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CalPERS Sues Magnate Barry Diller Over IAC/InterActive Stock Proposal

Pension giant CalPERS has sued business magnate Barry Diller over IAC/InterActive’s plan to implement a dual class stock structure, which the pension fund opposes because it could take power away from public stockholders.

Canadian Pension Fund Buys Into New Zealand With $417m Deal

The Canada Pension Plan Investment Board (CPPIB) has purchased a 50 percent stake in a portfolio of office buildings and shopping centers in New Zealand for $417 million, according to the pension fund.

The portfolio was previously owned by Canadian pension peer PSP Investments; after the deal, PSP and the CPPIB each own a 50 percent stake.

Connecticut Gov, Unions Strike Deal For Longer Timeline on Pension Payments, Lower Discount Rate

Connecticut Gov. Dannel Malloy and a group of unions struck a deal last week that will spread the state’s pension contributions over a longer period of time, thus lowering the short-term cost of those payments.

The deal still needs approval from the legislature; but if they don’t vote on the matter within 30 days of the next legislative session (which begins Jan. 4), the proposal becomes law.

The deal also lowers the assumed rate of return of the state’s pension fund to 6.9 percent from 8 percent.

Cutting California Worker Debt Bigger Than Pensions

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

A new labor contract negotiated by the leaders of a 95,000-member California worker union has a pay raise that, an opposition group said last week, is more than offset by medical costs and Gov. Brown’s push to have workers begin paying toward their retiree health care.

Most California workers contribute 5 to 11 percent of their pay toward their CalPERS pensions, while most state employers contribute 27 percent of pay. The Highway patrol has the highest employer contribution, 50 percent of pay, and an employee rate of 11.5 percent of pay.

But only state employers have been paying for retiree health care during its rapid growth. Until recently, state workers have not paid for a remarkably generous retiree health plan that actually pays more of their health care premium when they retire.

While on the job, the state pays 80 percent of the health care premium for most state workers and their dependents. When most retire, the state pays 100 percent of the average individual premium and 90 percent for dependents, which last year was $1,605 a month.

How did what Brown has called an “anomaly” happen?

Some trace it to a cost-cutting move more than two decades ago by the administration of former Gov. Pete Wilson. Active workers were required to begin paying some of the cost of their health care. No change was made for retiree health care.

At about the same time, legislation by former Assemblyman Dave Elder, D-Long Beach (AB 1104 in 1991) created a fund in the state treasurer’s office to begin “prefunding” state worker retire health care.

Annual payments from the state and workers could go into an investment fund to help cut the long-term cost of retiree health care. Investment earnings are expected to pay two-thirds of the cost of California Public Employees Retirement system pensions.

Prefunding retiree health care also would improve “intergenerational equity,” the fairness principle that public services should be paid for by those that receive them not passed on to future taxpayers. (See previous post: “How pensions pass the buck to future generations”)

But lawmakers had other priorities, and they chose not to put money in the state worker retiree health care fund created by the Elder legislation. Pay-as-you-go state worker retiree health care would go on to become one of the fastest-growing state budget costs.

The state paid $458 million in 2001 (0.6 percent of the general fund) for state worker retiree health care and this fiscal year is expected to pay $2 billion (1.7 percent of the general fund), according to the Finance department. The state payment for CalPERS pensions is $5.4 billion.

Now pay-as-you-go state worker retiree health care, unaided by investment earnings, has created a long-term debt for state worker retiree health care that is larger than the debt for state worker pensions.

The estimated debt or “unfunded liability” for retiree health care promised state workers was $74.1 billion as of June 30, 2015, according to a report issued by state Controller Betty Yee last January.

The unfunded liability for pensions promised state workers was $49.6 billion as of June 30, 2015, according to the CalPERS annual valuation of state worker pension plans issued last April.

Meanwhile, retiree health care from private-sector employers is declining. The number of large private firms (200 or more employees) offering any level of retiree health care fell from 66 percent in 1988 to 28 percent in 2013, a Kaiser report said, and this year dropped to 24 percent.

For government employees, retiree health care from employers is not a given, particularly for teachers who, unlike most state workers, do not receive federal Social Security in addition to their state pensions.

A California State Teachers Retirement System survey in 2011-12 found 11 percent of teachers had no employer retiree health care, 49 percent had some retiree premium support until age 65 and Medicare eligibility, and 29 percent had lifetime employer health care support.

“Postretirement premium support varies by hire date and is decreasing,” said the CalSTRS study.

The tentative contract negotiated with SEIU Local 1000 would be, if approved by members, a big step toward the cost-cutting state worker retiree health care reform Brown announced in January last year.

The administration already has new contracts with several smaller unions that include the retiree health care reforms. Prefunding began in 2010 with the Highway Patrol contributing 0.5 percent of pay, now 2 percent until 2018.

One part of Brown’s plan opposed by unions was rejected by the Legislature last year. An optional low-cost health plan with a high deductible would have taken less from the paycheck, but more from the pocket before insurance begins paying medical expenses.

A key part of the plan is negotiating contracts with prefunding that require workers to pay half of the “normal cost” of retiree health care, the estimated cost of retiree health care earned during a year excluding debt from previous years.

Controller Yee said in her January report that fully prefunding retiree health care and cutting the debt from $74.1 billion to $48.4 billion would have cost $3.99 billion last fiscal year, doubling the pay-as-you-go tab.

For new hires, Brown’s plan requires five more years of service to become eligible for retiree health care. Current workers are eligible for 50 percent coverage after 10 years on the job, increasing to 100 percent after 20 years. The new thresholds are 15 and 25 years.

Retiree health care for new hires is capped at the premium support level they received while on the job, eventually ending the “anomaly” of health coverage increasing on retirement, regarded by some as an incentive for early retirement.

While announcing his state worker retiree health care reform last year, Brown pointed to a chart showing that if no action is taken the debt by 2047-48 grows to $300 billion, but under his plan the debt by 2044-45 drops to zero.

“This is a long-term liability that would only get bigger without taking action,” Joe DeAnda, a spokesman for Brown’s Human Resources department said last week, when asked if the retiree health care reform is still on track to cut the debt as planned.

“Starting to prefund retiree health care, along with the other measures we’ve incorporated into labor contracts during the latest round of bargaining, will eliminate this unfunded liability over the next three decades,” he said.

Brown’s plan asked CalPERS to “increase efforts to ensure” retirees eligible for Medicare at age 65 are switching to lower-cost supplemental plans. Most state workers can retire at age 50. But their pension formula, along with annual service credit, continues to increase until age 63 if they stay on the job.

About 69 percent of retirees are in a Medicare supplemental plan, a CalPERS spokeswoman said last week, and 31 percent are in basic health plans, some ineligible for Medicare for a variety of reasons including age.

A Legislative Analyst’s Office report on state worker retirement health benefits in March last year suggested that the Legislature consider offering new hires an alternative to the current plan, perhaps higher pay and contributions to a retiree health insurance plan.

The Analyst said, among other things, the governor’s plan could “require some employees to pay for benefits they will never receive.” Some state workers may leave before serving the 10 or 15 years needed for minimum retiree health care.

Another potential problem, said the Analyst, is that bargaining to begin prefunding retiree health care may require offsetting pay raises, as happened when Brown negotiated pension cuts for new hires four years ago.

A $1 pay raise for the typical state worker increases state costs by about $1.34 due to Social Security, Medicare, and pensions. The Analyst said a dollar-for-dollar offset, or even 75 cents per dollar, could cost the state more than paying all of the prefunding cost without a worker share.

There “arguably is some ambiguity” about whether state worker retiree is a “contractual obligation” protected from cuts, said the Analyst. (The state Supreme Court has agreed to hear an appeal of a ruling that allows cuts in the pension offered at hire.)

The website of a dissident group said the SEIU Local 1000 president, Yvonne Walker, will “continue to misrepresent the facts regarding retiree healthcare costs as not a protected right.”

The tentative contract has an 11.5 percent pay raise (4 percent in 2017, 4 percent in 2018, and 3.5 percent in 2019) and will take 3.5 percent from paychecks for retiree health care (1.2 percent in 2018, 1.1 percent in 2019, and 1.2 percent in 2020).

“When members factor in the increased out-of-pocket expenses of pre-funding retirement healthcare and increased CalPERS medical costs this is not a raise,” said the website of the dissident group, WeAreLocal1000.

After contract negotiations that began in April stalled, the union announced that it would strike on Dec. 5. The agreement with the Brown administration was announced two days before the strike date.

“Our tentative agreement achieves many of the goals we identified as priorities in four areas: improvements in compensation, professional development, working conditions, and health and safety,” Walker said on the SEIU Local 1000 website. “At the same time, we protected the hard-earned rights we won during previous negotiations.”

U.S. State Pensions Need a Miracle?

Leo Kolivakis is a blogger, trader and independent senior pension and investment analyst. This post was originally published at Pension Pulse.

Frank McGuire of Newsmax Finance reports, Former Fed Adviser: ‘Some Miracle’ Needed to Defuse $1.3 Trillion Pensions Time Bomb:

America will need “some miracle” to survive the looming economic disaster of $1.3 trillion worth of underfunded government pensions, a former Federal Reserve adviser has warned.

“The average state pension in the last fiscal year returned something south of 1%. You cannot fill that gap with a bulldozer, impossible,” Danielle DiMartino Booth told Real Vision TV.

The median state pension had 74.5 percent of assets needed to meet promised benefits, down from 75.6 percent the prior year. The decline followed two years of gains. The shortfall for states overall was $1.1 trillion in 2015 and has continued to grow.

“Anyone who knows their compounding tables knows you don’t make that up. You don’t get that back unless you get some miracle,” Business Insider quoted the president of Money Strong as saying.

“The baby boomers are no longer an actuarial theory,” she said. “They’re a reality. The checks are being written.”

Pressure on governments to increase pension contributions has mounted because of investment losses during the recession that ended in 2009, benefit increases, rising retirements and flat or declining public payrolls that have cut the number of workers paying in. U.S. state and local government pensions logged median increases of 3.4 percent for the 12 months ended June 30, 2015, according to data from Wilshire Associates.

State and local pensions count on annual gains of 7 percent to 8 percent to pay retirement benefits for teachers, police officers and other civil employees. The funds are being forced to re-evaluate projected investment gains that determine how much money taxpayers need to put into them, given the recent run of lackluster returns.

And while many aging Americans have accepted the “new reality” that they would be retiring at 70 instead of 65, any additional extension won’t be welcome. “They’re turning 71. And the physiological decision to stay in the workforce won’t work for much longer. And that means that these pensions are going to come under tremendous amounts of pressure,” she said.

“And the idea that we can escape what’s to come, given demographically what we’re staring at is naive at best. And it’s reckless at worst,” DiMartino Booth said. “And when you throw private equity and all of the dry powder that they have — that they’re sitting on — still waiting to deploy on pensions’ behalf, at really egregious valuations, yeah, it’s hard to sleep at night,” she said.

DiMartino Booth cited Dallas as an example of the pensions crisis, where returns for the $2.27 billion Police and Fire Pension System have suffered due to risky investments in real estate.

“We’re seeing this surge of people trying to retire early and take the money. Because they see it’s not going to be there. And if that dynamic and that belief spreads– forget all the other problems,” DiMartino Booth said. “The pension fund — underfunding is Ground Zero.”

DiMartino Booth warned of public violence if her pensions predictions come to fruition. Large pension shortfalls may lead to cuts in services as governments face pressure to pump more cash into the retirement systems.

“This is where the smile comes off my face. We are an angry country. We’re an angry world. The wealth effect is dead. The inequality divide is unlike anything we’ve seen since the years that preceded the Great Depression,” she said.

To be sure, New Jersey became the state with the worst-funded public pension system in the U.S. in 2015, followed closely by Kentucky and Illinois, Bloomberg recently reported.

The Garden State had $135.7 billion less than it needs to cover all the benefits that have been promised, a $22.6 billion increase over the prior year, according to data compiled by Bloomberg. Illinois’s unfunded pension liabilities rose to $119.1 billion from $111.5 billion.

The two were among states whose retirement systems slipped further behind as rock-bottom bond yields and lackluster stock-market gains caused investment returns to fall short of targets.

Danielle DiMartino Booth, president of Money Strong, is one smart lady. I’ve heard her speak a few times on CNBC and she understands Fed policy and the economy.

In this interview, she highlights a lot of the issues I’ve been warning of for years, namely, state pensions are delusional, reality will hit them all hard which effectively means higher contributions, lower benefits, higher property taxes and a slower economy as baby boomers retire with little to no savings.

I’ve also been warning my readers that the global pension crisis isn’t getting better, it’s deflationary and it will exacerbate rising inequality which is itself very deflationary.

I discussed all this in my recent comment on CalPERS getting real on future returns:

So, CalPERS is getting real on future returns? It’s about time. I’ve long argued that US public pensions are delusional when it comes to their investment return assumptions and that if they used the discount rates most Canadian public pensions use, they’d be insolvent.

And J.J. Jelincic is right, taking too little risk in public equities is walking away from upside but he’s not being completely honest because when a mature pension plan with negative cash flows the size of CalPERS is underfunded, taking more risk in public equities can also spell doom because it introduces a lot more volatility in the asset mix (ie. downside risk).

When it comes to pensions, it’s not just about taking more risk, it’s about taking smarter risks, it’s about delivering high risk-adjusted returns over the long run to minimize the volatility in contribution risk.

Sure, CalPERS can allocate 60% of its portfolio to MSCI global stocks and hope for the best but can it then live through the volatility or worse still, a prolonged recession and bear market?

This too has huge implications because pension plans are path dependent which means the starting point matters and if the plan is underfunded or severely underfunded, taking more risk can put it in a deeper hole, one that it might never get out of.

…

The main reason why US public pensions don’t like lowering their return assumptions is because it effectively means public sector workers and state and local governments will need to contribute more to shore up these pensions. And this isn’t always feasible, which means property taxes might need to rise too to shore up these public pensions.

This is why I keep stating the pension crisis is deflationary. The shift from defined-benefit to defined-contribution plans shifts the retirement risk entirely on to employees which will eventually succumb to pension poverty once they outlive their meager savings (forcing higher social welfare costs for governments) and public sector pension deficits will only be met by lowering return assumptions, hiking the contributions, cutting benefits or raising property taxes, all of which take money out of the system and impact aggregate demand in a negative way.

This is why it’s a huge deal if CalPERS goes ahead and lowers its investment return assumptions. The ripple effects will be felt throughout the economy especially if other US public pensions follow suit.

The point is CalPERS is a mature plan with negative cash flows and it’s underfunded so it needs to get real on its return assumptions as do plenty of other US state pensions that are in the same or much worse situation (most are far worse).

Now, to be fair, the situation isn’t dire as the article above states the median state pension has had 74.5 percent of assets needed to meet promised benefits, down from 75.6 percent the prior year. Typically any figure close to 80% is considered fine to pension actuaries who smooth things out over a long period.

But as DiMartino Booth correctly points out, the structural headwinds pensions face, driven primarily by demographics but other factors too, are unlike anything in the past and looking ahead, the environment is very grim for US state pensions.

Maybe the Trump reflation rally will continue for the next four years and interest rates will normalize at 5-6% — the best scenario for pensions. But if I were advising US state pensions, I’d say this is a pipe dream scenario and they are all better off getting real on future returns, just like CalPERS is currently doing.

Defusing America’s pensions time bomb will require some serious structural reforms to the governance of these plans and adopting a shared-risk model so that the risk of these plans doesn’t just fall on sponsors and taxpayers. Beneficiaries need to accept that when times are tough, their benefits will necessarily be lower until these plans get back to fully funded status.

For Corporate Pensions, November Best Month of 2016 As Funding Status Jumps

The aggregate funding ratio of the country’s largest corporate pension plans climbed significantly in November, jumping 3 percentage points from 77.2 percent to 80.3 percent.

Funding-wise, it was easily the best month of 2016 for corporate pensions.

Does Size Matter For PE Fund Performance?

Leo Kolivakis is a blogger, trader and independent senior pension and investment analyst. This post was originally published at Pension Pulse.

Dylan Cox of Pitchbook reports, Size doesn’t matter in PE fund performance over the long term:

Despite the dueling claims that smaller PE fund managers lack sophistication or sufficient scale, or that larger fund managers lack the nimbleness, operational focus and expertise necessary to improve portfolio companies, returns across different fund sizes are relatively uniform in the long term. 10-year horizon IRRs for PE funds of any size bucket are all between 10% and 11%.

When comparing returns on a horizon basis, it’s important to remember that the data is indicative of market conditions over time, and not the returns of any one vintage. For example, a lower IRR across the industry between the five- and 10-year horizon is not indicative of a loss of alpha-generating capacity after the five-year mark, but rather a reflection of the stretched hold periods and asset write-offs that plagued many PE portfolios during the recession. Similarly, the three-year horizon IRR is the highest we observe, due to the fact that these investments were made before the recent run-up in valuations and have been subsequently marked as such—even though many of these returns have yet to be fully realized through an exit.

Interestingly, funds with less than $250 million in AUM have underperformed the rest of the asset class on a one- and three-year horizon. This is at least partially due to the aforementioned run-up in valuations which stemmed from cash-heavy corporate balance sheets that went looking for inorganic growth through strategic acquisitions—a strategy that often doesn’t reach the lower middle market (LMM) of PE. Only in the last few months have valuations started to rise in the LMM and below, as PE firms of all stripes increasingly look for value plays through add-ons and smaller portfolio companies.

Note: This column was previously published in The Lead Left.

For more data and analysis into PE fund performance, download our new Benchmarking Report.

Let me first thank Ken Akoundi of Investor DNA for bringing this up to my attention. You can subscribe to Ken’s distribution list where he sends a daily email with links to various articles covering industry news here.

As far as this study, I would be careful interpreting aggregate data on PE funds and note that previous studies have shown that there is performance persistence in the private equity industry.

Yesterday I covered why big hedge funds are getting bigger or risk going home. You should read that comment because a lot of what I wrote there is driving the same bifurcation between small and large PE funds in the industry.

Importantly, big institutions looking for scale are not going to waste their time performing due diligence on several small PE funds which may or may not perform better than their larger rivals. They will go to the large brand name private equity funds that everybody knows well because they will be able to invest and co-invest (where they pay no fees) large sums with them.

And just like big hedge funds are dropping their fees, big PE funds are dropping their fees but locking in their investors for a longer period, effectively emulating Warren Buffet’s approach. I discussed why they are doing this last year in this comment.

These are treacherous times for private equity and big institutional investors are taking note, demanding a lot more from their PE partners and making sure private equity’s diminishing returns and misalignment of interests don’t impact their long-term performance.

Still, large PE funds are generating huge returns, embracing the quick flip and reorienting their internal strategies to adapt to a tough environment.

In Canada, there is a big push by pensions to go direct in private equity, foregoing funds altogether. Dasha Afanasieva of Reuters reports, Canada’s OMERS private equity arm makes first European sale:

Ontario’s municipal workers pension fund has sold a majority stake in marine-services company V.Group to buyout firm Advent International in the first sale by the Canadian fund’s private equity arm in Europe.

Pension funds and other institutional investors are a growing force in direct private investment as they seek to bypass investing in traditional buyout funds and boost returns against a backdrop of low global interest rates.

As part of the shift to more direct investment, the Ontario Municipal Employees Retirement System (OMERS) set up a private equity team (OPE) and now has about $10-billion invested.

It started a London operation in 2009 and two years later it bought V.Group, which manages more than 1,000 vessels and employs more than 3,000 people, from Exponent Private Equity for an enterprise value of $520-million (U.S.).

Mark Redman, global head of private equity at OMERS Private Markets, said the V.Group sale was its fourth successful exit worldwide this year and vindicated the fund’s strategy. He said no more private equity sales were in the works for now.

“I am delighted that we have demonstrated ultimate proof of concept with this exit and am confident the global team shall continue to generate the long-term, stable returns necessary to meet the OMERS pension promise,” he said.

OMERS, which has about $80-billion (Canadian) of assets under management, still allocates some $2-billion Canadian dollars through private equity funds, but OPE expects this to decline further as it focuses more on direct investments.

OPE declined to disclose how much Advent paid for 51 per cent of V.Group. OPE will remain a minority investor.

OPE targets investments in companies with enterprise values of $200-million to $1.5-billion with a geographical focus is on Canada, the United States and Europe, with a particular emphasis on Britain.

As pension funds increasingly focus on direct private investments, traditional private equity houses are in turn setting up funds which hold onto companies for longer and target potentially lower returns.

Bankers say this broad trend in the private equity industry has led to higher valuations as the fundraising pool has grown bigger than ever.

Advent has a $13-billion (U.S.) fund for equity investments outside Latin America of between $100-million and $1-billion.

The sale announced on Monday followed bolt on acquisitions of Bibby Ship Management and Selandia Ship Management Group by V.Group.

Goldman Sachs acted as financial advisers to the shipping services company; Weil acted as legal counsel and EY as financial diligence advisers.

Now, a couple of comments. While I welcome OPE’s success in going direct, OMERS still needs to invest in private equity funds. And some of Canada’s largest pensions, like CPPIB, will never go direct in private equity because they don’t feel like they can compete with top funds in this space.

[Note: It might help if OPE reports the IRR of their direct operations, net of all expenses relative to the IRR of their fund investments, net of all fees so their stakeholders can understand the pros and cons of going direct in private equity. Here you need to look at a long period.]

There is a lot of misinformation when it comes to Canadian pensions ‘going direct’ in private equity. Yes, they have a much longer investment horizon than traditional funds which is a competitive advantage, but PE funds are adapting and going longer too and in the end, it will be very hard, if not impossible, for any Canadian pension to compete with top PE funds.

I am not saying there aren’t qualified people doing wonderful work investing directly in PE at Canada’s large pensions, but the fact is it will be hard for them to match the performance of top PE funds, even after fees and expenses are taken into account.

Who knows, maybe OPE will prove me wrong, but this is a tough environment for private equity and I’m not sure going direct in this asset class is a wise long-term strategy (unlike infrastructure, where most of Canada’s large pensions are investing directly).

Hope you enjoyed this comment, please remember to subscribe or donate to PensionPulse via PayPal on the top right-hand side to support my effort in bringing you the every latest insights on pensions and investments [good time to remind all of you this blog takes a lot of work and it requires your ongoing support.]

Brazil’s Pension Overhaul Aims to Save $200 Billion By 2027, Mostly By Cutting Benefits

Brazilian President Michel Temer details of his controversial pension overhaul plan earlier this week, and now further details are coming out about the expected savings the proposal would bring.

The overhaul would raise retirement ages and increase contribution required from workers — in effect, a significant cut in benefits for the country’s workers.

But the plan will bring billions in savings for the country over the next decade, to the tune of $200 billion.

From Reuters:

Brazil’s government expects to reduce expenditures by about 687 billion reais ($200 billion) between 2018 and 2027 with proposed changes to its costly pension system, the government’s pension secretary said on Tuesday.

The proposal to overhaul Brazil’s pension system, seen by investors as the most important of President Michel Temer’s agenda to shore up the country’s public finances, would automatically adjust up the minimum age of retirement as the population’s life expectancy grows, pension secretary Marcelo Caetano said.

Other changes would include removing tax exemptions on revenues from exports and demand rural workers to start contributing to the pensions system, Caetano told journalists.

The controversial pension reform plan at the heart of Temer’s austerity drive aims to shore up an economy mired in its worst recession on record by bringing under control a widening budget deficit. Temer unveiled the reform on Monday by saying it was necessary to avoid a collapse in the pension system.

California Supreme Court Agrees to Rule On Its Own Pensions

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

The California Supreme Court last week agreed to hear an appeal of a groundbreaking ruling that allows cuts in the pensions earned by current state and local government workers, including judges.

When judges have an obvious conflict of interest and excuse themselves from ruling on a case, the legal term is “recuse.”

But the seven Supreme Court justices seem unlikely to recuse themselves from a possible landmark ruling on this Marin County pension case, mainly because there is no clear alternative.

There is at least one well-publicized example of how judges ruling on their own pensions creates the appearance of self-serving, if not what President-elect Trump called a “rigged” system.

As Orange County unsuccessfully tried to overturn a retroactive pension increase for deputy sheriffs, an attorney arguing the case for the deputies in 2011 reminded the judges they were ruling on their own pensions.

“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.

“Then she took a couple of questions and sat down. She gave no legal citations, no elaborate arguments. Nothing,” Moorlach wrote.

The Arizona supreme court had an obvious way to avoid ruling on their own pensions earlier this month. Two appeals court judges sued to overturn reform legislation in 2011 that increased their pension contributions from 7 percent of pay to 13 percent.

Four Supreme Court justices appointed before 2011 recused themselves, leaving the decision to a panel of one Supreme Court justice and four lower-court judges who took office after 2011 and were not affected by the reform.

The panel overturned the reform on a 3-to-2 vote, costing the Arizona Public Safety Personnel Retirement System an estimated $220 million in back payments and adding $1.3 billion to the pension debt or “unfunded liability.”

The majority ruled that the pension promised at hire becomes a contract that can’t be cut, the Associated Press reported. The minority, including Justice Clint Bolick, said freezing contributions could jeopardize the pension plan.

Arizona switched new judges and elected officials to 401(k)-style plans in 2013, limiting pensions from the system to police, firefighters and correctional officers. A pension reform approved by voters earlier this year is projected to save $475 million.

In Rhode Island last year, an embattled judge who refused to recuse herself approved a settlement of union suits against major cost-cutting reforms after accepting a state motion to have a jury hear the cases.

A nationally known lawyer, David Boies, and others urged Superior Court Judge Sarah Taft-Carter to recuse herself because the ruling could affect her pension in addition to the pensions of her son, mother and uncle.

“If my financial interest should require disqualification, then all other state judges would be similarly required to recuse themselves,” Taft-Carter told the New York Times. “Plaintiffs brought this case the way they did to try to avoid federal jurisdiction,” Boies said.

The settlement retained 92 percent of the $4 billion savings expected from reforms that increase the retirement age, shift workers to a federal-style hybrid plan combining smaller pensions with a 401(k)-style plan, and suspend cost-of-living adjustments, the Providence Journal reported.

The Journal said giving the cases to a jury would make it more difficult for unions to prove that pensions are implied contracts. The leader of the reforms, Treasurer Gina Raimondo, who became governor, argued that pensions created by statute can be amended like statutes.

In California, some union suits challenging cost-cutting reforms in retiree health care have been filed in federal court, where judges have no state conflict. Pension suits are rarely if ever filed in federal court.

Landmark guidelines issued in a retiree health care case five years ago seemed to show federal court deference to state law and may foreshadow how the state Supreme Court will view the new pension case.

An agreement negotiated with Orange County unions in 2008 separated active and retired worker health care premiums, ending a pool begun in 1985 that raised county costs but cut payments by retirees because their age-related coverage costs more.

When the cut was upheld by a district court and appealed by retirees, the federal 9th circuit court asked the state Supreme Court: “Whether, as a matter of California law, a California county and its employees can form an implied contract that confers vested rights to health benefits on retired county employees.”

The state Supreme Court unanimously said in 2011 that a contract with vested rights “can be implied under certain circumstances from a county ordinance or resolution” if an intent to do so can be shown by evidence.

A federal district court, following the new state guidelines, again ruled that Orange County can end the retiree health care pool. The federal 9th circuit panel upheld the ruling in 2014.

The Marin County appellate court ruling in August gave new hope to cost-cutting pension reformers, and alarmed pension advocates, by breaking with what has become known as the “California rule”:

Pensions offered at hire become vested rights, protected by contract law, that can only be cut if offset by a comparable new benefit, which erases employer savings and limits most reforms to new hires without vested rights.

The rigid contract rule created by California judges in previous rulings (not by legislation, as reformers like to point out) has only been adopted by a dozen states. There is no similar rule for the remaining private-sector pensions regulated by a 1974 federal law.

With a section on the “emergence of the unfunded pension liability crisis,” the unanimous ruling by a three-member appellate panel in the Marin County case is aimed at allowing flexible cuts in growing pension costs that are taking funding from basic government services.

The bipartisan Little Hoover Commission and other reformers argue that allowing cuts in the pensions earned by current workers in the future, while protecting pensions already earned, is urgently needed to cut budget-devouring costs and make pensions affordable in the future.

Observing the California rule, Gov. Brown’s modest pension reform only applies to new hires, taking decades to yield significant savings. The reforms cover CalPERS, CalSTRS and county systems, but not UC and the half dozen troubled big-city pension systems.

The reform also exempts new judges from some of the cost-cutting provisions, lower pensions and a cap on total pension amounts. Judges often seem to be treated like a special case by the Legislature and the California Public Employees Retirement System.

Among CalPERS plans only judges have the most generous pension formula because they tend to enter the system at a later age and retire late. And only judges are eligible for retiree health care that pays 100 percent of the premium after 10 years of service, not 20 years like most state workers.

In addition, the main judges plan was 100 percent funded last year, far above 68 percent for the average CalPERS plan this year.

Judges hired before Nov. 9, 1994, are still in the only CalPERS pay-as-you-go plan with no investment fund. An annual CalPERS letter urging “prefunding” of the old plan said long-term costs would be cut and retirees assured of a pension check, if legislative funding is delayed.

Lawmakers and judges can clash. A superior court judge awarded judges back pay with 10 percent interest of about $5,000 per judge and a pension increase, ruling that a five-year salary freeze did not keep pace with increases in state worker pay as required by law.

Brown pushed legislation this year to end the link with state worker pay, Courthouse News Service reported, which would force judges to “beg” lawmakers for pay raises. Compromise legislation kept a modified state worker link, but sharply cut the back pay interest to about 0.5 percent of pay.

The Marin County case accepted by the Supreme Court last week is a union challenge to “anti-spiking” provisions in Brown’s reform legislation that prevent pensions from being boosted by stand-by duty, in-kind health care and other things.

The Supreme Court said it will delay action on the Marin case until an appellate court rules on similar union challenges to Brown’s “anti-spiking” reform in a consolidation of cases from Alameda, Contra Costa and Merced counties.

401k Plans “Very Concerned” About Being Sued: Report

A majority of 401k sponsors, big and small, are concerned about being sued, according to new research from Cerulli Associates.

Most of the lawsuits have so far targeted massive plans, but even small plans are feeling the heat. And it’s having an effect on investment strategy, as many plans consider a more passive approach amid scrutiny of fees.

From 401kSpecialist:

More than half of 401k plan sponsors express concern over potential lawsuits, new research from Cerulli Associates finds.

[…]

Survey data shows that smaller 401k plan sponsors are also taking notice of this increasingly litigious environment, as reflected by the nearly one-quarter of small plan sponsors (less than $100 million in 401k assets) who describe themselves as “very concerned” about potential litigation.

In particular, fee-related lawsuits have been a pervasive theme in the 401k plan market in 2016, further underscoring the 401k industry’s intense focus on reducing plan-related expenses. A significant consequence of this focus on fees is an increased interest in passive investing.

Plan sponsor survey results show that the top two reasons for which 401k plan sponsors choose to offer passive (indexed) options on the plan menu are because of “an advisor or consultant recommendation” or because they “believe cost is the most important factor.”

Several defined contribution investment only (DCIO) asset managers tell Cerulli that the demand for passive products is driven, primarily, by the desire to reduce overall plan costs.

“As advisors become increasingly fee conscious, some view passive options as a way to drive down overall plan expenses, which in turn demonstrates their value to the plan,” Jessica Sclafani, associate director at Cerulli, said in a statement.

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