In a First, CalSTRS May Set State and Teacher Rates

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.

Actuaries are recommending that one of California’s oldest public pension systems, the California State Teachers Retirement System formed in 1913, lower its investment earnings forecast from 7.5 percent to 7.25 percent.

If the newly empowered CalSTRS board adopts the lower forecast next week, state rates paid to the pension fund would increase by 0.5 percent of pay, an additional $153 million bringing the total state payment next fiscal year to $2.8 billion.

Rates paid by an estimated 80,000 teachers hired after Jan. 1, 2013, when a pension reform lowered benefits, also would increase by 0.5 percent, taking about $200 a year from the average salary of $40,000.

The new rate-setting power is sharply limited. But it’s a big change for CalSTRS which, unlike nearly all California public pension funds, has lacked the power to raise employer rates, needing legislation instead.

CalSTRS could only plead with the Legisture for a rate increase as the funding level of its projected assets needed to pay future pensions fell from 120 percent in 2000 to less than 60 percent in 2009. Now despite a long bull stock market, the funding level will drop from 69 percent to 64 percent if the new forecast is adopted.

Legislation expected to put CalSTRS on the path to reaching 100 percent by 2046 was finally enacted three years ago. Most of the increased cost will come from school districts as their rates more than double, gradually going from 8.25 percent of pay to 19.1 percent in 2020.

The long phase in of the school district rates, which increase to 14.43 percent of pay in July, is already said by some to be severely squeezing money available for student services and teacher pay raises.

The legislation gave CalSTRS very limited power to raise school district rates beginning in 2021. Any increase is limited to 1 percent of pay a year, and the total school district rate cannot exceed 20.25 percent of pay.

The legislation increased the state rate from 4.5 percent of pay to the current rate of 8.8 percent. In its biggest power boost, CalSTRS was authorized to raise state rates 0.5 percent of pay a year, reaching a maximum of 23.8 percent before the legislation expires in 2046.

Teachers had been paying about the same CalSTRS rate as school districts, 8 percent of pay compared to the 8.25 percent for their employers. The legislation increased the rate paid by teachers hired before Jan. 1, 2013, to 10.25 percent of pay.

Their rate was capped by “California rule” court decisions that pensions offered at hire can’t be cut, unless offset by a new benefit. The new benefit for teachers hired before 2013 made a routine annual 2 percent cost-of-living adjustment a vested right that can’t be cut.

Rates paid by teachers hired after 2012, however, were not capped but are limited. The reform calls for an equal employer-employee share of the “normal” cost, the pension earned during a year excluding the often larger debt or “unfunded liability” from prior years.

It’s the requirement that teachers hired after the pension reform pay half the normal cost that would trigger the 0.5 percent of pay CalSTRS rate increase for some teachers, if the earnings forecast used to “discount” future pension costs is lowered to 7.25 percent.

About 20,000 new hires have been hired during each of the last three years. So, CalSTRS estimates that 80,000 teachers with the new 2% at age 62 formula, about 20 percent of the total, would get a rate increase in July if the earnings forecast is lowered to 7.25 percent.

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The CalSTRS board may decide whether to use its new rate power for the first time at a meeting next Wednesday (Feb. 1) in San Diego, which can be viewed by webcast after clicking on a tab on the CalSTRS website.

The board will receive an “actuarial experience” study, the first in five years. The consulting actuary, Milliman, found that over the next 30 years the life span of the average retiree is expected to increase by three years.

The report recommends lowering the earnings forecast to 7.25 percent because “there is a less than 50 percent probability” of a 7.5 percent return over the long term, based on “capital market assumptions” and dropping the inflation forecast from 3 to 2.75 percent.

“Going to 7.00% would be an acceptable alternative if the board wanted to add another level of conservatism in the actuarial assumptions by increasing the likelihood the investment assumption will be met long term,” the report said.

The state budget proposed by Gov. Brown for the new fiscal year beginning in July assumes a $153 million increase in the state payment based on a lower 7.25 percent earnings forecast.

If the earnings forecast was dropped to 7 percent, the report said, the state rate would be expected to increase 0.5 percent a year for 10 years, instead of for five years as expected under a 7.25 percent forecast.

For teachers hired after 2012 that receive lower pensions under the reform, the rate increase next year would be 1 percent of pay or about a $400 a year pay cut for the average teacher, instead of 0.5 percent of pay and a cut of $200 a year.

Though it’s not recommended, the report said the CalSTRS board could decide to leave the earnings forecast at 7.5 percent, with no rate increase for the state and new teachers, and still be on a path to full funding by 2046 because of its new power to raise rates later.

Whether earnings forecasts used by public pension funds to discount future pension obligations are too optimistic, and thus conceal massive debt, is one of the main disputes in the debate over the need for more cost-cutting reform.

The Pension Tracker at Stanford University, for example, shows that California public pension systems report a debt or unfunded liability of $228.2 billion using a 7.5 percent discount rate. The debt soars to $969.5 billion if the discount rate is 3.25 percent as used by CalPERS for terminated plans.

The California Public Employees Retirement System, which has different investment allocations and pension costs than CalSTRS, dropped its earnings forecast from 7.5 percent to 7 percent last month, causing a major rate increase that will be phased in over eight years.

The lower earnings forecast dropped the CalPERS funding level from 69 percent to 64 percent, Ted Eliopoulos, CalPERS chief investment officer, told Bloomberg News earlier this month. (As previously noted, the CalSTRS funding level also could drop from 68.5 to 64 percent.)

Consultants told CalPERS last spring that its investment portfolio would probably earn only 6.2 percent during the next decade. Higher earnings in the following decades were expected to keep earnings above 7.5 percent in the long run, a point cited by early opponents.

CalPERS staff met with employer groups, public employee union leaders, and retiree associations to explain the need for a rate increase. The Brown administration reportedly helped negotiate an agreement, and the lower forecast was adopted with little opposition.

While describing the process that resulted in the lower CalPERS earnings forecast, the new CalSTRS report said CalPERS has not yet released an official estimate of the rate increase for non-teaching school employees.

“However, information presented at the CalPERS Board meeting in December indicates the contribution rate for school employers will likely double from its current level of 13.888 percent of payroll,” said the CalSTRS report.

CalPERS had no immediate comment on the CalSTRS report yesterday.

The new CalPERS rate increase is the fourth in recent years: earnings forecast lowered from 7.75 percent to 7.5 percent in 2012, actuarial method no longer annually refinances debt in 2013, and a longer average life span for retirees in 2014.

In California, Another Ruling Says Pension Set At Hire Can Be Cut

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 second appeals court panel has unanimously ruled that the public pension offered at hire can be cut without an offsetting new benefit, broadening support for what pension reformers call a “game changer” if the state Supreme Court agrees.

The new ruling on Dec. 30 in a state firefighters suit on pension-boosting “airtime” purchases made several references to a groundbreaking ruling last summer in a Marin County pension “spiking” suit.

“The law is quite clear that they are entitled only to a ‘reasonable’ pension, not one providing fixed or definite benefits immune from modification or elimination by the governing body,” wrote Justice Martin Jenkins.

The two appeals court rulings are contrary to previous rulings known as the “California rule”: The pension offered at hire becomes a vested right, protected by contract law, that can only be cut if offset by a comparable new benefit, erasing any savings.

Most pension reforms are limited to new hires (who are not yet vested), taking decades to yield significant savings. To get major savings, some reformers want to cut the pensions of existing workers, protecting what’s already earned but reducing future pension earnings.

A key to the California rule is a 1955 Supreme Court ruling (Allen v. City of Long Beach) that “reasonable” pension changes should be related to the theory and “successful operation” of a pension system and any disadvantage “should be accompanied by comparable new advantages.”

The Marin appellate ruling argued in detail that “should” have comparable new advantages, which is only advisory, had somehow become a mandatory “must” have comparable new advantages in the series of California rule cases.

“We agree with this conclusion reached by our colleagues,” Jenkins wrote.

Justice Jenkins
Unions argued in the Marin and firefighters suits that the California rule prevented the bans on “airtime” and “spiking” for existing workers in a pension reform enacted four years ago by Gov. Brown and the Legislature.

Cal Fire Local 2881 (formerly known as CDF Firefighters) sued the California Public Employees Retirement System to resume employee airtime purchases, citing CalPERS’ own publication saying vested pension rights begin when members start work.

“Public employees obtain a vested right to the provisions of the applicable retirement law that exists during the course of their public employment. Promised benefits may be increased during employment, but not decreased, absent the employees’ consent,” said the CalPERS publication.

Critics of the California rule argue that if the employee’s job and pay can be cut, why can’t the pension legally regarded as “deferred compensation” be cut? The brief 1955 Allen ruling gives no rationale for a “comparable new advantage.”

The CalPERS response to the firefighters said the pension system could not resume airtime purchases without a determination that the ban is unconstitutional. The trial court held airtime “was not a vested right,” said CalPERS, “and even if it were, the Legislature could eliminate it.”

Legislation sponsored by the California Professional Firefighters and the Service Employees International Union (AB 719 in 2003) allowed employees in CalPERS to increase their pensions by purchasing up to five years of additional service credit, the maximum allowed by federal tax law.

The program intended to have no cost to employers was informally called “airtime” because no work was performed for the service credit. Airtime yielded a lifetime monthly retirement payment, with no risk of investment losses, based on the earnings forecast assumed by CalPERS at the time of purchase.

The earnings forecast was 8.25 percent a year when the program began in 2003, but had dropped to 7.5 percent by the time the program ended in 2012. The CalPERS board acted last month to gradually drop the earnings forecast to 7 percent over the next eight years.

“It’s a tremendous investment,” Dan Pellissier, president of California Pension Reform, a former gubernatorial and legislative aide who purchased airtime, said in 2012. “I think all of the investment advisers say it’s a no-brainer.”

As it turned out, airtime was an even better deal than the purchasers thought. The trial court ruling in the firefighters suit said CalPERS discovered some time after April 2010 that it had been charging purchasers less than the actual cost of airtime.

The CalPERS “Review of Additional Retirement Service Credits” study said in effect “that in selling Airtime to state employees CalPERS was selling $1.00 worth of benefits for between $0.72 and $0.89,” wrote Alameda County Superior Court Judge Evelio Grillo.

The study was not available from CalPERS last week. A CalPERS spokeswoman said about 61,217 members purchased airtime from Jan. 1, 2004, when the program began through Dec. 31, 2012, when it ended.

There was no significant increase or rush to purchase airtime between the passage of the reform legislation in October 2012 and when the ban took effect at the end of that year, the spokeswoman said. There were 363 airtime purchases in October, 376 in November and 386 in December.

CalPERS members could pay the full cost of airtime with a lump sum or select a payment plan of up to 15 years. Interest was charged on the unpaid balance at the current “crediting rate,” which was 6 percent compounded annually in 2003.

The elimination of airtime was part of Brown’s 12-point pension reform plan issued in 2011.

“Pensions are intended to provide retirement stability for time actually worked,” said Brown’s point No. 10. “Employers, and ultimately taxpayers, should not bear the burden of guaranteeing the additional employee investment risk that comes with airtime purchases.”

The ruling in the Marin suit allows the county, with no offsetting new benefit, to impose the spiking ban in the 2012 reform legislation that prevents existing workers from continuing to boost pensions with standby pay, call-back pay, and other things.

The state Supreme Court has agreed to hear an appeal of the Marin ruling. But the high court will wait until an appeals court rules on three similar spiking ban suits consolidated from Alameda, Contra Costa, and Merced counties.

Last month, yet another three-justice appeals court panel upheld a denial of a claim by San Joaquin County correctional officers that the 2012 pension reform prevented an end to county payments toward their cost-of-living adjustments until 2018.

This appeals court ruling included lengthy quotes from the Marin ruling about how the 2012 pension reform was a response to a pension funding “crisis” that will force cuts in local government services and layoffs if not corrected.

“We express no view about the Marin Assn. court’s interpretation of precedent regarding the validity of changes to retirement benefits,” said a footnote in the San Joaquin ruling. “We merely agree with its account of the historical backdrop animating recent pension reform legislation in California.”

CalPERS Acts to Cut Earnings Forecast, Raise Rates

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 key committee last week approved a drop in the often-criticized CalPERS investment earnings forecast, gradually raising record rates already being paid by state and local governments. The change was then approved, as expected, by the full board.

The earnings forecast will drop from 7.5 percent to 7 percent, giving the nation’s largest public pension fund one of the most conservative forecasts, possibly setting a nationwide trend in the view of some.

But the painful and costly drop in the forecast used to “discount” or offset future pension obligations is still well above the 6.2 percent earnings forecast expected by CalPERS consultants during the next decade, which drove the action to drop the forecast.

Acting this month, rather than in February as some expected, seemed to reflect a general agreement and sense of urgency among employers and employees. As of last June, the CalPERS funding level fell to 68 percent of the projected assets needed to pay future pensions.

“It’s a little bit of pain for everyone,” said CalPERS President Rob Feckner, noting that five groups had come together on the action: labor, employers, the Brown administration, CalPERS staff, and the CalPERS board.

The committee approved a plan that would lower the earnings forecast or discount rate over three years, beginning with the state next year. Schools were split from the state and would begin in 2018 along with local governments.

The rate increase from a lower discount rate is phased in over five years. Some employee rates will go up, particularly for those hired after a pension reform in 2013 requiring them to pay half the “normal” cost, excluding debt from previous years.

When fully phased in the lower discount rate will cost the state an additional $2 billion, Eric Stern of Brown’s Finance department told the committee, half from the general fund that contributes $5.4 billion to CalPERS this year and the other half from special funds.

The rate increase comes in the middle of the usual four-year cycle for setting a discount rate. Wilshire and other consultants think that for several reasons global economic conditions have deteriorated since the current discount rate was reaffirmed at 7.5 percent two years ago.

Another sign of how seriously CalPERS regards the market change was the announcement Monday that, in a closed September session, the asset allocation of the $303 billion portfolio had been changed to reduce growth investments and the risk of losses.

Global equity investments were reduced from 51 percent to 46 percent of the portfolio, private equity dropped from 10 percent to 8 percent. Inflation assets increased from 6 to 9 percent, cash from 1 percent to 4 percent, and real estate from 12 to 13 percent.

Ted Eliopoulos, CalPERS chief investment officer, said the announcement was delayed to allow time for CalPERS to make some of the fund transfers. CalPERS investment changes often are not announced until later to avoid moving the markets.

At the Finance committee yesterday, board member J.J. Jelincic said the new asset allocation dropped the earnings forecast to 6.25 percent. His motion to drop the discount rate to 6.25 percent died without a second.

Staff told the committee that Jelincic’s assumption that the new allocation is expected to yield 6.25 percent is correct for the next decade. But the 7 percent discount rate is supported by the long-term yield over three decades.

At the Investment committee on Monday, Jelincic said CalPERS members need to know what’s being done with their money. His request for the public release of part of the transcript of the closed session, along with the agenda item, was referred to legal counsel.

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Part of the urgency for action is that the underfunded California Public Employees Retirement System is unusually vulnerable to a major investment loss, unlike 2007 when it went into the deep recession and stock market crash with a funding level of 101 percent.

Two years ago, when the current 7.5 percent discount rate was reaffirmed, the funding level was estimated to be 77 percent, up from a low of 61 percent in 2009 after the CalPERS investment fund dropped from about $260 billion to $160 billion.

But since 2014, the economic outlook has declined and CalPERS investment earnings were well below the 7.5 percent target (0.6 percent last fiscal year and 2.4 percent the previous year), dropping the funding level to 68 percent as of June 30 this year.

“In all the data that (staff and consultants) have presented to us and that I’ve read, you drop to a level of 50 percent and it’s a point of no return as we know a pension system today,” board member Henry Jones said. “You may return, but it won’t be the same.”

Some think raising rates and the discount rate high enough to project 100 percent funding would become impractical. CalPERS is a mature system with the number of retirees soon expected to outnumber active workers.

Investment funds must be sold to pay pensions now, about $5 billion this year to add to $14 billion from employer-employee contributions to pay $19 billion for the pensions of the retirees. Reducing this growing “negative cash flow” is one of the reasons for raising rates.

Critics contend that an overly optimistic discount rate hides massive national state and local government pension debt. They argue that a risk-free discount rate should be used to aid “intergenerational equity” and reduce debt passed to future generations.

But the cost of using a risk-free rate to discount risk-free pension debt, following a basic finance principle, also would be massive. The yield on a 20-year Treasury bond early this month was about 3 percent.

Since the recession, CalPERS employer rates have increased roughly 50 percent. The discount rate was dropped from 7.75 to 7.5 percent in 2012. An actuarial method that no longer annually refinances debt was adopted in 2013.

The rate increase from a longer average life expectancy for retirees adopted in 2014 is still being phased in over a five-year period.

Some board members, perhaps referring to advance coverage of their meeting in the national media, said that a widely watched lowering of the discount rate by CalPERS would set a good example for other public pension funds.

“The recommendation before us gives us a chance to be a leader in the nation in responsible pension funding, and I think from a reputational perspective that is something it’s time for this system to take the lead on,” said board member Richard Gilliahan, Brown’s Human Resources director.

Board members also expect criticism that the discount rate was not dropped far enough. But state Controller Betty Yee and other board members said they will continue to work on the issue during the process leading to the scheduled rate review in 2018.

“This is all about the long-term sustainability of the fund,” said Richard Costigan, the Finance committee chair. “We are going to continue to have a robust discussion. This is just the start.”

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.

Legislative Analyst's Office report, March 16, 2015, p. 6

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.”

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.

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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.

CalPERS, CalSTRS Considering More Rate Increases

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 state’s two largest public pension systems never recovered from huge investment losses during the deep recession and stock market crash in 2008. CalPERS lost about $100 billion and CalSTRS about $68 billion.

Now after a lengthy bull market, most experts are predicting a decade of weak investment returns, well below the annual average earnings of 7.5 percent that CalPERS and CalSTRS expect to pay two-thirds of their future pension costs.

The two systems are still seriously underfunded, CalPERS at 68 percent and CalSTRS at 65 percent. This is not money in the bank. It’s an estimate of the future pension costs covered by expected employer-employee contributions and the investment earnings forecast.

Last week, the CalPERS and CalSTRS boards got separate staff briefings on how the “maturing” of the two big retirement systems creates new funding difficulties. Both are nearing a time when there will be more retirees in the system than active workers.

The California State Teachers Retirement System board, for example, was told that in 1971 there were were six active workers in the system for every retiree. Today CalSTRS only has 1.5 active workers for every retiree, similar to the CalPERS ratio.

A wave of baby boom retirees that began around 2011, and the continuing increase in the average life span of retirees, have added to the growing cost of paying pensions, giving both systems what actuaries call “negative cash flow.”

The annual cost of paying pensions is more than the annual contributions from employers and employees. So, the pension funds are forced to “eat their seed corn” by selling some investments to cover the gap, thus reducing potential investment earnings.

The California Public Employees Retirement System had about $14 billion in contributions in fiscal 2015-16 and pension payments totaling $19 billion. By 2035, the board was told, contributions are expected to be $17 billion and pension payments $35 billion.

Mature pension funds also have another difficulty. The pension investment fund becomes much larger than the active worker payroll, which means that replacing an investment loss requires a larger employer contribution increase.

The CaSTRS board was told that replacing a 10 percent investment loss in 1975, when the teacher payroll and investment fund were about equal, would have required a contribution increase of 0.5 percent of payroll.

Replacing a 10 percent investment loss today, when the investment fund is six times greater than the payroll, requires a contribution increase of 3 percent of pay. CalSTRS has had losses of 10 percent (below the 7.5 percent forecast) four times in the last two decades.

Both systems recently adopted modest “risk mitigation” strategies to reduce losses. When CalPERS earns 11.5 percent or more, half of the excess will be shifted to conservative investments. CalSTRS is shifting 9 percent of its fund to more conservative investments.

Gov. Brown’s modest cost-cutting pension reform gives new CalPERS and CalSTRS employees hired after Jan. 1, 2013, lower pension formulas, capped at the upper end, and possibly higher contributions. Significant employer savings are decades away.

Meanwhile, CalPERS and CalSTRS are still phasing in record high employer contribution increases. And both will be considering more rate increases in the next several months.

Chart

A CalPERS rate increase of roughly 50 percent was enacted in three consecutive years: a lower earnings forecast in 2012, an actuarial method that no longer annually refinances debt in 2013, and a longer average life expectancey for retirees in 2014.

A staff survey of more than 600 CalPERS employers in October and early this month found that most are aware of discussions about another drop in the earnings forecast used to “discount” pension debt.

Nearly two-thirds have begun planning for a rate increase with budget forecasts and 13 percent are “prefunding” by contributing more than the required rate. Their top priorities are less volatile and more predictable rates and a phase-in rather than lump-sum increase.

A League of California Cities lobbyist, Dane Hutchings, told the board the association has no formal position on another rate increase. But he thinks most cities expect an increase and pressure to improve funding after new accounting rules expose more pension debt.

Pensions are needed to help cities remain competitive in the job market, Hutchings said, but another rate increase will be painful for some. “We have cities that are very close to filing for bankruptcy,” he said.

The governor unsuccessfully pushed for a major CalPERS rate increase when the risk mitigation streategy was adopted last year. The CalPERS staff is concerned that its consultant, Wilshire, dropped its 10-year earnings forecast to about 6.1 percent, echoing many experts.

“Given that, we think it’s appropriate for this committee to look at our discount rate,” said Ted Eliopoulos, CalPERS chief investment officer.

A Wilshire consultant, Andrew Junkin, told the board the 30-year earnings forecast is still 7.5 percent or more. But, he added, that assumes there is no major investment loss, like one big enough to cause officials to question whether the state should continue to offer pensions.

“I’ll use this phrase, I don’t mean to be inflammatory, there could be a return that puts you out of business somewhere before you get to year 30,” Junkin said.

CalPERS was 100 percent funded in 2007 before the stock market crash dropped funding to 61 percent. Experts have told CalPERS, now only 68 percent funded, that if funding drops below 50 percent getting back to full funding could require impractical rate increases and earnings forecasts.

The board was told that a rate increase must be approved by April to take effect for the state and schools in the new fiscal year beginning next July and for local governments in July 2018.

Supporters suggested a rate increase by April would allow a phase in before a recession, if one is on the way, while being fiduciarily responsible. “Pay now or pay more later,” said board member Richard Gillihan, a Brown administration official.

Alarmed union representatives, backed by some board members, urged the board to go slow and follow the regular two-year process leading to a full “asset liability management” review scheduled in 2018.

Dave Low of the California School Employees Association said many non-teaching school workers have not had a pay raise for five or six years. He said if Brown is not putting money in the state budget to offset a rate increase his members could be harmed.

“If you’re not at the table, you’re probably on the menu,” Low said, apparently referring to an old saying about labor bargaining. “We feel like we are on the menu in this discussion.”

With the consent of other board members, Richard Costigan, chairman of the CalPERS fionance committee, directed staff to prepare a report for the December board meeting on a vote for a rate increase by April.

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Unique among large California public pension systems, CalSTRS has been unable to raise employer rates, needing legislation instead. That changed with a long-delayed rate increase two years ago that is phasing in a $5 billion rate increase over seven years.

School district rates will more than double, going from 8.25 percent of pay to 19.1 percent by July 2020. Teachers got a small rate increase, going from 8 percent of pay to 10.25 percent for most and to 9.21 percent for teachers hired after the reform on Jan. 1, 2013.

The state rate (a way that CalSTRS remains unique, since other systems only get contributions from employers and employees) is scheduled to go from 5.5 percent of pay to 8.8 percent.

The legislation also gave the CalSTRS board the new power to raise annual rates for the deep-pocketed state, limited to a 0.5 percent of pay each year. And now for the first time, the CalSTRS board is scheduled to consider an annual state rate increase next April.

If the board maximizes its new power, the current state rate of about 6 percent of pay theoretically could go to 21 percent before the legislation expires in 30 years, when the system would be fully funded if investments hit their earnings target, the board was told last week.

The legislation gave the CalSTRS board another new power to annually adjust school district rates beginning July 1, 2021. But the employer rate is capped at 20.5 percent of pay, allowing only small changes in the phased-in rate reaching 19.1 percent by 2020.

“There is no need to increase state contributions further, based on what we have seen to date, even with the 1 percent return last year,” David Lamoureux, a CalSTRS actuary, told the board last week.

The CalSTRS board is scheduled to review “actuarial assumptions” in February, including estimates of the average retiree life span and probably a discussion of the earnings forecast.

“There is a possibility, depending on where we end up with the assumptions, that it could trigger an increase in the normal cost of more than 1 percent (of pay), and it could increase the member contribution rate,” Lamoureux said.

The “normal” cost is the rate for the pension earned during a year, excluding the debt or “unfunded liability” from previous years usually resulting from investment earnings that fall below the forecast.

Under the pension reform, employees are required to pay half of the normal cost when it increases by 1 percent or more.

CalPERS Cuts Tiny Town’s Pensions By 60 Percent

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.

Doing what it has never done before, the CalPERS board voted yesterday to slash the pensions of all five former employees of a small Sierra County town, Loyalton, by an estimated 60 percent.

It’s a rare situation in which Loyalton, population 769 in the last census and shrinking since the closure of a century-old sawmill in 2001, voluntarily terminated its CalPERS contract in March 2013 without paying off its $1.7 million pension debt.

A New York Times headline last month said the nation’s largest public pension fund ($300 billion) giving little Loyalton a pay-up-or-else ultimatum would be a “test of ‘bulletproof’ public pensions.”

A staff report said CalPERS went to unusual lengths to avoid blowing a big hole in the Loyalton pensions — 50 telephone calls and 10 collection notices — and waited more than three years before pulling the trigger on the deep pension cuts.

A divided Loyalton city council attempted to get back into CalPERS, talked about getting a loan with installment payments, and pleaded ignorance about the need to pay off the big debt to preserve the pensions of four retirees and one person not yet retired.

The division continued yesterday after the CalPERS board was told the Loyalton city council voted the previous day to make payments from the city budget to replace the roughly 60 percent cut in the pensions, ensuring that retirees receive 100 percent of the promised amount.

Loyalton Councilwoman Patricia Whitley, a former mayor who voted to leave CalPERS, said the council voted unanimously this week to offer the retirees a supplemental city payment to restore their full pensions.

“It’s really not a settled thing,” said Whitley. “The employees have to agree. We have to have some sort of agreement between us, because now it becomes a contract between us and the employees.”

Loyalton Mayor Mark Marin said there was no vote at the council meeting this week, only an understanding, and he was skeptical about the retirees accepting the proposal.

“The employees are not going to go for this,” Marin said. “The city is so broke. They will start paying the benefits. But what happens if the city goes bankrupt? Then people are screwed.”

Marin said some of the retirees are talking to an attorney about possible legal action. A CalPERS staff report said there is a risk that a pension cut could trigger an employee lawsuit against the city requiring CalPERS involvement.

Whitley has said a 50 percent pay raise that may not have been legitimate increased the cost of unaffordable pensions. The CalPERS report said Loyalton generously increased its pension formula to “2.7 at 55” in 2004, more than the “2 at 55” for most state and school workers.

Marin said he has been told that the vote to leave CalPERS may have been illegal because it was done as an “emergency” action. He said city council members wanted to divert the pension contribution to a city museum and other uses.

“PERS has been really good to us,” said Whitley. “They have at least listened to us and taken it to heart. So we have gained some mutual respect, I think. This is really their first case, I guess.”

Marin said he thinks “Pandora’s box” was opened by the CalPERS vote to let Loyalton off the hook for its pension debt: “It’s going to open it up big time. There is going to be other cities doing this crap, because Loyalton got away with it.”

Putting a lien on Loyalton assets or attaching its revenue were mentioned at the CalPERS board in September. But the financially distressed city would be further harmed, the board was told, and cities often are able to block attempts to take their revenue.

loyalton

Modest annual pensions are shown for three Loyalton retirees in 2015 on Transparent California, a searchable public database on the internet that lists the pay and pensions of state and local government employees and retirees:

Patsy Jardin $36,035, John Cussins $36,034, and Orville McGarity $6,814.

The giant California Public Employees Retirement System, with more than 2,000 pension plans for more than 3,000 government employers, maintains a pool to pay the pensions of retirees in terminated pension plans.

The Terminated Agency Pool paid $4.7 million to 716 retirees and beneficiaries from 93 terminated plans last fiscal year. The pool has a large surplus and was 261.9 percent funded as of June 30, 2014.

If its financial health allows, the pool can under state law continue to pay the full pensions of retirees whose employers did not pay off their debt — but not when, like Loyalton, the employer voluntarily terminates its CalPERS contract.

So, apparently for the first time, CalPERS declared an employer, Loyalton, in default and cut the pensions of its retirees “in proportion” to the amount of the debt. The Loyalton debt was 39.5 percent funded as of March 31, 2013.

An updated calculation could change the estimate of a 60 percent pension cut. Until then, said Whitley, Loyalton won’t know whether the payments offered retirees will be more or less than the annual contributions the city had been making to CalPERS.

The large CalPERS termination fee for Loyalton’s five modest pensions, $1.66 million, is the amount CalPERS expects to need to make the lifetime payments with no new contributions from the city or active employees.

CalPERS had been using its investment earnings forecast, now 7.5 percent, to calculate termination fees before switching in 2011 to a risk-free bond rate, 3.25 percent recently, that sharply boosts the regular debt or “unfunded liability.”

A federal judge in the Stockton bankruptcy said a termination fee that boosted the city’s pension debt from $211 million to $1.6 billion was a “poison pill” if the city tried to move to another pension provider, such as a county pension system.

Several small cities that considered leaving CalPERS did not after looking at the high termination fee, among them Pacific Grove, Villa Park, and Canyon Lake. CalPERS has given employers a hypothetical termination fee in their annual plan valuations since 2011.

The CalPERS viewpoint: If the terminated pool falls short under the collapse of a large pension plan, the funds of all the state and local government plans in CalPERS could be used to cover the shortfall, possibly jeopardizing their ability to pay pensions.

The CalPERS board president, Rob Feckner, said in a news release the Loyalton pension cuts, made with regret, are part of a fiduciary duty to keep CalPERS funding secure by ensuring that employers adhere to contracts.

“When they don’t, the law requires us to act,” he said. “The people who suffer for this are Loyalton’s public servants, who had every right to expect that the city would pay its bill and fulfill the benefit promises it made to them.”

As for two other delinquent employers given demand letters, the CalPERS staff report said, the California Fairs Financing Payment made a “significant” payment last month and expects to be “fully current by June 30, 2017.”

The Niland Sanitary District is voluntarily terminating its CalPERS plan. The staff report said there is reason to doubt Niland’s claim of no active employees since 2013, which will be checked by an audit.

Why Fresno, California Avoided Bankruptcy, Unlike Stockton

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.

At a time when some are calling soaring state and local government pension debt a crisis, there is a notable outlier. The Fresno city pension system has been fully funded for at least a decade and last year projected a $289 million surplus.

The main reason Fresno pensions have remained fully funded: The city’s public employee unions have accepted comparatively low retirement benefits, a particularly important concession by the police and firefighters who are a big part of the budget.

When another Central Valley city, Stockton, declared bankruptcy four years ago city officials said they would not cut the largest debt, a $211 million pension “unfunded liability,” because attractive retirement benefits are needed to remain competitive in the job market.

Stockton’s decision to cut only bond debt, despite a federal judge’s landmark ruling that CalPERS pension debt also can be cut in bankruptcy, was contested by two national bond insurers and a major bondholder, Franklin.

Not having a large pension debt to pay off helped Fresno cope with budget deficits during the recession. Speaking to the Bond Buyer last August, Mayor Ashley Swearengin recalled Time magazine mentioning Fresno as a possible bankruptcy.

Swearengin

Moody’s did not give Fresno bonds a hard-earned upgrade from a junk rating until last summer. Nearly a dozen rounds of painful quarterly budget cuts, begun early in the recession, left Fresno with a depleted workforce as the city struggled to close budge gaps.

“We had 4,100 employees and now we have 3,300,” Swearengin told the Bond Buyer. “Of those jobs, only 200 to 300 were layoffs. The rest were people who left, retired, or positions that had been held vacant, but were funded.”

The Fresno pension systems, never falling below 100 percent funded on an actuarial basis, continued receiving required employer-employee contributions during the recession, a timely addition to pension fund investments as the stock market began a major bull run after the bottom in 2009.

“In some people’s minds the city might have landed in bankruptcy if the city management and the unions hadn’t agreed on the incredibly hard step of instituting layoffs and freezes to keep the city functioning,” Robert Theller, Fresno Retirement Systems administrator, said last week.

Theller attributed the fully funded pensions to low payouts, unions that disagree with management on some points but are generally cooperative, good timing on a $152 million pension obligation bond in 2002, and conservative pension boards that invest carefully.

“It’s a well-run ship, and it has been for many decades,” said Theller, one of the reasons he was excited about taking the post last January.

Fresno Police & Fire Retirement System funding level

Fresno city pensions can seem at odds with conventional pension wisdom. The investment earnings forecast is 7.5 percent, which critics usually contend is overly optimistic and conceals massive debt.

Recruitment and retention of Fresno city employees is not said to be a serious problem, even though retirement benefits are well below those offered by the Fresno County pension system, deep in debt with a $1 billion unfunded liability.

Like the large coastal cities, Fresno, the largest Central Valley city (estimated 2015 population 520,052, Sacramento 490,712), has independent city and county retirement systems that are not part of CalPERS, the giant California Public Employees Retirement System.

The rare Fresno city pension surplus was reported last March by Robert Fellner of Transparent California, a searchable public data base that lists the pay and pensions of individual state and local government employees and retirees.

Fellner said the average Fresno city pension for a police or firefighter with 30 years of service was $70,627 and the average pension for other (non-safety) 30-year city employees was $39.644.

In comparison, he said, the average Fresno County pension for a non-safety employee with 30 years of service was $61,513, more than 50 percent higher than the pension of a similar city employee.

“Fresno County will spend a staggering 52 percent of pay on retirement benefits, which is over triple the 16 percent rate that Fresno City pays, and over 17 times more than the 3 percent that the median private employer spends on employees’ retirement accounts,” Fellner reported.

The city and county both provided average full-career pensions that exceeded the average pay, $36,975, of private-sector workers in Fresno County, Fellner said, according to 2014 data from the U.S. Bureau of Labor and Statistics.

On the same day last month, Oct. 25, Fellner’s Fresno report was featured on Fox television news, while an academic newsletter distributed a study that found the Fresno County pension system led the nation in eating up county budgets.

The study by the Center for Retirement Research at Boston College used its own methodology to compare the percentage of “own-source revenue” (excluding transfers from state or local government) taken by pensions, retiree health care, and debt service.

Fresno County ranked No. 1 (see chart below), in a nationwide sample of 178 counties, with pensions taking 57.1 percent of own-source revenue, retiree health care (OPEB) 0 percent, and debt service 4.5 percent.

In an email response to a request for comment on the study, the Fresno County Employees Retirement Association said it “does not control, create, or negotiate benefit formulas” and “continues to have the ability to provide guaranteed retirement benefits.”

Fresno ranked No. 33 in the study, among a nationwide sample of 173 cities, with pensions taking 8.9 percent of own-source revenue, retiree health 2.2 percent, and debt service 7.1 percent.

The president of the Fresno Police Officers Association, Jacky Parks, said last week the low city pensions have had an impact on recruiting and retention. For example, he said, a “lateral transfer” from an employer in CalPERS can be difficult for several reasons such as differences in “pensionable pay.”

Jacky Parks

CalPERS sponsored legislation, SB 400 in 1999, that gave the Highway Patrol a “3 at 50” pension formula providing 3 percent of final pay for each year served at age 50, capping the pension at 90 percent of pay.

Critics say the costly “3 at 50” formula, widely adopted by large local governments, is “unsustainable” and a major cause of pension debt. Fresno offers a “2 at 50” formula increasing to 2.7 percent at age 55, capped at 75 percent of pay.

Parks said Fresno also has a DROP plan that allows officers to earn a retirement benefit comparable to the “3 at 50” formula. He said most officers enter the DROP plan at age 50, limiting them to no more than 10 additional years on the job.

(The Deferred Retirement Option Program freezes the pension earned at that point. The pension amount, plus COLAs and interest at a rate approved by the pension board, goes into a special account until the employee leaves the job.)

Parks said Fresno officers are “proud we have a solvent system” and are aware that “everyone is a little worried” about the financial condition of the Fresno County retirement system.

“The philosophy of our (pension) trust is that you need to be financially responsible so this is going to be forever, so the next guy that gets here doesn’t need to worry,” Parks said.

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Ruling Challenges Prevailing View of California Pension Law

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.

Three appeals court justices, citing the alarming view of critics that public pensions are headed for the financial cliff, looked for a new way to allow a change in direction and found one.

In a ruling in a Marin County case last August that reformers called a “game changer,” the panel weakened the “California rule” protecting the pensions of current workers. Most cost-cutting reforms have been limited to new hires, which can take decades to yield savings.

One reason unions asked the state Supreme Court to review the new ruling last month is that another three-justice panel, also from the first district appeals court, made an opposite ruling in a San Francisco case last year.

“Not only does the court of appeal opinion conflict with sixty years’ worth of California Supreme Court precedent, it flies in the face of a decision by the same district court of appeal only a year ago,” said the union appeal, arguing that “unanimity of decision” is needed on “vested pension rights doctrine.”

The California rule stems from a state Supreme Court ruling in 1955 (Allen v. City of Long Beach) that the pension offered at hire becomes a vested right, protected by contract law, that can only be cut if offset by a comparable new benefit, erasing employer cost savings.

Pension cuts for current workers in the Marin and San Francisco cases were an attempt to curb employer pension costs that soared after heavy pension fund investment losses during the recession and financial crisis in 2008.

The ruling in the San Francisco case overturned most of a voter-approved cut in a supplemental COLA for pensions, citing the California rule that a pension cut must be offset by a new benefit. The state Supreme Court declined to hear an appeal.

The Marin ruling allows the county, with no offsetting new benefit, to impose “anti-spiking” state legislation enacted in 2012 that prevents current workers from continuing the previously authorized boosting of pensions with standby pay, call-back pay, and other things.

Some suggest the Marin ruling could lead to cuts in pensions current workers earned in the past, even though the ruling is “limited” and the case is about pensions earned in the future. Uncertainty about what could be cut is another reason unions want a high court review.

The California rule, adopted by courts in a dozen other states, is unusal for a number of reasons. Cuts in the pensions that will be earned by current workers in the future are allowed in the dwindling number of private-sector pensions.

Pensions are regarded as deferred salary. Government employers can cut salary, but under the California rule they cannot cut pension amounts current workers will earn in the future, unless there is a comparable new benefit.

“This interpretation is contrary to federal Contract Clause jurisprudence, which holds that prospective changes to a contract should not be considered unconstitutional impairments,” argues Amy Monahan, a legal scholar.

Her 64-page paper, “Statutes as Contracts? The ‘California Rule’ and Its Impact on Public Pension Reform,” is mentioned by reformers such as former San Jose Mayor Chuck Reed, who think cutting pensions not yet earned is the key to curbing runaway pension costs.

Monahan argues, according to an abstract of her article, that California courts have not explained the “basis” for the California rule and have “improperly infringed on legislative power” with “a rule that is inconsistent with both contract and economic theory.”

The state Supreme Court ruling in the 1955 Allen v. Long Beach case gives little or no explanation of why cuts in pensions not yet earned by time on the job should be offset by a comparable new benefit. The main part of the ruling is a single sentence:

“To be sustained as reasonable, alterations of employees’ pension rights must bear some material relation to the theory of a pension system and its successful operation, and changes in a pension plan which result in disadvantage to employees should be accompanied by comparable new advantages.”

Monahan said the court “merely stated the new rule” and as support cited two appellate court rulings that mention the theory of a pension system and note that certain detrimental changes were offset by new advantages.

“It is unclear why the Allen court chose to make these appellate court observations part of a new rule regarding pension modification,” Monahan said. “The Allen case is a bombshell.”

The Marin ruling does not argue that the standard-setting Allen ruling is invalid but, like the San Francisco ruling, follows the common law procedure of citing previous rulings, intended to ensure that similar facts yield similar outcomes.

Still, the Marin and San Francisco rulings cite dozens of previous rulings, though often not the same ones, while following their presumably logical legal paths that take them to opposite conclusions.

Justice Richman
“There is no absolute requirement that elimination or reduction of an anticipated retirement benefit ‘must’ be counterbalanced by a ‘comparable new benefit,” said the Marin ruling written by Justice James Richman and concurred in by Justices J. Anthony Kline and Maria Miller.

“This diminution in the supplemental COLA cannot be sustained as reasonable because no comparable advantage was offered to pensioners or employees in return,” said the San Francisco ruling written by Justice Henry Needham and concurred in by Presiding Justice Barbara Jones and Justice Mark Simons.

Justice Needham
The San Francisco ruling briefly notes that during the financial crisis the city pension fund plunged from 103 percent funded (market value) in 2008 to 72 percent a year later. A reform approved by 69 percent of voters in 2011 cut costs by limiting a supplemental COLA to years when the system was fully funded.

The supplement adding up to 3.5 percent to the standard cost-of-living adjustment for retirees of up to 2 percent, depending on inflation, had been awarded when pension fund investments during the previous year exceeded expected earnings, then 7.5 percent.

Skimming off “excess” earnings is questionable management, because the excess is needed to offset years with earnings shortfalls or losses. But the San Francisco pension system, which requires voter approval of pension increases, historically has been well funded.

Employers were given a contribution “holiday” from 1996 to 2004, making no payments into the pension fund, another example of questionable management. Measure C in 2011 was supported by all 11 county supervisors and business and labor groups.

A retiree suit to overturn the measure was called “the epitome of greed” by the president of the police union. A superior court ruling upheld the measure, concluding full funding was assumed when voters approved the supplement in 1996, then later increased the supplement and made it permanent.

The appeals court panel found no evidence that full funding had been a condition for the supplement. Following the California rule on vested rights, the panel said the supplement can’t be cut for workers retiring after 1966, but “may” be cut for workers retiring before then.

Last July, the San Francisco retirement board, pointing to the permissive “may,” restored the full supplement for those retiring before 1966. City Controller Ben Rosenfield sued the board for defying the will of voters.

Rosenfield told the San Francisco Chronicle a full supplement for 8,300 workers who retired before November 1966 will cost the city $200 million over the next five years. A superior court enjoined the board action last week.

The Marin ruling, making the case for cost reduction, begins with a look at the “emergence of the unfunded pension liability crisis.” A number of national and state reports on the issue are mentioned in a “background” section.

“In the aftermath of the severe economic downturn of 2008-2009,” said the ruling, “public attention across the nation began to focus on the alarming state of unfunded public pension liabilities.”

(An annual Milliman actuaries report last week said the 100 largest U.S. public pension systems were on average only 70 percent funded as of June 30, with a debt or unfunded liability of $1.38 trillion.

(The giant California Public Employees Retirement System, which does not include the Marin and San Francisco systems, was an estimated 68 percent funded last June with an unfunded liability of $139 billion.)

The longest look in the Marin ruling background section is at a report by the Little Hoover Commission in 2011 warning that “aggressive reforms” are needed to prevent growing pension costs from reducing government services and forcing layoffs.

“To provide immediate savings of the scope needed, state and local governments must have the flexibility to alter future, unaccrued retirement benefits for current workers,” the commission said in its top recommendation.

The Marin ruling cites a number of past court rulings that allowed cuts in the pensions of current workers to give the pension system the flexibility to adjust to changing conditions and preserve “reasonable” pensions in the future.

The previous rulings allowed increases in pension contributions, changes in retirement ages, repeals of COLAs, changes in required service years — even reduction of pensions in 1938 from two-thirds to one-half of salary.

Some public pension lawyers are alarmed by a comment in the Marin ruling on a 1967 appeals court ruling (Santin v. Cranston): “Until retirement, an employee’s entitlement to a pension is subject to change short of actual destruction.”

The Marin ruling said the 1955 Allen v. Long Beach ruling that said pension cuts “should” have a comparable new benefit was changed to “must” in a 1983 state Supreme Court ruling. But all Supreme Court rulings since then say “should” have a new benefit.

“It thus appears unlikely that the Supreme Court’s use of ‘must’ in the 1983 (Allen v. Board of Administration) decision was intended to herald a fundamental doctrinal shift,” the Marin ruling said, citing two rulings that “should” is advisory not compulsory.

In addition, the Marin ruling said the legislative cut in “spiking” gives Marin County employees a new benefit. Employee contributions that helped pay for the “spiking” provisions will no longer be deducted from their paychecks.

“Put simply, the new benefit is an increase in the employee’s net monthly compensation,” said the Marin ruling. “Put even more simply, it is more cash in hand every month.”

A post on the Reason Foundation website by an Emory Law School professor who has studied the California rule, Alexander Volokh, reviews four related cases and suggests the Marin ruling may be reversed.

Volokh argues that some of the previous rulings showing flexibility in the California rule were based on “highly unusual historical circumstance” not present in the Marin case. He said an employee near retirement would only have “more cash in hand” for a short period.

Comparable new benefits were granted in some of the cases cited in the Marin ruling, Volokh said, and other cases refused to make an exception for fiscal emergencies, since they were the government’s own fault and could be remedied by tax increases.

“Anthing can happen on appeal, but it wouldn’t be surprising to see this decision reversed by the Supreme Court,” Volokh said. The Supreme Court has at least 60 days to accept or reject the union appeal for a review of the Marin ruling, received Sept. 28.

Similar consolidated union suits against the Alameda, Contra Costa and Merced county pension systems have been briefed in appeals court but no date for oral arguments has been scheduled.

In A First, CalPERS May Cut Small Town’s Pensions

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 CalPERS crackdown on employers that have not been paying into the pension fund could cut the pensions of all four retirees of a small Sierra County city, Loyalton, which stopped making its payments more than three years ago.

It would be the first time that CalPERS used its power to cut pensions, in proportion to the payment not made by the employer, after a plan is terminated and closed to new members, a CalPERS spokesman said.

The city council of financially troubled Loyalton voted unanimously to stop making payments to CalPERS in March 2013. The city had a population of 769 in the last census and is about a 45-minute drive from Reno.

Four Loyalton retirees have continued to receive full California Public Employees Retirement System pensions. Another former Loyalton employee is vested in a city pension but has not yet retired and applied for it.

To avoid deep pension cuts, Loyalton owes CalPERS a $1.66 million lump sum payment that cannot be made over time with installments. The city has talked about trying to get back into CalPERS or possibly obtaining a loan.

According to a state controller’s report for 2015, Loyalton had revenues of $1.17 million, expenditures $1.68 million, liabilities $6.16 million, assets $11.1 million, fund equity $4.8 million, and population 733.

In a “final demand letter” on Aug. 31, CalPERS gave Loyalton 30 days to “bring its account to current.” If the city does not pay the amount owed, the CalPERS board will be asked to declare Loyalton in default, which could trigger the pension cuts.

Loyalton city council members and their lawyer plan to meet with CalPERS officials this week. The CalPERS board is not expected to act on the issue until its regularly scheduled meeting in November.

CalPERS also sent a 30-day demand to two other employers that are inactive but not yet terminated: the California Fairs Financing Authority, a joint powers authority of the state and fairs owing $360,958, and the Niland Sanitary District, owing $23,795.

If the Fairs authority and the Niland district do not make the payment, CalPERS staff will begin termination proceedings and ask the CalPERS board to terminate their contracts at the November meeting.

The CalPERS plan for the Fairs authority, now operating as a private organization, would face a $9.4 million lump sum payment if terminated, according to its valuation report. It has 20 retirees, 14 transferred members, and 24 separated.

The Niland district, located at the south end of the Salton Sea, would face a lump sum payment of $88,000 if terminated, said its CalPERS valuation report. It has one retiree, one transferred member, and two separated.

Last week, the CalPERS board was told that a new policy has been drafted to speed up collections. The task also has been placed under new top-level supervision in the CalPERS bureaucracy.

“The whole contract area was just recently moved into the finance area because we recognize that there was some breakdown in making sure we get these collections sooner,” Cheryl Eason, CalPERS chief finance officer, told the board.

tombstone

The deeply divided current members of the Loyalton city council agreed on one thing in telephone interviews last week: Two stone signs costing $10,000 each, telling motorists they are entering Loyalton, were not a good use of scarce city funds.

Some call them the “headstones.” Loyalton, which had a population of 1,030 in 1980, lost its main employer when the century-old Sierra Pacific lumber mill closed in 2001. An article in the Sierra County Prospect this year asked: “Is Loyalton dead?”

Loyalton is the largest and only incorporated city in Sierra County, population 3,240. A county history says it was carved out of Yuba County in 1852 because administration from Marysville in the Central Valley was too difficult.

The Sierra County seat is Downieville, population 282, about an hour drive (per Google maps) west of Loyalton on Highway 49. The county supervisors hold half of their meetings in Downieville and the other half in Loyalton.

A city council member who voted to terminate the CalPERS plan, Patricia Whitley, said a 50 percent pay raise that may not have been legitimate increased the cost of unaffordable pensions.

A city council member retired with a pension, John Cussins, who addressed the CalPERS board last week, said pay had been substandard before the pay increase, which was followed by a pay cut during the recession.

Some issues mentioned by Whitley and Cussins and Mayor Mark Marin: missing money, embezzlement, misuse of enterprise funds, illegal contracting, understaffing, employee turnover, a city museum building, and a city lawsuit over a troubled waste water project.

Cussins said he retired five years ago with a disability after more than 21 years as maintenance foreman playing a versatile role for the shorthanded city. He acted at times as a city manager or public works director, plowed snow, and dug graves.

Since retiring, Cussins said he has aided the city with drinking water maintenance and the use of his water and sewer licenses. His CalPERS pension last year was $36,034, according to Transparent California.

The large lump sum termination payment charged by CalPERS for five modest pensions, $1.66 million, results from a recent policy change. When a plan is terminated, CalPERS must pay the lifetime pensions with no more money from employers and employees.

CalPERS had used its investment earnings forecast, now 7.5 percent, to discount the terminated plan debt. Then in 2011, CalPERS dropped the terminated plan discount to a risk-free bond level (3.25 percent recently), causing the debt and termination fee to soar.

During the Stockton bankruptcy, a federal judge said a CalPERS termination fee that boosted the city’s 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.

Several small cities that considered leaving CalPERS did not after looking at the high termination fee, among them Pacific Grove, Villa Park, and Canyon Lake. CalPERS has included a hypothetical termination fee in annual local government plan valuations since 2011.

Terminated CalPERS plans go into a pool that paid $4.7 million to 716 retirees and beneficiaries from 93 plans in the fiscal year ending June 30. The Terminated Agency Pool was 261.9 percent funded as of June 30, 2014.

CalPERS likes to keep a healthy surplus in the terminated pool for the same reason, some would say, that it lowered the discount rate and has the power to cut the pensions of underfunded plans that go into the pool.

If the Terminated Agency Pool falls short, the funds of all of the state and local government plans in CalPERS could be used to cover the shortfall — a big bite if a large plan entered the pool, which some feared in 2011 as the recession widened pension funding gaps.

A staff report to the CalPERS board last week said an underfunded plan that has not paid the fee can, after reasonable efforts to collect, enter the terminated pool with little or no cut in pensions if there is no impact on the pool’s “actuarial soundness.”

Whether Loyalton qualifies for this type of “limited” entry into the terminated pool is not clear. Sticking points for the CalPERS board might be the voluntary termination, years of ignoring collection demands, setting a precedent, and maintaining equal treatment of plans.

Putting a lien on Loyalton assets or attaching its revenue stream were mentioned at the CalPERS board last week. But taking revenue would further harm the financially distressed city, the board was told, and cities often are able to block attempts to attach their revenue.