Pension Reform – The San Jose Model

Pension reform in San Jose began in June 2012 when voters, by a margin of 69% to 31%, approved Measure B. Despite overwhelming support from voters, however, this vote triggered a cascade of union funded lawsuits which by 2015 had overturned several of the key provisions of the reform measure. Finally, in August 2015, the San Jose city council passed a compromise resolution that replaced Measure B with a scaled down reform; this was approved by voters in November 2016.

The provisions of this new pension reform measure should be of keen interest to local reformers everywhere in California, because they survived relentless attacks in court. While these reforms may not prove sufficient to completely solve the challenge to adequately fund pension benefits for city workers in San Jose, they are nonetheless significant. San Jose’s current unfunded pension liability now stands at just over $3.0 billion. These reforms are estimated to save $1.7 billion over the next ten years. Here are highlights:

HIGHLIGHTS OF SAN JOSE’S 2016 PENSION REFORM

1 –  Voter approval required from now on:
Any retirement benefit – including pensions and retirement healthcare – cannot be enhanced as the result of negotiations between the city council and union leadership, unless those enhancements are first approved by voters.

2 – New employees will be subject to a reformed package of retirement benefits:
Employees hired after the following dates (Police, 8/04/2013; Fire, 1/02/2015; Misc., 9/30/2012) shall be deemed “Tier II” employees, with the following retirement benefits:

  • Cost sharing: The city shall not pay more than 50% of the normal and unfunded payments due the pension system; this will be phased in by increasing the employee share of the unfunded payment at a rate of 0.33% of additional withholding of their pay per year.
  • Age of eligibility: Police and firefighters shall be eligible for retirement benefits at age 57; miscellaneous employees at age 62.
  • Cost of living adjustments: annual COLA increases to pensions shall be limited to the lessor of the CPI index or between 2.0% and 1.25%.
  • Pension eligible compensation: Final compensation for purposes of calculating the pension shall be based on the average of the final three years of work, and (with some exceptions for police and firefighters) be limited to base pay only.
  • Cap on pension benefit: Police and fire retiree pensions are capped at 80% of pension eligible salary, for miscellaneous employees the cap is 70% of pension eligible salary.

3 – “Disability” retirements awarded by independent panel.

4 – “Supplemental Payments” discontinued:
Prior to this reform, whenever investment returns in any given year exceeded the target percentage, supplemental payments were made to retirees. This practice took place even when the pension system was carrying a significant unfunded liability. This new provision even bars supplemental payments if the fund eventually exceeds 100% funding, in order to take into account the possibility that subsequent annual returns may again fall short of projections.

5 – Defined benefit retirement healthcare discontinued:
The defined benefit retiree healthcare plan is ended and instead a Voluntary Employee Beneficiary Association (VEBA) is established for new and current Tier 2 employees. The contribution rate will be 4% into the VEBA. Tier One employees can opt-in to the new VEBA, or keep their defined benefit healthcare plan with a contribution rate of 8% of payroll.

6 – Retirement contributions fixed:
Similar in intent to item #4, even if the pension system becomes more than 100% funded, there will be no lowering of the required employee contributions to the fund via payroll withholding – again, to take into account the possibility that subsequent annual returns may again fall short of projections.

7 – No retroactive benefits enhancements:
If retirement benefits are approved by voters, they are only to apply to work performed subsequent to the date of approval. If an employee transfers into a new job with the city that offers better retirement benefits than the job they vacated, these enhancements only apply to their work subsequent to their transfer.

PENSION REFORM – SAMPLE LANGUAGE

Section 1503-A. Reservation of Voter Authority.
(a) There shall be no enhancements to defined retirement benefits in effect as of January 1, 2017, without voter approval. A defined retirement benefit is any defined post-employment benefit program, including defined benefit pension plans and defined benefit retiree healthcare benefits. An enhancement is any change to defined retirement benefits, including any change to pension or retiree healthcare benefits or retirement formula that increases the total aggregate cost of the benefit in terms of normal cost and unfunded liability as determined by the Retirement Board’s actuary. This does not include other changes which do not directly modify specific defined retirement benefits, including but not limited to any medical plan design changes, subsequent compensation increases which may increase an employee’s final compensation, or any assumption changes as determined by the Retirement Board.

(b) If the State Legislature or the voters of the State of California enact a requirement of voter approval for the continuation of defined pension benefits, the voters of the City of San Jose hereby approve the continuation of the pension benefits in existence at the time of passage of the State measure including those established by this measure.

Section 1504-A. Retirement Benefits – Tier 2.
The Tier 2 retirement plan shall include the following benefits listed below. This retirement program shall be referred to as “Tier 2” and shall be effective for employees hired on or after the following dates except as otherwise provided in this section: (1) Sworn Police Officers: August 4, 2013; (2) Sworn Firefighters: January 2, 2015 and (3) Federated: September 30, 2012. Employees initially hired before the effective date of Tier 2 shall be Tier 1 employees, even if subsequently rehired. Employees who qualify as “classic” lateral employees under the Public Employees’ Pension Reform Act and are initially hired by the City of San Jose on or after January 1, 2013, are considered Tier 1 employees.

(a) Cost Sharing. The City’s cost for the Tier 2 defined benefit plan shall not exceed 50% of the total cost of the Tier 2 defined benefit plan (both normal cost and unfunded liabilities), except as provided herein. Normal cost shall always be split 50/50.In the event an unfunded liability is determined to exist, employees will contribute toward the unfunded liability in increasing increments of 0.33% per year, with the City paying the balance of the unfunded liability, until such time that the unfunded liability is shared 50/50 between the employer and employee.

(b) Age. The age of eligibility for service retirement shall be 57 for employees in the Police and Fire Retirement Plans and 62 for employees in the Federated Retirement System. Earlier Retirement may be permitted with a reduction in pension benefit by a factor of 7% per year for employees in the Police and Fire Retirement Plan and a reduction in pension benefit by a factor of 5% per year for employees in the Federated Retirement System. An employee is not eligible for a service retirement earlier than the age of 50 for employees in the Police and Fire Retirement Plan or age 55 for employees in the Federated Retirement System. Tier 2 employees shall be eligible for a service retirement after earning five years of retirement service credit.

(c) COLA. Cost of living adjustments, or COLA, shall be equal to the increase in the Consumer Price Index (CPI), defined as San Jose – San Francisco – Oakland U.S. Bureau of Labor Statistics index, CPI-Urban Consumers, December to December, with the following limitations:

1. For Police and Fire Retirement Plan members, cost of living adjustments applicable to the retirement allowance shall be the lesser of the Consumer Price Index (CPI), or 2.0%.

2. For Federated Retirement System members, cost of living adjustments applicable to the retirement allowance shall be the lesser of CPI or:
a. 1-10 total years of City service and hired after the effective date of the implementing ordinances of the revised Tier 2: 1.25%
b. 1-10 years total years of City service and hired before the effective date of the implementing ordinances of the revised Tier 2: 1.5%
c. 11-20 total years of City service: 1.5%
d. 21-25 total years of City service: 1.75%
e. 26 or more total years of City service: 2.0%

3. The first COLA adjustment will be prorated based on the number of months retired in the first calendar year of retirement.

(d) Final Compensation. “Final compensation” shall mean the average annual earned pay of the highest three consecutive years of service. Final compensation shall be base pay only, excluding premium pays or other additional compensation, except members of the Police and Fire Plan whose pay shall include the same premium pays as Tier 1 members.

(e) Maximum Allowance and Accrual Rate. For Police and Fire Plan members, service retirement benefits shall be capped at a maximum of 80% of final compensation for an employee who has 30 or more years of service at the accrual rate contained in the Alternative Pension Reform Settlement Framework approved by City Council on August 25, 2015. For Federated Retirement System members, service retirement benefits shall be capped at a maximum of 70% of final compensation for an employee who has 35 or more years of service at the accrual rate contained in the Alternative Pension Reform Settlement Framework approved by City Council on December 15, 2015, and January 12, 2016.

(f) Year of Service. An employee will be eligible for a full year of service credit upon reaching 2080 hours of regular time worked (including paid leave, but not including overtime).

Section 1505-A. Disability Retirements.

(a) The definition of “disability” shall be that as contained in the San Jose Municipal Code in Sections 3.36.900 and 3.28.1210 as of the date of this measure.

(b) Each plan member seeking a disability retirement shall have their disability determined by a panel of medical experts appointed by the Retirement Boards.

(c) The independent panel of medical experts will make their determination based upon majority vote, which may be appealed to an administrative law judge.

Section 1506-A. Supplemental Payments to Retirees.

The Supplemental Retiree Benefit Reserve (“SRBR”) has been discontinued, and the assets returned to the appropriate retirement trust fund. In the event assets are required to be retained in the SRBR, no supplemental payments shall be permitted from that fund without voter approval. The SRBR will be replaced with a Guaranteed Purchasing Power (GPP) benefit for all Tier 1 retirees. The GPP is intended to maintain the monthly allowance for Tier 1 retirees at 75% of purchasing power of their original pension benefit effective with the date of the retiree’s retirement. The GPP will apply in limited circumstances (for example, when inflation exceeds the COLA for Tier 1 retirees for an extended period of time). Any calculated benefit will be paid annually in February.

Section 1507-A. Retiree Healthcare.

The defined benefit retiree healthcare plan will be closed to new employees as defined by the San Jose Municipal Code in Chapter 3.36, Part 1 and Chapter 3.28, Part 1. Section 1508-A. Actuarial Soundness (for both pension and retiree healthcare plans).

(a) In recognition of the interests of the taxpayers and the responsibilities to the plan beneficiaries, all pension and retiree healthcare plans shall be operated in conformance with Article XVI, Section 17 of the California Constitution. This includes but is not limited to:

1. All plans and their trustees shall assure prompt delivery of benefits and related services to participants and their beneficiaries;

2. All plans shall be subject to an annual actuarial analysis that is publicly disclosed in order to assure the plan has sufficient assets;

3. All plan trustees shall discharge their duties with respect to the system solely in the interest of, and for the exclusive purposes of providing benefits to participants and their beneficiaries, minimizing employer contributions thereto, and defraying reasonable expenses of administering the system;

4. All plan trustees shall diversify the investments of the system so as to minimize the risk of loss and maximize the rate of return, unless under the circumstances it is not prudent to do so;

5. Determine contribution rates on a stated contribution policy, developed by the retirement system boards and;

6. When investing the assets of the plans, the objective of all plan trustees shall be to maximize the rate of return without undue risk of loss while having proper regard to the funding objectives of the plans and the volatility of the plans’ contributions as a percentage of payroll.

Section 1509-A. Retirement Contributions.

There shall be no offset to normal cost contribution rates in the event plan funding exceeds 100%. Both the City and employees shall always make the full annual required plan contributions as calculated by the Retirement Board actuaries which will be in compliance with applicable laws and will ensure the qualified status under the Internal Revenue Code.

Section 1510-A. No Retroactive Defined Retirement Benefit Enhancements.

(a) Any enhancement to a member’s defined retirement benefit adopted on or after January 1, 2017, shall apply only to service performed on or after the operative date of the enhancement and shall not be applied to any service performed prior to the operative date of the enhancement.

(b) If a change to a member’s retirement membership classification or a change in employment results in an enhancement in the retirement formula or defined retirement benefits applicable to that member, except as otherwise provided under the plans as of [effective date of ordinance], that enhancement shall apply only to service performed on or after the effective date of the change and shall not be applied to any service performed prior to the effective date of the change.

(c) “Operative date” would be the date that any resolution or ordinance implementing the enhancement to a member’s defined retirement formula or defined retirement benefit adopted by the City Council becomes effective.

REFERENCES

City of San Jose, “Alternative Pension Reform Act,” 2016 (full text)
http://sanjoseca.gov/DocumentCenter/View/59737

City of San Jose, Alternative Pension Reform Act Ballot Measure – references for voters, 2016
http://www.sanjoseca.gov/index.aspx?nid=3208

City of San Jose, Framework Agreement summarizing Alternative Pension Reform Act, 2015
http://www.sanjoseca.gov/DocumentCenter/View/46068

City of San Jose, “Sustainable Retirement Benefits and Compensation Act,” 2012 (full text)
http://www.sanjoseca.gov/DocumentCenter/View/5166

City of San Jose, Measure B (Sustainable Benefits and Compensation Act) – references for voters, 2012
http://www.sanjoseca.gov/index.aspx?NID=5187

Ballotpedia – San Jose Pension Modification Agreement, Measure F (November 2016)
https://ballotpedia.org/San_Jose,_California,_Pension_Modification_Agreement,_Measure_F_(November_2016)

Ballotpedia – San Jose Pension Reform, Measure B (June 2012)
https://ballotpedia.org/San_Jose_Pension_Reform,_Measure_B_(June_2012)

San Jose Mercury News, August 25, 2015 – San Jose council approves Measure B settlement
http://www.mercurynews.com/2015/08/25/san-jose-council-approves-measure-b-settlement/