California Rule Does Not Protect “Airtime”

Earlier this week the California Supreme Court ruled in the case CalFire vs CalPERS. The case challenged one of the provisions of California’s 2014 pension reform legislation (PEPRA) which had eliminated the purchase of “Airtime.”

This was the practice whereby retiring public employees could purchase “service credits” that would lengthen the number of years they worked, which would increase the amount of their pensions, even though they hadn’t actually worked those additional years. While the amount these retirees would pay was always estimated to cover how much they’d eventually get back, with interest, in their pensions, in practice these estimates were always too low.

The plaintiffs in the case claimed that airtime was protected by the “California Rule,” which, they argued, prevents pension benefits from being reduced unless some other benefit of equal value is offered in return. However, the court found that the California Rule was not applicable in this case, setting an interesting precedent for other pending cases.

According to attorney and pension law expert Jonathan Holtzman, this ruling is a breakthrough.

“This is the first case in which, ever, where the court has attempted to define a principled basis for vesting doctrine – to analyze in a rigorous manner the legal basis of the vesting doctrine,” Holtzman said, “Although it does not resolve the issue, the case leaves wide open the question whether vesting protects prospective benefits of current employees.  It takes a narrow view of what constitutes a pension benefit. The Unions’ position has been that every part of the pension benefit is vested.  It is very clear that is not valid.

Holtzman went on to explain that this ruling will make it harder to argue that many retirement benefits are protected by the California Rule.

“The court recognizes that the only potential basis for a benefit that does not constitute deferred compensation to become vested is as a matter of contract.  And the court points out in clear terms that there is a presumption against benefits created by statute from becoming vested.  The Court also strengthens the requirement that the legislative intention to “vest” a benefit must be unmistakable. They are saying you have to have explicit legislative intent that a benefit is contractual before you can say it is subject to the California Rule.”

“Vesting is always an implied question. The court will ask ‘did you unambiguously intend that the benefit would last forever?’ The promise that a benefit will last forever doesn’t have to explicit, but it does have to be ‘unambiguously intended.’ That is a tough standard for any benefit to meet.”

There are several pension related cases working their way up through California’s courts. The next big one is the Alameda County Deputy Sheriffs’ Assn. v. Alameda County Employees’ Retirement Assn. But in the wake of the ruling in CalFire vs CalPERS, it is possible the California Supreme Court will throw this one back down to the appellate court. Again, from Jonathan Holtzman: “After you get a major decision like this it is not unusual for the court to remand those cases to give the courts of appeal another shot at those cases in light of the decision.”

The Alameda case is similar to the CalFire case in that it is a challenge brought by unions representing public employees affected by the PEPRA legislation. In this case, what is at issue is not purchases of airtime, but the practice known as pension spiking, whereby various forms of ancillary pay are included in determining an employee’s final compensation. Just as airtime increases the years worked, which increases a pension, spiking increases the final pay, which also increases a pension. But it is likely that the CalFire ruling strengthens the possibility that spiking will not be considered subject to the California Rule, and therefore having the California Supreme Court consider this case would be redundant.

At this point, there is no active case, anywhere in California, that concerns the third and biggest variable affecting pensions, the “multiplier.” When pensions are calculated at the end of a public employee’s career, the formula used goes like this: Years worked, times final salary, times the “multiplier.”

The multiplier is a percent, always in the low single digits, that represents the amount of pension that is earned for each year of work. For example, if someone had worked 10 years, had a final salary of $100K, and a multiplier of 2.0 percent, upon becoming eligible for retirement, their pension would be $20K. If their multiplier were 3.0 percent, their pension would be $30K.

As a matter of historical fact, the significance of the multiplier was demonstrated in a financially visceral manner in the years between 1999 and 2005. During this six year period, pension multipliers were raised across virtually all government agencies in California. It started during the boom of 1999, then once the market crashed, it continued anyway because it wouldn’t be fair to deny one agency the perk that had been awarded to some other agency. The impact was a financial catastrophe in slow motion, still unfolding.

Public safety employees, for example, had their multiplier raised from 2 percent to three percent. Overnight, the amounts of their future pensions increased by 50 percent. And in an act that is astonishing for many reasons, one of which is its absolute indifference to financial caution, this increase to the multiplier was awarded retroactively. If you don’t know about this, or don’t yet appreciate what it meant, pay close attention.

Prior to the pension benefit perks of 1999-2005, if you worked for 30 years in public safety, you would earn a pension equivalent to 30 (years) times your final salary, times a 2 percent multiplier. One would expect that if that multiplier were raised, it would be raised for work from now on. That is, if you’d worked for 15 years through 1999, then worked another 15 years from 2000 through 2014, your pension would now be calculated as follows: 15 years times final salary times 2 percent, plus, 15 years times final salary times 3 percent. That would be a financially prudent way to increase a benefit. But the experts at CalPERS and the other pension funds, plus the union leaders they goaded into demanding all this, were not financially prudent.

Instead they changed everything affected by the multiplier, forward and backward in time. If you retired in 1998 after a 30 year career, you’d get a pension equal to 30 times final salary times 2 percent. If you retired in 1999 after a 30 year career, you’d get a pension equal to 30 times final salary times 3 percent. The collective impact of this change, because it was retroactive, is far more than 50 percent. It is possibly the biggest single factor as to why pension contributions have become an unaffordable burden on cities, counties, the state, and the taxpayers who support all of it.

The other reason that the retroactive pension increases of 1999-2005 are astonishing – and a moral outrage – brings us back to pension reform efforts today. To restore solvency to public sector pensions without raising taxes and cutting services, the multiplier has to be reduced. It is important and helpful to eliminate purchases of airtime that artificially increase years worked. It is also helpful to eliminate pension spiking that artificially increases pension eligible final compensation. But without lowering the multiplier, we can’t get there. Here’s the moral outrage: Nobody wants to reduce the pension multiplier retroactively. They only want to reduce it for future work. But even that supposedly violates the California Rule.

How is it right, that the single biggest determinant of how much a pension will cost, the multiplier, was permitted to be boosted retroactively back when financial fantasy manifested itself in the form of an internet stock bubble, but now that financial reality has struck, it is impermissible to lower it, and only prospectively? The reason is the California Rule. Or is it?

It is possible, and only perhaps a stretch, to argue that even the multiplier is not a core benefit destined to last forever. It can be argued that raising the pension multiplier in legislation does not mean it cannot be lowered in the future unless it is, at the least, “unambiguously implied,” in the text of that legislation. One might therefore argue that even the multiplier is not subject to the California Rule.

These are the questions that have been opened up by the CalFire vs CalPERS ruling. At first glance, it appeared the court sidestepped the question of the California Rule. But they created a standard for invoking the California Rule that is likely to mean most of the current court challenges to PEPRA will probably be rejected. And they guarantee that if and when a case truly does challenge the California Rule, it will not be an incremental reform that is at stake.

The larger question at this point, is where would such a transformative reform come from? Here in California, the alliance between the pension bankers and the government unions is more powerful than ever.

 *   *   *

Edward Ring is a co-founder of the California Policy Center and served as its first president.