1975, the tax rate was increased and benefits reduced. In 1983, some benefits were taxed and retirement ages increased.

A federal lobbyist, Tom Lussier, told the CalPERS board Congress seems unlikely to consider Social Security funding until after the presidential election last year. He said an apparently growing concern about retirement security may take the talks beyond cuts.

“If we are really going to acknowledge the retirement security crisis that we are talking about, the discussion should be about expanding Social Security and making it a richer benefit as opposed to going the other way,” Lussier said.

A third point made by the President last week, in addition to the retirement savings plan and Social Security solvency, is a proposed labor rule that attempts to “crack down” on self-serving financial advice sometimes given to consumers.

“The goal here is to put an end to Wall Street brokers who benefit from backdoor payments or hidden fees at the expense of their clients,” Obama said.

Lussier said another rule, pending at the labor department and in Congress, would require retirement savings and investment plans, such as IRAs and 401(k)s, to give individuals an estimate of their value at a normal retirement age.

He said the belief is that “most people will be frightened” by the number and motivated to save more.

Ed Mendel is a reporter who covered the capital for nearly three decades, most recently for the San Diego Union-Tribune. More of his stories are at CalPensions.com

A union coalition contends that a proposed initiative is being falsely portrayed as only a potential cut in pensions for new employees, when in fact it could cut or eliminate pensions earned by current employees for work done in the future.

One of the initiative authors, former San Jose Mayor Chuck Reed, disagrees with the union reading of the proposal. But it’s a key pension reform issue that could lead to another disputed initiative title and summary.

Cutting pensions current workers earn in the future, while protecting amounts already earned, would get the immediate savings sought by those who say “unsustainable” rising pension costs are eating up funds needed for other programs.

Notably, finding a way to reduce pension amounts earned by current workers in the future, as allowed in private-sector pensions, was the top recommendation of a report by the watchdog Little Hoover Commission in 2011.

But like Gov. Brown’s reform enacted a year later, pension cuts are usually limited to new hires, which can take decades to yield significant savings. The pensions of current workers in California and 11 other states are protected by the “California rule.”

Under a series of state court decisions, a main one in 1955, the pension promised on the date of hire is widely believed to become a “vested right,” protected by contract law, that can only be cut if offset by a new benefit of comparable value.

An initiative filed last month by a bipartisan coalition led by Reed and former San Diego City Councilman Carl DeMaio is a state constitutional amendment that would give voters more control over pensions.

The dispute is over a part of the initiative that gives voters the right to use the initiative or referendum “to determine the amount of and manner in which compensation and retirement benefits are provided to employees of a government employer.”

Lance Olson, an attorney for public employee unions, said the provision overturns the “California rule” on vested rights and allows cities and other government employers to ask voters to reduce or eliminate pensions earned by current workers in the future.

He said the provision is strengthened by an introductory line, “not withstanding any other provision of this Constitution or any other law,” and there is no language limiting the provision to new employees.

“Voters will now have the right to change the benefits for current employees,” said Olson, who has drafted three statewide ballot measures approved by voters. “There is nothing in there about future or new employees.”
Reed, a lawyer, said the initiative clearly applies to current workers by requiring voter approval of pension increases. But he does not think the initiative allows voters to reduce the pensions current workers earn in the future.

“It confirms the voters’ right to approve compensation and benefits,” said Reed. “That’s not the same thing as approving a right to reduce benefits.” Then he added: “You can be sure they won’t be arguing that after this passes.”

Opponents of the initiative, concerned that the authors seem to be “defining” the issue on their terms, can get passionate about whether the initiative is being deliberately misrepresented.

“They come from the school you tell the lie early and tell it often enough, it becomes the truth — and we can’t let that happen,” said Dave Low, chairman of Californians for Retirement Security, a coalition of public employee unions.

Reed said one reason the initiative simply gives voters more control of pensions, rather than impose a complicated reform plan, is that it’s an easy-to-understand proposal voters can read for themselves.

“It’s their standard tactic to attack anybody on a personal level,” Reed said. “I’m used to it. I just say: Read the language. It is what it is. It doesn’t matter what I say.”

The vested rights of current worker pensions is not a new issue for Reed. He dropped an initiative last year after Attorney General Kamala Harris gave it what he said was an “inaccurate and misleading” title and summary, making voter approval unlikely.

One of Reed’s complaints was that the summary incorrectly said the initiative “eliminates” the vested rights of current workers, a portrayal found by a labor polling firm to foster a “visceral negative response” among voters.

The Sacramento Bee reported that a Garin-Hart-Yang poll said: “More important than rejecting the language of this ballot proposal, California voters reject the idea of reducing or eliminating retirement benefits for current public employees.”

Another Reed complaint was that Harris’s summary “singles out a few specific public occupations that are held in high regard by voters.” Dan Pellissier of California Pension Reform made a similar complaint when he dropped an initiative in 2012.

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

Reed filed a lawsuit asking for a rewrite of the summary. A superior court judge, finding the initiative was an attempt to overturn the “California rule” on vested rights, ruled the Harris description was not “false or misleading.”

Local pension reforms led by Reed and DeMaio, approved by voters in June 2012, attempted in different ways to reduce the cost of pensions earned by current workers in the future.

The San Diego measure switched all new hires, except police, to a 401(k)-style plan and called for a five-year freeze on the pay used to calculate pensions, while still allowing pay raises.

The San Jose measure gave current workers the option of 1) paying much more for their pension or 2) switching to a lower pension. A superior court judge upheld most of the measure, but ruled that the option violated the vested rights of current workers.

The city appealed the ruling. Reed and others think the “California rule” is an outdated misreading of contract law, quite different from federal interpretations, that is likely to be overturned if given a hard look by a high court.

The title and summary for the new initiative filed by Reed and others on June 5 is expected to be issued by Harris by Aug. 11. Reed said the initiative campaign, not yet accepting contributions, may do some polling on the new title and summary.

Low said the union coalition, after a decade of focus groups and polling on pension cuts, thinks the initiative would be rejected by voters even if it’s rewritten to remove obvious flaws.

“We are confident that just basically taking away pensions for all new employees is bad enough, from our research, that the voters won’t buy it,” he said.

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

Private equity firms have produced big profits for CalPERS, not to mention a pay-to-play scandal, while keeping a big share for themselves as an incentive — traditionally 20 percent of profits plus annual management fees of up to 2 percent.

With its size as the nation’s largest public pension fund providing leverage in negotiations, and a new emphasis in recent years on cutting management fees, CalPERS seems likely to have negotiated favorable deals with private equity firms.

But after the board was told last April that CalPERS could not track the incentive payments, known as “carried interest,” a wave of media criticism grew with stories in the New York Times late last month and Fortune magazine last week.

A pension fraud investigator, Edward Siedle of Benchmark Financial Services, launched an Internet fund-raising campaign on Kickstarter to raise $750,000 for a “forensic investigation” of the California Public Employees Retirement System.

Last week, CalPERS announced that a new reporting system under development since 2012 will enable the reporting of “the total carried interest” paid to its private equity firms during fiscal 2014-15, probably this fall.

The report may be incomplete. CalPERS sent a new e-mail request last week to the 6 percent of its private equity firms that have declined so far to provide the information on carried interest.

The CalPERS board member who raised the tracking issue, J.J. Jelincic, estimated last April that the carried interest could be $600 million to $900 million a year, adding to the $1.6 million in total external management fees reported last fiscal year.

Jelincic said last week that, contrary to his earlier skepticism, staff has convinced him they indeed do not know the carried interest amounts. At a past conference, he said, a staff member estimated that the average carried interest is roughly 10 percent of profit.

Private equity firms with a strong record of returns desired by investors apparently can charge 20 percent or more, Jelincic said. In a kind of market pricing, other less proven private equity firms may agree to a much lower carried interest rate.

Part of the media criticism is that in 2011 CalPERS dropped a consultant, LP Capital Advisors, that had been monitoring its private equity portfolio, which has about 350 managers with 700 funds and a net value last year of $31 billion.

Brad Pacheco, a CalPERS spokesman, said the consultant’s reports were incomplete, inconsistent and covered the total private equity fund, not the CalPERS share of carried interest.

The report this fall from the new CalPERS system, called the Private Equity Accounting and Reporting Solution or PEARS, will use the industry standards issued in 2012 by the International Limited Partners Association.

A chart in an “investment office cost effectiveness” report to the board last April shows the private equity base management fees, excluding the profit share, dropping from about 2 percent of assets in 2010 to 1.5 percent in 2014.

Several large private equity firms agreed to lower their CalPERS management fees after a pay-to-play scandal surfaced in 2009, prompting a number of reforms by CalPERS and the Legislature.

The April report showed an investment management cost for all CalPERS funds of 0.41 percent, below the 0.48 percent benchmark for similar pension funds. In the last four years one-time savings were $429 million and ongoing savings grew to $293 million a year.

“The kinds of savings that are indicated here — you need to be applauded for the work in that area,” Henry Jones, the investment committee chairman told the staff after hearing the report. “I think we need to let the public and world know about these savings as we go forward.”

Private equity investments, mainly available only to pension funds and other large institutional investors, are expected to yield higher returns than stocks traded on the public market.

One example of their importance: After huge investment losses in the 2008 stock market crash and economic recession, both CalPERS and the California State Teachers Retirement System increased their private equity allocations.

The CalPERS target for private equity jumped from 10 to 14 percent of the investment portfolio, CalSTRS from 9 to 12 percent. The CalPERS target has since returned to 10 percent of a portfolio valued last week at $308.7 billion.

By far the most lucrative and controversial type of private equity is the “leveraged buyout,” now about 60 percent of CalPERS private equity assets. Often a company is purchased with loans that use the targeted company’s own assets as collateral.

Advocates say the companies purchased in leveraged buyouts typically are modernized by outside experts, made more cost-efficient and competitive in various ways and returned to the market after several years in a kind of “creative destruction” that is good for the overall economy.

Critics say too often companies are “ripped, stripped and flipped,” jobs outsourced, borrowing increased simply to pay the purchaser dividends, bankruptcies declared, and a new class of billionaires created as public pensions help gut the economy.

In what some call private equity’s “golden years” before the market crash in 2008, a former CalPERS board member, Alfred Villalobos, collected more than $50 million in “placement agent” fees from firms seeking CalPERS investments.

A former board member who became the CalPERS chief executive, Fred Buenrostro, pleaded guilty to bribery-related charges for aiding Villalobos and awaits sentencing. Villalobos died last January while awaiting trial, an apparent suicide.

Last week Jelincic said tracking private equity profit shares should help CalPERS monitor how investments are used. He also suggested that CalPERS consider doing its own private equity investments, even if the needed “skill sets” require higher pay.

“We ought to take a serious look at whether we need to bring it in-house,” said Jelincic. “But if you don’t know what you are paying, you don’t know which way to go.”

A long-time CalPERS investment office employee, Jelincic has been on leave since his election to the board in 2010. During his campaign, the former president of the largest state worker union advocated more internal investment management.

The cost report last April said managing a larger percentage of its investments internally, particularly compared to other U.S. public pension funds, is one of the reasons CalPERS costs are lower than the international benchmark for its peers. (See chart below)

As if to show how both CalPERS and the times have changed, pressing firms to reveal their profit share and suggesting a switch to internal management is a stark reversal of the old attitude toward private equity.

In 2006 Los Angeles Times reporters made a Public Records Act request to CalPERS for letters, e-mails and memos from Villalobos and former state Sen. Richard Polanco about investment opportunities.

Rejecting the request, a letter from a CalPERS attorney to the Times said “the release of the (sic) some of the requested information may harm CalPERS’ ability to continue to invest with top-tier equity funds.”

Some private equity firms warned that “CalPERS’ current status as an ‘investor of choice’ will be damaged,” said the letter, and others “recently expressly refused to allow CalPERS to invest with them” due to concerns about disclosure.

Photo by  rocor via Flickr CC License

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

An accounting board best known for requiring the calculation and reporting of the debt owed for retiree health care promised government workers, which often turned out to be shockingly large, is having another moment.

This month the Governmental Accounting Standards Board applied new rules for reporting pension debt to retiree heath care. It’s a broader look, shows year-to-year changes, and requires local governments in state systems to report their share of debt.

And the new numbers must be reported on the face page of financial documents, not buried deep in the notes of lengthy documents known only to those with green eyeshades.

This month also is the end of the first fiscal year for which local governments are required to report their share of pension debt under the new rules. The two big state pension systems, CalPERS and CalSTRS, are helping local governments do the paperwork.

The purpose of the new rules was briefly outlined last week by the accounting board chairman, David Vaudt, in an interview with CNBC about the change for retiree health care, often called in government Other Post-Employment Benefits.

“Previously, what happened under current standards is that the pension and OPEB liabilities appeared in the footnotes of the financial statement, and regretfully that didn’t get the attention of the policymakers, the mayors and councils, the governors and the legislators,” Vaudt said.

“So, what the new standards will do is they will elevate that pension liability, that OPEB liability to the face of the financial statement. And this will provide a much clearer picture, an enhanced picture, of what these promises actually are, what the magnitude of those promises are, and whether assets are being set aside to actually pay for those benefits in the future.”

Needless to say, public knowledge of a problem does not necessarily lead to a prompt political solution.

The first report of California state worker retiree health care debt, following the earlier GASB directive, was $47.8 billion in 2007. By last year the debt had grown to $72 billion, larger than the $50 billion debt or “unfunded liability” for state worker pensions.

State worker retiree health care has been one of the fastest-growing state expenses: $1.9 billion next fiscal year, up fourfold from $458 million in 2001. It’s also one of the most generous benefits, requiring no contribution from most state workers.

The subsidy pays 100 percent of the average health care premium for retirees, 90 percent for their dependents. It’s an incentive for early retirement at age 50 or 55, some argue, because the subsidy for active state workers is 80 to 85 percent of the premium.

On becoming eligible for Medicare at age 65, retired state workers are expected to enroll and switch to a supplemental state health insurance plan for costs not covered by the federal plan.

Last January Gov. Brown proposed a long-term plan to cut costs. State worker retiree health care would be shifted from “pay-as-you-go” funding, which only pays the health insurance premiums each year, to pension-like “prefunding” that invests additional money to earn interest.

State workers would contribute half of the normal cost of the plan, work longer to qualify for full retiree health care, receive a subsidy no higher than active workers, have the option of a lower-cost health plan, and face tighter dependent eligibility and Medicare switch reviews.

The plan must be bargained with unions. An incentive for unions might be that agreeing to the plan would strengthen the “vested right” to retiree health care, which some think may not have the legal protection currently given to pensions.

A chart in the governor’s revised budget proposal last month shows retiree health care costs rising for nearly three decades under the plan, as prefunding is added to pay-as-you-go costs, before dropping sharply to yield big savings.

One of the big criticisms of public pensions, that investment earnings are too optimistic and conceal massive debt, surfaced in the Legislature in 2006, when the state Senate removed David Crane from the CalSTRS board.

For almost a year, Crane had repeatedly questioned whether the CalSTRS earnings forecast was too high. His opponents reportedly said he was undermining support for public pensions, leading to a Senate vote not to confirm his appointment.

How important are pension fund earnings? CalSTRS and CalPERS both expect a diversified portfolio of stocks, bonds and other investments to pay about two-thirds of future pension costs, with another third from employer-employee contributions.

The current earnings forecast of the two big pension systems is 7.5 percent a year, down from 8 percent a decade ago. What happens when the earnings forecast drops was shown in a well-publicized paper by Stanford graduate students in 2010.

Using a risk-free bond rate recommended by some economists for pensions, 4.14 percent, the debt or “unfunded liability” for CalPERS, CalSTRS and UC Retirement ballooned from $55.4 billion to $500 billion.

A credit-rating firm, Moody’s, began using a lower earnings forecast for pension debt in 2013. The stricter stance is costing Moody’s business as some cities use other firms to get higher bond ratings, the Wall Street Journal reported this month.

The new GASB rules, aiming for middle ground with a “blended” rate, allow a pension fund to use its earnings forecast. But if the projected assets fall short of covering future pension obligations, a lower bond earnings rate must be used for the shortfall.

Two years ago CalSTRS feared its debt under the new rules would be the nation’s largest, $167 billion. But last year legislation raised employer-employee contributions $5 billion over seven years, dropping the debt to $58.4 billion.

The part of CalSTRS debt school districts and other employers will report is based on their share of total contributions. The districts have the option of using financial data from last fiscal year or waiting until October for data from the current year.

The CalPERS debt for non-teaching school employees also will be based on the district’s share of total contributions. CalPERS is preparing accounting valuation reports for its state, local government and school plans, charging $850 or $2,500 per plan.

In the early years of California pension funds, there was no controversy over earnings forecast and no ballooning debt. Public pension funds like CalPERS, formed in 1932, were only allowed to invest in bonds with a predictable yield.

Then in 1966 voters approved Proposition 1 that allowed up to 25 percent of pension fund investments to be in large-company stock that paid dividends and met other safety tests.

Voters rejected a measure in 1982, Proposition 6, that would have allowed 60 percent of pension fund investments to be in stocks. But in 1984 voters approved Proposition 21 allowing any investment that followed the “prudent person” rule.

The ballot pamphlet argument for Proposition 21 said pension board trustees would be “personally liable” if they fail to exercise the care of a “prudent person” knowledgeable in investment matters.

Now CalPERS and CalSTRS purchase insurance to protect board members from being personally liable for bad investment decisions. There have been no lawsuits or legal claims alleging board members made imprudent decisions.

 

Photo by TaxRebate.org.uk

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.

The CalSTRS board voted this month to “watch” a new cost-neutral bill in Congress that would reduce what has been an unpleasant surprise for some teachers and a shock to others — joining CalSTRS can cut Social Security benefits.

Two federal laws enacted to avoid Social Security overpayment and inequity are mainly aimed at government employees who receive a pension but no Social Security. In California, that includes nearly all teachers and many police and firefighters.

A long-standing CalSTRS policy seeks the repeal of the Government Pension Offset enacted in 1977, which cuts Social Security survivor benefits, and the Windfall Elimination Provision enacted in 1983, a cut in Social Security monthly payments.

The two federal laws are unfair, CalSTRS argues, and harm teacher recruitment. Among those often hit are teachers who earn Social Security before entering the profession or who earn Social Security on non-teaching summer jobs.

“CalSTRS members (873,329) represent the single largest group of state and local government employees in the country who do not participate in Social Security, and the offsets particularly impact educators who begin their career at a later date,” Mary Anne Ashley, CalSTRS governmental affairs director, told the board.

A survey done for the California State Teachers Retirement System in 2013 found that 63 percent of retired CalSTRS members earn a Social Security benefit, and 41 percent were affected by the Windfall Elimination Provision.

Offset repeal legislation, costly and unneeded in many states with full Social Security participation, has been routinely rejected in Congress. A few years ago the estimated cost of repeal to Social Security was $61 billion to $80 billion over 10 years. Only 15 states do not provide Social Security for teachers.

This year, a cost-neutral bill was introduced. But it only partially reduces the Windfall offset and leaves the Pension survivor offset untouched. Part of the cost of allowing workers to keep more of their Social Security earnings is reduced by recovering Social Security overpayments.

Another part of HR 711 by Rep. Kevin Brady, R-Texas, that helps reduce its cost was criticized by CalSTRS board members. The Windfall offset would be expanded to cover another large group: those who teach less than the five years needed to vest and receive a pension.

“So is it correct, then, that this is a bill that would basically help some of our members and hurt other of our members, and if that’s the case is there a rationale?” asked board member Paul Rosenstiel.

The CalSTRS fiduciary counsel, Harvey Leiderman, compared the bill to “Sophie’s Choice,” the mother in a William Styron novel and movie forced in Nazi Germany to choose a labor camp for one child and the gas chamber for the other.

Last year CalSTRS had 146,471 inactive non-vested members who could be hit by the Windfall offset under the bill. If these members do not remove their interest-earning pension contributions from CalSTRS by age 70½, they face a tax penalty.

Ed Foglia of the Retired Employees Association of the California Teachers Association said the bill is not supported by its affiliate, the National Education Association.

The bill would fix “half of the problem” for some at the expense of others, he told the CalSTRS board, and Congress might think passage of the bill solved the problem, so there is no need to repeal the offsets.

“What we are asking you to do is at the very least have a ‘no position’ on this and see if you can mitigate the problem so no one is hurt,” Foglia said.

The CalSTRS board voted to “watch” HR 711 and “engage” the author about board concerns. The board voted to support the current bill to repeal the two Social Security offsets, HR 973 by Rep. Rodney Davis, R-Illinois.

What’s eliminated by the Windfall Elimination Provision? Social Security is designed to replace a much larger part of the income of low-wage earners than of higher-wage earners.

A worker whose primary job provides a pension but not Social Security could get the “windfall” of being treated like a low-wage earner while working on another job covered by Social Security.

So, instead of getting the usual 90 percent of the first $826 of average monthly earnings, a worker covered by the Windfall Elimination Provision only gets 40 percent of the first $826. (See chart above)

What’s offset by the Government Pension Offset? The Social Security spousal payment was established in the 1930s when spouses who stayed home to raise families often were dependent on the working spouse.

As it became common for both husband and wife to work, the Social Security spousal payment to a widow or widower was reduced dollar-for-dollar by the amount of their own Social Security benefit.

So, to give workers who receive a government pension but no Social Security a similar “offset,” their Social Security spousal payment was reduced by two-thirds of their government pension.

In the past CalSTRS has given Congress a detailed analysis showing why the two Social Security offsets are unfair and arbitrary, emphasizing the impact of the spousal offset on its membership that is 70 percent female with longer expected life spans.

“There are discrepancies between the theoretical policy of the offset provisions and the actual consequences of the offsets,” board member Dana Dillon told a Senate subcommittee in 2007.

Leading politicians have urged repeal of the offsets. Sen. Dianne Feinstein carried repeal legislation for a decade, followed by former Sen. John Kerry. President Obama, while campaigning in 2008, said he would work to repeal the offsets.

The California Retired Teachers Association makes lobbying trips to Washington, D.C., each congressional session. A grass-roots group, the Committee for Social Security Fairness, has an educational and organization campaign to reform the offsets.

The California Legislature routinely passes resolutions urging Congress to repeal the offsets. This year it’s SJR 1 by Sen. Jim Beall, D-San Jose. While in the Assembly in 2009, Superintendent of Public Instruction Tom Torlakson carried the resolution.

At an Assembly hearing, Torlakson gave specific examples of teachers hurt by the offsets. “This comes under a couple of possible labels,” he said. “It would be a ‘Catch 22’ or it would be a massive rip-off.”

A law in 2005 requires employers not in Social Security to tell new hires about the offsets. In a 2008 survey of CalSTRS members, 29 percent with Social Security credits were unaware of the income offset, and 44 percent of active members were unaware of the spousal benefit offset.

 

Photo by Stephen Curtin 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 pension reform initiative filed last week requires voter approval of termination fees, the big upfront payment demanded by CalPERS when a plan is closed to new members.

CalPERS says it needs the money to ensure payment of the pensions promised members who remain in the closed plan. The termination fee is calculated by dropping the pension fund earnings forecast from the current 7.5 percent to as low as 2.98 percent.

It’s particularly important because if a closed plan does not have enough assets to pay promised pensions, CalPERS has the power under current law to cut the pensions to the level covered by the assets.

A series of state court decisions, a key one in 1955, are widely believed to mean that the public 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.

But as U.S. Bankruptcy Judge Christopher Klein probed state pension law during the Stockton bankruptcy trail in May last year, David Lamoureux, CalPERS deputy chief actuary, described in detail how CalPERS pensions can be cut outside of bankruptcy.

Ruling that CalPERS pensions can be cut in bankruptcy, Klein said a termination fee that boosted the Stockton pension debt or “unfunded liability” from $211 million to $1.6 billion was a “poison pill” if the city tried to move to another pension provider.

The CalPERS board is said by some to be dominated by public employee union members and their allies. But under the state constitution, CalPERS has a fiduciary duty to give pension protection priority over minimizing taxpayer costs.

Pensions and taxpayers had equal standing until voters approved labor-backed Proposition 62 in 1992, a constitutional amendment giving public pension systems sole control of their assets and actuarial functions after a state “raid” on CalPERS funds.

The initiative filed last week by a bipartisan group is a constitutional amendment that requires voter approval of a “defined benefit pension plan” for new state and local government employees hired on or after Jan. 1, 2019.

Depending on the votes for everything from giant statewide CalSTRS and CalPERS school plans to six-member cemetery district benefits, some current plans could be closed to new members, triggering a termination fee.

If voters then reject a large CalPERS termination fee, would pensions be cut to the level covered by plan assets or would there be a lengthy legal battle?

Vallejo and San Bernardino officials said a CalPERS threat of a costly legal battle, possibly all the way to the U.S. Supreme Court, influenced their decisions not to try to cut pensions in bankruptcy. Stockton officials, on the other hand, said from the outset they wanted to protect pensions.

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VOTER EMPOWERMENT ACT OF 2016

g) Retirement boards shall not impose termination fees, accelerate payments on existing debt, or impose other financial conditions against a government employer that proposes to close a defined benefit pension plan to new members, unless voters of that jurisdiction or the sponsoring government employer approve the fees, accelerated payment, or financial conditions.

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Critics sometimes say of CalPERS, borrowing from an old “roach motel” pesticide commercial and the “Hotel California” pop song: “You can check in, but you can’t check out.”

Several small plans considered leaving CalPERS but did not after looking at a large termination fee. Democrat Chuck Reed, a leader with Republican Carl DeMaio of the bipartisan group that filed the initiative, has first-hand experience with the termination fee.

While he served as mayor of San Jose, Reed and the city council voted unanimously three years ago to explore switching their own retirement plan from pensions to 401(k)-style individual investment plans.

Most San Jose employees are in two large city-run plans. The council considered terminating its own CalPERS plan as a share-the-pain gesture after voters in June 2012 approved a Reed-backed reform that, among other things, cut pensions for new hires.

The small plan created in 1998 for mayors and the city council had about 30 members, 10 retired. The plan had 72 percent of the projected assets needed to pay future pensions, with a pension debt or “unfunded liability” of $976,000.

“CalPERS said, ‘You can write us a check for $5 million,’” Reed said last week.

The price tag was far too high. Reed, barred by term limits from running for re-election, left office in January and receives a CalPERS pension, a benefit that would have been unchanged even if the small plan had switched to 401(k) plans for new hires.

Two small cities, Pacific Grove and Canyon Lake, have looked at leaving CalPERS but balked at the high termination fees. Villa Park officials asked for a termination fee estimate to publicize the high CalPERS termination fee.

The Orange County city, population 5,800, has 30 members in its CalPERS plan, seven active, and contracts for police and firefighter services. The updated Villa Park minimum CalPERS termination fee was $3.7 million.

“We don’t have the money, and we are not going to borrow money,” Villa Park Mayor Diana Fascenelli said in a report last March in the Orange County Register.

For some, the big termination fee for plans closed to new members brings to mind a “Ponzi scheme,” where money needed to pay earlier investors comes from new investors. Reed and a former Villa Park mayor, Rick Barnett, made the comparison.

Gov. Brown had the same reaction to a CalPERS analysis of his proposal to give new hires a federal-style “hybrid” plan, combining a smaller pension with a 401(k)-style plan, that was rejected by the Legislature.

“When I read the PERS analysis they say if you close the system of defined benefit (pensions) and don’t let any more people in, then the system would become shaky — well, that tells you you’ve got a Ponzi scheme,” Brown told legislators in 2011.

During the Stockton bankruptcy trial, Lamoureux, the CalPERS chief deputy actuary, explained why the city had a $1.6 billion termination fee. A low bond-based earnings forecast was used to discount the future pension debt.

After the termination fee is paid, CalPERS becomes responsible for the pension debt and cannot get more money from the local government employer if funds fall short as pensions are paid during the lifetime of the retirees.

If a city cannot pay all of the debt owed for a terminated plan, the CalPERS board has the power to evenly cut pensions to an amount that would be covered by what the city was able to pay.

But after the payment has been made and responsibility for the plan shifts from the city to CalPERS, if the terminated agency pool falls short the funds of all of the state and local government plans in the system could be used to cover the shortfall.

CalPERS keeps a healthy surplus, and a lot of risk-free bond investments, in its Terminated Agency Pool. As of June 30, 2013, the pool had about 90 small plans, $78 million in future pension obligations, $194 million in assets and was 249 percent funded.

For the first time, the CalPERS board was given a detailed annual valuation report of the Terminated Agency Pool last month in addition to the usual briefing on the status of the fund.

Ed Mendel is a reporter who covered the Capitol in Sacramento for nearly three decades, most recently for the San Diego Union-Tribune. Find more of his stories at Calpensions.com.

New state and local government employees hired in California on or after Jan. 1, 2019, could receive a 401(k)-style retirement plan under a proposed initiative — but giving them a pension would require the approval of voters.

The “Voter Empowerment Act of 2016” was filed last week by a bipartisan group led by two men who led local pension reforms approved by voters in 2012 in their cities: former San Jose Mayor Chuck Reed and former San Diego Councilman Carl DeMaio.

Their new drive to cut the cost of pensions said to be eating up government budgets is aided by an unusually low number of voter signatures needed to place a state constitutional amendment on the ballot, 585,407, due to low voter turnout in the previous election.

A Public Policy Institute of California poll issued in January last year said 85 percent of likely voters say pension and retirement costs are “at least somewhat of a problem” for state and local government budgets.

“One idea to deal with the situation is to change the pension system for new employees from defined benefits to a defined contribution system similar to a 401(k) plan,” said a PPIC news release. “Asked about this idea, 71 percent of adults and 73 percent of likely voters support it, with strong majorities across parties in favor.”

Previous PPIC polls also found strong support for switching government employees to 401(k)-style individual investment plans that have replaced pensions in most of the private sector.

Employers make an annual payment to the employee’s tax-deferred investment plan, avoiding the long-term debt of lifetime pensions. And the risk of underperforming investments, expected to pay two-thirds of many pension costs, is shifted to the employee.

But critics say the 401(k) was intended to be a supplement not the main retirement plan, often provides inadequate retirement due to low contributions and poor investment decisions, and is vulnerable to big investment losses shortly before retirement that are difficult to replace.

“It’s exactly what we expected,” Steve Maviglio, a public employee union consultant said after the initiative was filed. “It’s fraught with flaws, potential major implications for both existing and future employees and will likely result in years of litigation.”

Maviglio said a legal and financial analysis of the proposed initiative is being conducted, and its “negative impacts” will be pointed out to the public. Details of fatal flaws may not be revealed until it’s too late in the qualification process for a rewrite.

Reed and DeMaio have experience in battling public employee unions that shaped the 3¼-page proposed initiative. It’s said to have been vetted by legal experts in an attempt to avoid lengthy legal battles.

DeMaio estimated that $2.5 million to $3.5 million will be needed for the signature drive, depending on “games” played by unions. In San Diego, signature gatherers at retail outlets were followed by opponents urging voters not to sign.

Reed dropped a proposed initiative last year after state Attorney General Kamala Harris issued what he said was an “inaccurate and misleading” title and summary making voter approval unlikely if not impossible. He said the new initiative was filed early, allowing time, if needed, for litigation with Harris, who is running for the U.S. Senate.

The California Public Employment Relations Board unsuccessfully sued to keep the San Diego initiative off the ballot. The labor-friendly board also has filed lawsuits against the San Jose measure.

The proposed initiative says “government agencies and retirement boards must fully and faithfully implement voter-approved initiatives” on pay and retirement benefits, “whether placed on the ballot by a government agency or voters.”

Former Gov. Arnold Schwarzenegger briefly backed a proposal in 2005 that would have switched state and local government new hires to 401(k)-style plans, until hard-hitting union television ads said death and disability benefits would be eliminated.

The initiative proposed for the November ballot next year says “nothing in this section shall be interpreted to modify or limit any disability benefits provided for government employees or death benefits for families of government employees.”

A key provision of Reed’s San Jose measure gives current workers the option of paying more for their pension or receiving a lower pension. But it was overturned by a superior court as a violation of “vested rights,” and the ruling is being appealed.

Under the “California rule,” a series of state court decisions, one in 1955, are widely believed to mean that the pension offered on the date of hire becomes a vested right, protected by contract law, that cannot be cut unless offset by a comparable benefit.

The proposed initiative is intended to avoid a legal conflict over the vested rights of current workers, forgoing the San Jose option, the San Diego five-year cap on pay used to calculate pensions or other attempts to quickly get major pension savings.

One of the drivers of “voter empowerment” is a court decision that removed a Ventura County 401(k)-style initiative from the ballot last fall. The judge said a county cannot “opt out” of a pension system on its own, needing state legislation instead.

The proposed initiative does not take effect for new hires until Jan. 1, 2019, allowing time for state and local government to decide on a retirement benefit and then, if it’s a pension, get voter approval. A 401(k)-style plan would not need voter approval.

Government employer costs are limited to 50 percent of the total cost of retirement benefits for new hires, including pensions, 401(k)-style plans and retiree health care. The pension reform Gov. Brown pushed through the Legislature in 2012 is different.

His pension reform calls for a 50-50 split between employers and employees of the pension “normal” cost, which excludes the debt or “unfunded liability” from previous years.

So pension contributions from employers, who must cover pension debt costs, are often two or three times larger than the amount employees pay toward their pensions. The initiative would change that, requiring new hires to pay half the cost of pension debt.

How limiting employers to 50 percent of the total cost would affect a 401(k)-style plan is not clear. Some employers match employee contributions to a 401(k) plan up to a certain amount.

In addition to the public employee union coalition, the proposed initiative will be analyzed by the California Public Employees Retirement System and the California State Teachers Retirement System.

“Comprehensive pension reform has already been enacted for public sector workers in California, and it is anticipated to save tens of billions of dollars,” Brad Pacheco, a CalPERS spokesman, said yesterday. “It reduces benefits for new hires, and current employees are now contributing more each month toward their pensions than in the past.”

Ed Mendel is a reporter who covered the Capitol in Sacramento for nearly three decades, most recently for the San Diego Union-Tribune. Find more of his stories at Calpensions.com

CalPERS is considering small increases in employer and employee rates over decades to reduce the risk of big investment losses, a policy that also would lower an earnings forecast critics say is too optimistic.

The proposal is a response to the “maturing” of a CalPERS system that soon will have more retirees than active workers. From two active workers for each retiree in 2002, the ratio fell to 1.45 to one by 2012 and is expected to be 0.8 to 0.6 to one in the next decades.

As a result, investment losses will trigger bigger California Public Employees Retirement System employer rate increases. It’s a kind of “leveraging” effect as the investment fund becomes increasingly larger than the payroll on which rates are based.

The risk of big investment losses is a threat for other reasons. Funding could drop below 50 percent of the projected assets needed to pay future pensions — a fuzzy red line said to make returning to full funding nearly impossible, requiring onerous rates and unlikely investment returns.

“The concern that I have is that the volatility we have built into the funding system is such that it may cause such severe strain on the employers that they may not be able to make the contributions,” Alan Milligan, CalPERS chief actuary, told a board workshop on risk last month.

The new risk reduction policy is advocated by top staff who took office after CalPERS had huge investment losses in 2008: Milligan, CEO Anne Stausboll, Chief Investment Officer Ted Eliopoulos, and Chief Financial Officer Cheryl Eason.

It’s a sea change from the late 1990s when CalPERS cut employer rates to near zero for two years and sponsored a large retroactive pension increase for state workers, setting a benchmark for local police and firefighter pensions critics say is unsustainable.

Awash in earnings from a booming stock market and a funding level that briefly reached about 135 percent, CalPERS told the Legislature that, due to “superior” investment returns, SB 400 in 1999 would not increase state rates for “at least a decade.”

A 17-page CalPERS brochure on SB400 distributed to the Legislature quoted former CalPERS President William Crist: “This is a special opportunity to restore equity among CalPERS members without it costing a dime of additional taxpayer money.”

But after a market plunge, soaring CalPERS state rates were cited by former Gov. Arnold Schwarzenegger in 2005 as he briefly backed a proposal to switch new state and local government hires from pensions to 401(k)-style individual investment plans.

In 2007 CalPERS was 100 percent funded with investments valued at $260 billion. Then a deep recession and stock market crash in 2008 dropped investments to $160 billion with a funding level of about 60 percent.

Now after an historic bull market, and a rate increase of roughly 50 percent that is still being phased in, the CalPERS investment fund was valued at $303 billion last week with a funding level last June estimated at 77 percent.

In each of the last three years, CalPERS made changes that raised employer rates: the earnings forecast dropped from 7.75 percent to 7.5 percent in March 2012, new actuarial methods in April 2013, and new longevity projections in February last year.

A staff report on risk last November said employer contribution rates for many CalPERS plans are at record highs, exceeding 30 percent of payroll for more than 100 miscellaneous plans and more than 40 percent of pay for 150 police and firefighter plans.

“Employers are reporting that these contribution levels are putting significant strain on their budgets and limiting their ability to provide services to the people in their jurisdictions,” said the report.

The proposal to reduce the risk of investment losses would gradually shift CalPERS to a less “volatile” mix of investments, narrowing up-and-down market swings but also lowering expected earnings.

A gradual increase in employer and employee contribution rates will be needed to offset the lower yield expected from a more conservative investment mix that reduces the risk of a big loss.

CalPERS can only raise employer rates. Employee rates would go up because Gov. Brown’s pension reform requires an equal employer-employee split of the pension normal cost, which excludes debt from previous years.

The risk reduction proposal is a broad concept lacking details that would be added by the CalPERS board. But some samples based on 5,000 simulations of 50-year projections (see below) show small rate increases over decades.

A key step would be slowly lowering the forecast of investment earnings expected to be available to pay or “discount” future pension debt. The current CalPERS earnings forecast or discount rate is 7.5 percent a year.

Critics say the earnings forecast is too optimistic and conceals massive pension debt. Corporate pensions had a discount rate of 4 percent last year. Unlike government employers, corporations can go out of business, so their pensions operate under tighter rules.

The CalPERS proposal has samples of reduced risk and investment volatility that would lower the discount rate to 7 percent or 6.5 percent. In one of the samples, getting to an investment volatility with a discount rate of 6.5 percent takes more than 20 years.

An issue before the CalPERS board last month was whether small cuts in the discount rate would be “flexible,” occurring only in good investment years, or “blended” with a small scheduled cut perhaps every four years.

Two board members said they were concerned about the negative “optics” of a lower discount rate that would increase the pension debt or “unfunded liability.” Theresa Taylor said pension opponents would have more to “latch on to.”

Stausboll said the positive message would be that CalPERS is addressing the discount rate, “the thing I think we get most of the criticism for,” and has a clear plan for “ensuring sustainability” of the pension system.

Several board members said they preferred the blended plan. Its certainty also was favorably mentioned by representatives of the largest state worker union, SEIU, and a statewide firefighter association, who said their groups had not taken a position on the issue.

A decision on the method of lowering the discount rate was delayed to hear from employers and employees. A stakeholder panel has been scheduled Aug. 19, and two employer webinars are scheduled this week.

As part of its risk reduction, CalPERS is developing a “message and communication” plan to show employers that, if they have the means, making additional pension contributions to reduce their unfunded liability makes good business sense.

CalPERS also is getting a legal analysis of offering employers, who currently have no choice of investment mix, the “ability to choose from one or two additional asset allocations” to select their own level of risk.

Photo by  rocor via Flickr CC License