In December of 2018, the California Supreme Court will hear arguments in what is generally referred to as the Cal Fire pension case. The ruling could potentially overturn what is commonly referred to as the “California Rule.” The current interpretation of the rule is that pension benefits, once increased, cannot be reduced for existing employees even for future years of service without the agency providing a benefit of equal value to the employee.
What reforms would become possible if the Supreme Court rules that changes for future years of service are not protected by the California Rule?
To demonstrate how this ruling could be a game changer and open the door to pension reform for nearly every city and county in California, this article uses the potential savings for various reform options for the County of Sonoma.
It should be noted that any changes to the pension system if there is a favorable ruling by the court would need to be made by the governing body of each agency and if they refuse to act, could also be made by the taxpayers through the voter initiative process.
Current Situation in Sonoma County
The pension system for Sonoma County employees was founded in 1945 and up until 1993 was a sustainable and affordable system that paid career employees 2% per year of service. This would mean, for example, that after a 35 year career a retiree would collect a pension equal to 70% of their final base salary. Sonoma County employees are also eligible to receive Social Security benefits. Over the first 48 years until 1993, the pension system had accrued $355 million in total pension liabilities (money owed to retirees and earned to date by current employees).
But then, due to a series of illegal pension increases back to the date people were hired in 1998, 2003, 2004 and 2006, pensions for employees with only 30 years of employment jumped (including “spiking”) to 96% of their gross pay. After the first increase, the liability had doubled from the 1993 $355 million amount to $793 million in 1999. The liability doubled again in 9 years and hit $1.9 billion in 2009. Last year, in 2017 the pension liability reached $3.34 billion, a staggering 941% growth over 24 years.
The Growth of Sonoma County’s Pension Liability
To pay off the soaring liability, Sonoma County issued pension obligation bonds in 1994, 2003 and 2010 totaling $597 million dollars of principal. Paying off the bonds with interest will cost taxpayers $1.2 billion on top of their normal pension contributions. Currently, the County owes $650 million in principal and interest on the bonds that will cost them an average of $43 million per year until 2030.
In addition, the County’s contribution to the pension system (including debt service on the pension obligation bonds) has grown from $8 million in 1998 to $117 million in 2017. In other words, we have a serious math problem on our hands. While tax revenues have been growing at 3% per year, pension and healthcare costs have grown by 19%. Something has to give. In Sonoma County we have two choices, do nothing and pay higher taxes for fewer services, or, if possible (depending on the outcome of the Supreme Court case), reform our pension system to make it more equitable for taxpayers and more secure for employees and retirees.
So far, money has been taken from our roads and infrastructure maintenance budgets and the County has borrowed $597 million to pay for pensions. Soon, more and more money is going to come from cuts to fire and police protection, and services for those to in need. The retroactive pension increases not properly funded have essentially created a debt generation engine that sticks our children and grandchildren with enormous debt for services received in the past.
The Pension Increases May Have Been Illegal
In 2012 responding to a complaint I filed, the Sonoma County Civil Grand Jury could not find any evidence that the County followed the law when pensions were increased. The California Government Code in Section 7507 requires that the public be notified of the future annual cost of the increase. However, records show that all of the retroactive pension increases were enacted without determining the future annual costs and the public was never notified. This is a serious issue since public notification is the only protection taxpayers have. In addition, documents uncovered by New Sonoma indicate that the agreement was for the General employees to pay 100% of the past and future cost of the increase and Safety employees to pay 50% of the cost. This requirement was never enforced by the Sonoma County Retirement Association as it should have, so the vast majority of the costs for the benefit increases have been illegally borne by the County’s taxpayers.
These same increases were enacted at the state and local level from 1999 to 2008 for almost every public agency throughout the state. Cursory investigations of other cities conducted by the California Policy Center and Civil Grand Jury’s in Marin and Sutter county found similar violations at every agency investigated. A lawsuit is currently under appeal that would void illegal increases back to the date they were enacted which would in Sonoma County’s case save taxpayers $1.2 billion over the years ahead. But even if this case fails, other reform options may be available soon as a result of a favorable supreme court ruling. Here they are:
1. Cap the Employer Contribution
A lot of problems could be fixed at the governance level if employees felt the impact of growing unfunded liabilities. As long as the current situation of the employer/taxpayer covering 100% of the unfunded liability and debt service on the bonds exists, the problem will continue to grow and reforms will be minimal because all actuarial losses fall on the taxpayer.
Capping the employer contribution at 15% of salary (still 5 times what private sector employers contribute to retirement funds for their employees) would cut pension costs in Sonoma County from $117 million to $55.4 million, a savings to the county of $61.6 million per year. And as pension costs increase over the years ahead, the employees will pay all the costs associated with the growth.
2. Split All Pension Costs 50/50 Between the County and Employees
Currently the employer contribution is 19% of payroll. The current pension bond debt service, all paid for by the employer, is 11.3% of payroll. The current employee contribution is 11.6% of payroll. Therefore Sonoma County’s total pension costs in 2017 were 42% of payroll.
Capping employer contributions at 50% of pension costs or 21% of payroll would save the county $50 million per year, a cost that would be borne by employees in additional pension contributions.
3. Provide an Opt Out for Employees to a 401k Plan
Instead of forcing employees to contribute 21% of their take-home pay to their pension, a 401k option could be created.
Existing employees could be provided with the option of moving the present value of their future pension benefit into a 401k account and opting out of the defined benefit pension system. Going forward, the County could provide them with a 10% of base salary 401k contribution which the employee could match for a 20% contribution. Then, if the employee wanted to turn their account balance into a defined benefit for life, they could purchase an annuity upon retirement using their 401k funds.
Studies show young people entering the workforce prefer the portability of a 401k plan because they don’t see themselves in the same career their entire lives. Defined benefit pension funds also punish folks who leave the system early and highly reward those that stay because they are back loaded by design.
A lot of folks might also choose this option because they may be worried about the soundness of their pension plan, which in Sonoma County’s case, they should be.
4. Improve Pension Board Governance
Require a majority of non pension fund members on the Sonoma County Employee Retirement Association (SCERA) board or move the servicing of the fund, if possible to a private entity because of the conflicts of interest that exist when board members are also part of the pension system.
5. Establish Greater Transparency
Establish a COIN Ordinance to require the County Supervisors to hire an outside negotiator during contract negotiations and to provide the public with the cost impact of any changes to the citizens ahead of approval.
6. Mandate Public/Private Pay Equity
Require the County to perform a prevailing wage study and offer new County hires salaries that are similar to what Sonoma County residents earn in the private sector for work requiring comparable education and skills.
7. Return Spending Authority to Voters
Require voter approval of any pension obligation bonds, and require voter approval of any increases to pension formulas or increases to salaries in excess of inflation.
6. Eliminate Conflicts of Interest
Do not allow elected officials to be members of the pension system due to the obvious conflict of interest.
7. Improve Public Oversight
Create a permanent Citizens Advisory Committee on Pensions that would provide an annual study of the pension system and track the success of pension reform efforts and provide recommendations to the Board of Supervisors. All reports prepared by the committee will be posted on the Committee’s webpage on the County’s website. The committee would have the power to perform accounting and regulatory compliance audits of the Sonoma County Retirement Association, investigate any evidence of illegal acts, and recommend appropriate remedies to the Board of Supervisors. A description of any violations and any committee recommendations will be posted on the Committee’s webpage on the County’s website.
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Ken Churchill has over 40 years of business and financial management experience as founder, CEO and CFO of a solar energy company and environmental consulting firm. In 2012 after discovering the county illegally increased pensions without the required public notification of the cost he founded New Sonoma, and organization of financial experts and citizens to investigate the increase and inform the public. Information on New Sonoma and their findings and court case can be found at www.newsonoma.org.
Every two years, around this time, political mailers inundate the mailboxes of California’s registered voters. This week, many Sacramento residents received “Vote No on Prop 6″ mailer. Prop 6 is that pesky, subversive citizens ballot initiative that, if approved by voters, will roll back the gas tax.
But Prop. 6 isn’t the topic here. Rather, the topic is all taxes in California. Why is there relentless pressure to increase them? And what special interests are paying for these campaigns to increase (or preserve) taxes across California?
In that context, this No on Prop. 6 mailer is instructive. Because blazoned across the cover of this four page, 8.5″ x 11” glossy full color flyer, is Darrell Roberts, representing the California Professional Firefighters. Roberts is the president of IAFF Local 2180, the Chula Vista Firefighters Union. In addition to his duties as president of Local IAFF Local 2180, Roberts is a Fire Battalion Chief for the Chula Vista Fire Department. In that capacity, he earned $327,491 in 2017, including $99,887 of overtime.
Now let’s back up for just a moment and make something perfectly clear. This isn’t about disrespecting firefighters in general, or Mr. Roberts in particular. Quite the contrary. Firefighters perform dangerous, challenging jobs that require years of intense training. Every year in California, a few of them die in the line of duty. In some years, more than a few. Furthermore, firefighters constantly witness trauma, often horrific, every time they respond not only to fires, but medical emergencies and automobile accidents. Their jobs are tough.
For these reasons, critics of public sector compensation trends should always temper their observations with respect. It is far too easy to observe, accurately, that many other jobs carry higher risk of injury or death, while forgetting that first responders stand between citizens and mayhem not just in normal times, but also in extraordinary times. In a truly cataclysmic event, and 911 is a perfect example, firefighters are obligated to occupy the front lines. They are the ones who must stop whatever destructive storms afflict our society. They are the ones who must go in before safety is restored, and rescue the stranded victims.
With that necessary preamble, and without diminishing it in any way, a difficult conversation remains necessary regarding public sector compensation, and the political power of the public sector unions who push for continuous increases in compensation.
A California Policy Center analysis published nearly two years ago, using 2015 data, calculated the average pay and benefits for a California firefighter at $196,370 for those employed by cites, $198,959 for those working for counties, and $145,938 for those working for the state. Those averages have not fallen in the past three years, and they do not include the additional cost per firefighter, if and when their retirement pensions are adequately funded.
Mr. Robert’s own City of Chula Vista provides an example of these rising pension costs. In 2017 the average pay for a Chula Vista firefighter was $189,715. That included, on average, $41,112 for overtime and $31,381 for employer contributions to their defined benefit pensions. But as they say, you ain’t seen nothin’ yet.
Using CalPERS own projections for the City of Chula Vista, the average normal contribution by the city to fund police and firefighter pensions is expected to grow from 20 percent of payroll in FYE 6/30/2017 to 22 percent of payroll by FYE 6/30/2025. Nothing terribly dramatic there. But, get this, the so-called unfunded contribution – that additional amount necessary to pay down the city’s unfunded liability for police and firefighter pensions – is expected to grow from 13 percent of payroll in FYE 6/30/2017 to 32 percent of payroll in 6/30/2025.
Put another way, the City of Chula Vista’s employer payments for public safety pensions are going to go from 33 percent of payroll to 53 percent of payroll by 2025. And if the stock market decides to end its already record breaking bull run, harming the CalPERS investment portfolio, these payments will go much higher.
It’s also important to recognize the relationship between excess overtime expenses and the cost of pension and health benefits (including retirement health benefits). When public employers pay more than 50 percent above regular salary to fund pensions and benefits, and in the case of public safety, they do, then it makes financial sense to pay time-and-a-half to existing staff, since that will cost less. Lost in that equation is the stress this excessive overtime inflicts on overworked personnel, as well as the lost opportunity to bring benefit overhead back below fifty percent.
Collectively California’s state and local employers, based on projections already released from CalPERS, are going to have to increase their total contributions to public employee pension funds from approximately $31 billion in 2017 to an estimated $59 billion by 2025.
Maybe veteran firefighters truly believe they are entitled to annual pay and benefits packages in excess of $200,000 per year, or in Mr. Roberts case, in excess of $300,000 per year. But with all the political power these unions wield, they ought to be thinking of ways to help lower the cost-of-living in California. That would help everyone.
And perhaps it may disturb even the most respectful and appreciative among us, when a public servant who made $327,491 last year, asks us to support higher taxes.
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2017 Salaries for Chula Vista – Transparent California
California’s Public Sector Compensation Trends – California Policy Center, January 2017
Comprehensive Annual Financial Report, FYE 6/30/2017 – City of Chula Vista
Safety Plan of the City of Chula Vista, Annual Valuation Report as of 6/30/2017 – CalPERS
Miscellaneous Plan of the City of Chula Vista, Annual Valuation Report as of 6/30/2017 – CalPERS
2017 City Data, Government Compensation in California – California State Controller
California Government Pension Contributions Required to Double by 2024 – California Policy Center, January 2018
In August of last year retired attorney George Luke sued the Sonoma County Employees Retirement Association (SCERA) and the Board of Supervisors (BOS) because according to County records they did not follow the law when pensions were increased in 2002 and 2003. According to the law, before increasing pension benefits the supervisors are required to (1) hire an actuary to determine the future annual cost of the increase, (2) enact by majority vote a board resolution adopting the new formulas and (3) present the cost to the citizens at a regular BOS meeting so they would have the ability to know how their tax dollars are being spent. None of these requirements were even minimally met and that is why Luke sued.
Growth of Sonoma County Pension Liability vs Other Indicators
What is really appalling is documents obtained by my organization, New Sonoma, just 2 years ago proved it was not the BOS that enacted these increases at all, but a closed door settlement of a lawsuit between the employee unions and SCERA over what pay items should be considered pensionable. Here is how it happened.
In 1998 to settle another lawsuit brought by the unions (they have sued the county many times) SCERA added 45 additional pay items to pensionable pay, but the unions sued again over 2 items the unions thought should also have also been considered pensionable, the employer pickup of the employees’ pension contribution and their health insurance premiums. As part of the settlement somehow new formulas, which SCERA cannot legally change, became part of the settlement.
There’s more. The agreement struck between the employee unions and the supervisors required the Safety employees to pay half the cost of the increase and the non-safety employees to pay 100% of the cost. But because costs were underestimated by SCERA’s actuary, the additional employee contributions have fallen well short of the amount needed to avoid shifting the cost to taxpayers. This has been admitted by the supervisors and even former assembly member and current SEIU negotiator Michael Allen who said instead of the increased employee contribution being 5% it should have been 20% of salary. His estimate is exactly what mine is and if true, the county would have $70 million more each year to spend on basic services like road and infrastructure maintenance, which has about a $1 billion backlog to go along with the $1.1 billion unfunded pension and retiree healthcare liability.
Unfortunately, George lost the first round of his suit because Sonoma County judge Rene Chouteau ruled that even if the County did not follow the law it did not matter because the 3-year statute of limitations had been exceeded, which some might think is a strange ruling when the violation was failure to notify citizens of the increase and there is no resolution adopting the increase (so it never really happened). The plan now is to appeal the ruling because case law indicates every time a new check is written for an illegal pension amount, the statute of limitations starts all over again.
Why should county employees and retirees be worried? As the chart indicates, these illegal increases caused pension liabilities to grow 772 percent from 1993 to 2017 — a rise that was eleven times more than the 66 percent increase in Government Fund revenues during the same period.
The bottom line is that what can’t continue won’t and the longer the supervisors and unions wait to reform the system, the more drastic cuts to pensions will eventually be.
Ken Churchill is the Director of New Sonoma, and organization of financial experts and citizens concerned with the finances and governance of Sonoma County. More information can be found at www.newsonoma.org.
Here is a link to the full text of the amended complaint:
George Luke Vs. Sonoma County
Here is a link to the exhibits for the lawsuit:
George Luke Vs. Sonoma County Exhibits for Original Complaint
Here is a link to the exhibits for amended complaint:
George Luke Vs. Sonoma County Exhibits for Amended Complaint
Here is the article that appeared in the Press Democrat:
Most pension experts believe that without additional reform, pension payments are destined to put an unsustainable burden on California’s state and local governments. Even if pension fund investments meet their performance objectives over the next several years, California’s major pension funds have already announced that payments required from participating agencies are going to roughly double in the next six years. This is a best-case scenario, and it is already more than many cities and counties are going to be able to afford.
California’s first major statewide attempt to reform pensions was the PEPRA (Public Employee Pension Reform Act) legislation, which took effect on January 1st, 2013. This legislation reduced pension benefit formulas and increased required employee contributions, but for the most part only affected employees hired after January 1st, 2013.
The reason PEPRA didn’t significantly affect current employees was due to the so-called “California Rule,” a legal argument that interprets state and federal constitutional law to, in effect, prohibit changes to pension benefits for employees already working. The legal precedent for what is now called the California Rule was set in 1955, when the California Supreme Court ruled on a challenge to a 1951 city charter amendment in Allen v. City of of Long Beach. The operative language in that ruling was the following: “changes in a pension plan which result in disadvantage to employees should be accompanied by comparable new advantages.”
To learn more about the origin of the California Rule, how it has set a legal precedent not only in California but in dozens of other states, two authoritative sources are “Overprotecting Public Employee Pensions: The Contract Clause and the California Rule,” written by Alexander Volokh in 2014 for the Reason Foundation, and “Statutes as Contracts? The ‘California Rule’ and Its Impact on Public Pension Reform,” written by Amy B. Monahan, a professor at the University of Minnesota Law School, published in the Iowa Law Review in 2012.
Pension benefits, most simply stated, are based on a formula: Years worked times a “multiplier,” times final salary. Thus for each year a public employee works, the eventual pension they will earn upon retirement gets bigger. Starting back in 1999, California’s public sector employee unions successfully negotiated to increase their multiplier, which greatly increased the value of their pensions. In the case of the California Highway Patrol, for example, the multiplier went from 2% to 3%. But in nearly all cases, these increases to the multiplier didn’t simply apply to years of employment going forward. Instead, they were applied retroactively. For example, in a typical hypothetical case, an employee who had been employed for 29 years and was to retire one year hence would not get a pension equivalent to [ 29 x 2% + 1 x 3% ] x final salary. Instead, now they would get a pension equivalent to 30 x 3% x final salary.
Needless to say this significantly changed the size of the future pension liability. For years the impact of this change was smoothed over using creative accounting. But now it has come back to haunt California’s cities and counties.
Amazingly, the California rule doesn’t just prevent retroactive reductions to the pension benefit formula. Reducing formulas retroactively might seem to be reasonable, since formulas were increased retroactively. But the California rule, as it is interpreted by attorneys representing public employee unions, also prevents reductions to pension benefit accruals from now on. And on that question, in the case CalFire vs CalPERS, the California Supreme Court has an opportunity this year to make history.
Ironically, the active cases currently pending at the California Supreme Court were initiated by the unions themselves. In particular, they have challenged the PEPRA reform that prohibits what is known as “pension spiking,” where at the end of a public employee’s career they take steps to increase their pension. Spiking can take the form of increasing final pension eligible salary – which can be accomplished in various ways including a final year promotion or transfer that results in a much higher final salary. Another form of spiking is to increase the total number of pension eligible years worked, and the most common way to accomplish this is through the purchase of what is called “air time.”
Based on fuzzy math, the pension systems have offered retiring employees the opportunity to pay a lump sum into the pension system in exchange for more “service credits.” Someone with, say, ten years of service, upon retirement could pay (often the payment that would be financed, requiring no actual payment) to acquire five additional years of service credits. This would increase the amount of their pension by 50%, since their pension would now be based on fifteen years x 3% x final salary, instead of 10 years x 3% x final salary. To say this is a prized perk would be an understatement. How it became standard operating procedure, much less how the payments made were calculated to somehow justify such a major increase to pension benefits, is inexplicable. But when PEPRA included in its reform package an end to spiking, even for veteran employees, the unions went to court.
The spiking case that has wound its way to the California Supreme Court with the most disruptive potential started in Alameda County, then was appealed to California’s First Appellate Court District Three. The original parties to the lawsuit were the plaintiffs, Cal Fire Local 2881, vs CalPERS (Appellate Court case). On December 30, 2016, the appellate court ruled that PEPRA’s ban on pension spiking via purchases of airtime would stand. The union then appealed to the California Supreme Court.
An excellent compilation of the ongoing chronology of the California Supreme Court case Cal Fire Local 2881 v. CalPERS (CA Supreme Court case) can be found on the website of the law firm Messing, Adam and Jasmine. It will show that by February 2017 the unions filed a petition for review by the California Supreme Court, and that the court granted review in April 2017. In November 2017, Governor Brown got involved in the case, citing a compelling state interest in the outcome. Apparently not trusting his attorney general nor CalPERS to adequately defend PEPRA, the Governor’s office joined the case as an “intervener” in opposition to Cal Fire Local 2881. For nearly a year, both petitioners and respondents to the case have been filing briefs.
This case, which informed observers believe could be ruled on by the end of 2018, is not just about airtime. Because whether or not purchasing airtime is protected by the California Rule requires clarification of the California Rule. The ruling could be narrow, simply affirming or rejecting the ability of public employees to purchase airtime. Or the ruling could be quite broad, asserting that the California Rule does not entitle public employees to irreducible pension benefits, of any kind, to apply for work not yet performed.
One of many reviews of the legal issues confronting the California Supreme Court in this case is found in the amicus brief prepared by the California Business Roundtable in support of the respondents. A summary of the points raised in the California Business Roundtable’s amicus brief is available on the website of the Retirement Security Initiative, an advocacy organization focused on protecting and ensuring the fairness and sustainability of public sector retirement plans. An excerpt from that summary:
“The Roundtable brief asserts the California Rule has numerous legal flaws:
(1) It violates the bedrock principle that statutes create contractual rights only when the Legislature clearly intended to do so.
(2) It violates black-letter contract law by creating contractual rights that violate the reasonable expectations of the parties.
(3) It violates longstanding constitutional law by assuming that every contractual impairment automatically violates the California and Federal Contract Clauses.
(4) It lacks persuasive or precedential value. The Rule was initially adopted without anything resembling a full consideration of the relevant issues.
(5) It has been almost uniformly rejected by federal and state courts—including by several courts that previously accepted it.
(6) It has had—and will continue to have—devastating economic consequences on California’s public employers.”
Pension reform, and pension reformers, have often been characterized as “right-wing puppets of billionaires” by the people and organizations that disagree. The fact that one of the most liberal governors in the nation, Jerry Brown, actively intervened in this case in support of the respondent and in opposition to the unions, should put that characterization to rest.
If the California Supreme Court does dramatically clarify the California Rule, enabling pension benefit formulas to be altered for future work, it will only adjust the legal parameters in the fight over pensions in favor of reformers. After such a ruling there would still be a need for follow on legislation or ballot initiatives to actually make those changes.
What California’s elected officials and union leadership, for the most part, are belatedly realizing, is that without more pension reform, the entire institution of defined benefit pensions is imperiled. Hopefully California’s Supreme Court will soon make it easier for them all to make hard choices, to prevent such a dire outcome.
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Edward Ring co-founded the California Policy Center in 2010 and served as its president through 2016. He is a prolific writer on the topics of political reform and sustainable economic development.
California Government Pension Contributions Required to Double by 2024 – Best Case
– California Policy Center
California Public Employees’ Pension Reform Act (PEPRA): Summary And Comment
– Employee Benefits Law Group
Allen v. City of of Long Beach
– Stanford University Law Library
Overprotecting Public Employee Pensions: The Contract Clause and the California Rule
– Alexander Volokh, Reason Foundation
Statutes as Contracts? The ‘California Rule’ and Its Impact on Public Pension Reform
– Amy Monahan, Iowa Law Review
Did CalPERS Use Accounting “Gimmicks” to Enable Financially Unsustainable Pensions?
– California Policy Center
Cal Fire Local 2881, vs CalPERS (Appellate Court case)
– JUSTIA US Law Archive
Cal Fire Local 2881 v. CalPERS, California Supreme Court, Case No. S239958 – Case Review
– Messing, Adams and Jasmine
Intervener and Respondent State of California’s Answer Brief on the Merits
– Amicus Brief, Governor’s Office, State of California
Amicus Brief of the California Business Roundtable in Support of Respondents
– Amicus Brief, California Business Roundtable (CBR)
RSI Supports California Business Roundtable Amicus Brief
– Summary of CBR Amicus Brief by Retirement Security Initiative
Resources for California’s Pension Reformers
– California Policy Center
“It’s the economy, stupid.”
– Campaign slogan, Clinton campaign, 1992
To paraphrase America’s 42nd president, when it comes to public sector pensions – their financial health and the policies that govern them – it’s the unfunded liability, stupid.
The misunderstood, obfuscated, unaccountable, underrecognized, undervalued, underpaid, unfunded pension liabilities.
According to CalPERS own data, California’s cities that are part of the CalPERS system will make “normal” contributions this year totaling $1.3 billion. Their “unfunded” contributions will be 41% greater, $1.8 billion. As for counties that participate in CalPERS, this year their “normal” contributions will total $586 million, and their “unfunded” contributions will be 36% greater at $607 million.
That’s nothing, however. Again using CalPERS own estimates, in just six years the unfunded contribution for cities will more than double, from $1.8 billion today, to $3.9 billion in 2024. The unfunded contribution for counties will nearly triple, from $607 million today to $1.5 billion in 2024 (download spreadsheet summary for all CalPERS cities and counties).
Put another way, by 2024, “normal contribution” payments by cities and counties to CalPERS are estimated to total $2.8 billion, and the “unfunded contribution” payments are estimated to total almost exactly twice as much, $5.5 billion.
For starters, every pension reform that has ever made it through the state legislature, including the Public Employee Pension Reform Act of 2013 (PEPRA), does NOT require public employees to share in the cost to pay the unfunded liability. The implications are profound. As public agency press releases crow over the phasing in of a “50% employee share” of the costs of pensions, not mentioned is the fact that this 50% only applies to 1/3 of what’s being paid. Public employees are only required to share, via payroll withholding, in the “normal cost” of the pension.
Now if the “normal cost” were ever estimated at anywhere near the actual cost to fund a pension, this wouldn’t matter. But CalPERS, according to their own most recent financial report, is only 68% funded. That is, they have investments totaling $326 billion, and liabilities totaling $477 billion. This gap, $151 billion, is how much more CalPERS needs to have invested in order for their pension system to be fully funded.
A pension system’s “liability” refers to the present value of every future pension payment that every current participant – active or retired – has earned so far. In a 100% funded system, if every active employee retired tomorrow and no more payments ever went into the system, if the invested assets were equal to that liability, those assets plus the estimated future earnings on those invested assets would be enough to pay 100% of the estimated pension payments in the future, until every individual beneficiary died.
A pension system’s “normal payment” refers to the amount of money that has to be paid into a fully funded system each year to fund the present value of additional pension benefits earned by active employees in that year. When the normal payment isn’t enough, the unfunded liability grows.
And wow, has it grown.
CalPERS is $151 billion in the hole. All of California’s state and local pension systems combined, CalPERS, CalSTRS, and the many city and county independent systems, are estimated to be $326 billion in the hole. And that’s extrapolated from estimates recognized by the pension funds themselves. Scenarios that employ more conservative earnings assumptions calculate total unfunded liabilities that are easily double that amount.
With respect to CalPERS, how did this unfunded liability get so big?
An earlier CPC analysis released earlier this year attempts to answer this. Theories include the following: (1) Letting the agencies decide which type of asset smoothing they’d like to employ, (2) permitting the agencies to make minimal payments on the unfunded liability so the liability would actually increase despite the payments, (3) making overly optimistic actuarial assumptions, (4) not taking action sooner so the unfunded payment wouldn’t end up being more than twice as much as the normal payment.
One final alarming point.
CalPERS recently announced that for any future increases to the unfunded liability, the unfunded payment will have to be calculated based on a 20 year, straight-line amortization. This is a positive development, since the more aggressively participants pay down the unfunded liability, the less likely it is that these pension systems will experience a financial collapse if there is a sustained downturn in investment performance. But it begs the question – why, if only increases to the unfunded liability have to be paid down more aggressively, is the unfunded payment nonetheless predicted to double within the next six years?
CalPERS information officer Tara Gallegos, when presented with this question, offered the following answers:
(1) The discount rate (equal to the projected rate-of-return on invested assets) is being lowered from 7.5% to 7.0% per year. But this lowering is being phased in over five years, so it will not impact the 2018 unfunded contribution. Whenever the return-on-investment assumption is lowered, the amount of the unfunded liability goes up. By 2024, the full impact of the lowered discount rate will have been applied, significantly increasing the required unfunded contribution.
(2) Investment returns were lower than the projected rate of return for the years ending 6/30/2015 (2.4%) and 6/30/2016 (0.6%). Lower than projected actual returns also increases the unfunded liability, and hence the amount of the unfunded payment, but this too is being phased-in over five years. Therefore it will not impact the unfunded payment in 2018, but will be fully impacting the unfunded payment by 2024.
(3) The unfunded payment automatically increases by 3% per year to reflect the payroll growth assumption of 3% per year. This alone accounts, over six years, for 20% of the increase to the unfunded payment. The reason for this is because most current unfunded payments are calculated by cities and counties using the so-called “percent of payroll” method, where payments are structured to increase each year. CalPERS is going to require new unfunded payments to not only be on a 20 year payback schedule, but to use a “level payment” structure which prevents negative amortization in the early years of the term. Unfortunately, up to now, cities and counties were permitted to backload their payments on the unfunded liability, and hence each year have built in increases to their unfunded payments.
The real reason the unfunded liability has gotten so big is because nobody wanted to make conservative estimates. Everybody wanted the normal payments to be as small as possible. The public sector unions wanted to minimize how much their members would have to contribute via withholding. CalPERS and the politicians – both heavily influenced by the public sector unions – wanted to sell generous new pension enhancements to voters, and to do that they needed to make the costs appear minimal.
As a result, taxpayers are now paying 100% of an “unfunded contribution” that is already a bigger payment than the normal contribution, and within a few years is destined, best case, to be twice as much as the normal contribution.
Camouflaged by its conceptual intricacy, the cleverly obfuscated, deliberately underrecognized, creatively undervalued, chronically underpaid, belatedly rising unfunded pension liabilities payments are poised to gobble up every extra dime of California’s tax revenue. And that’s not all…
Sitting on the blistering thin skin of a debt bubble, a housing bubble, and a stock market bubble, amid rising global economic uncertainty, just one bursting jiggle will cause pension fund assets to plummet as unfunded liabilities soar.
And when that happens, cities and counties have to pay these new unfunded balances down on honest, 20 year straight-line terms. They’ll be selling the parks and libraries, starving the seniors, releasing the criminals, firing cops and firefighters, and enacting emergency, confiscatory new taxes.
Whatever it takes to feed additional billions into the maw of the pension systems.
Budget surplus? Dream on.
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Edward Ring co-founded the California Policy Center in 2010 and served as its president through 2016. He is a prolific writer on the topics of political reform and sustainable economic development.
How to Restore Financial Sustainability to Public Pensions, February 14, 2018
How to Assess Impact of a Market Correction on Pension Payments, February 7, 2018
How Much More Will Cities and Counties Pay CalPERS?, January 10, 2018
If You Think the Bull Market Rescued Pensions, Think Again, December 7, 2017
Did CalPERS Fail to Disclose Costs of Historic Bump in Pension Benefits?, October 26, 2017
Coping With the Pension Albatross, October 13, 2017
How Fraudulently Low “Normal Contributions” Wreak Havoc on Civic Finances, September 29, 2017
Pension Reform – The San Jose Model, September 6, 2017
Pension Reform – The San Diego Model, August 23, 2017
Last month the League of California Cities released a “Retirement System Sustainability Study and Findings.” The findings were not surprising.
“Key Findings” were (1) City pension costs will dramatically increase to unsustainable levels, (2) Rising pension costs will require cities to nearly double the percentage of their general fund dollars they pay to CalPERS, and (3) Cities have few options to address growing pension liabilities.
These findings corroborate the California Policy Center’s concurrent recent updates on the pension situation in California. In the January 31st update “California Government Pension Contributions Required to Double by 2024 – Best Case,” and the January 10th update “How Much More Will Cities and Counties Pay CalPERS?,” using CalPERS own “Public Agency Actuarial Valuation Reports,” it is shown that over the next six years, participating cities will need to increase their payments to CalPERS by 87%, from $3.1 billion in the 2017-18 fiscal year to $5.8 billion by the 2024-25 fiscal year.
This 87% rise in pension payments, officially announced by CalPERS, is definitely a best case. The report from the League of California Cities offers the following footnote on page 1 that underscores this fact: “Bartel Associates used the existing CalPERS’ discount rate and projections for local revenue growth. To the extent CalPERS market return performance and local revenue growth do not achieve those estimates, impacts to local agencies will increase. Additionally, the data does not take into account action pending before the CalPERS Board of Administration to prospectively reduce the employer amortization schedule from its current 30 year term to a 20 year term. Should the Board adopt staff’s recommendation, employer contributions are likely to increase.”
The report from the League of California Cities includes a section entitled “What Cities Can Do Today.” This section merits a read between the lines:
ANALYSIS OF RECOMMENDATIONS TO CITIES CONFRONTING UNSUSTAINABLE PENSIONS
1 – “Develop and implement a plan to pay down the city’s Unfunded Actuarial Liability (UAL): Possible methods include shorter amortization periods and pre-payment of cities UAL. This option may only work for cities in a better financial condition.”
1 (reading between the lines) – PAY CALPERS MORE. Reduce the unfunded liability by making your annual catch-up payment even more than CalPERS is instructing you to pay in their “Public Agency Actuarial Valuation Reports.” Doing this will save money over several years. But only if you can afford it.
2 – “Consider local ballot measures to enhance revenues: Some cities have been successful in passing a measure to increase revenues. Others have been unsuccessful. Given that these are voter approved measures, success varies depending on location.”
2 (reading between the lines) – RAISE TAXES. Do what you’ve been doing incessantly ever since pension benefits were enhanced right before the financial crisis of 2000 wiped out the pension fund surplus. Raise taxes. Say it’s “for the children” and to “protect seniors,” and based on the last several years of data, there is an 80% chance voters will approve the new tax.
3 – “Create a Pension Rate Stabilization Program (PRSP): Establishing and funding a local Section 115 Trust Fund can help offset unanticipated spikes in employer contributions. Initial funds still must be identified. Again, this is an option that may work for cities that are in a better financial condition.”
3 (reading between the lines) – PAY CALPERS MORE. Make payments into a separate investment fund, over and above your annual pension payments, earmarked for CalPERS. Then draw on those funds when the annual pension payments increase. But only if you can afford it.
4 – “Change service delivery methods and levels of certain public services: Many cities have already consolidated and cut local services during the Great Recession and have not been able to restore those service levels. Often, revenue growth from the improved economy has been absorbed by pension costs. The next round of service cuts will be even harder.”
4 (reading between the lines) – CUT SERVICES.
5. “Use procedures and transparent bargaining to increase employee pension contributions: Many local agencies and their employee organizations have already entered into such agreements.”
5 (reading between the lines) – MAKE BENEFICIARIES PAY MORE. Good idea. The League of California Cities might expand on the feasibility of this recommendation and provide examples of where it actually happened (cases where employees agreed to pay more towards their pension benefits but received an equivalent pay increase do not count).
6 – “Issue a pension obligation bond (POB): However, financial experts including the Government Finance Officers Association (GFOA) strongly discourage local agencies from issuing POBs. Moreover, this approach only delays and compounds the inevitable financial impacts.”
6 (reading between the lines) – GO INTO DEBT TO PAY OFF DEBT. Pension obligation bonds are at best a dangerous gamble, at worst a deceptive scam. The recommendation itself (above) dismisses itself in the final sentence, where it states “this approach only delays and compounds the inevitable financial impacts.”
WHAT CAN LOCAL ELECTED OFFICIALS DO ABOUT UNSUSTAINABLE PENSIONS?
1 – Learn what really happened and communicate it to everyone – employees, elected officials, journalists, citizens. CalPERS, an independent entity largely controlled by public employee unions, joined with powerful union lobbyists to push through pension benefit enhancements beginning in 1999. Despite a sobering and ongoing stock market correction that began only a year later in 2000, over the next several years these two special interests successfully lobbied to roll these financially unsustainable benefit enhancements through nearly every state and local agency in California.
Then, for years, whether intentionally or via a culture that encouraged wishful thinking, CalPERS obfuscated the deepening financial challenges from local officials and the public, deferring the day of reckoning. For more on this, read “Did CalPERS Use Accounting “Gimmicks” to Enable Financially Unsustainable Pensions?”
2 – Support legislation that will make it easier to take steps to reduce financially unsustainable pension benefits. For example, state senator John Moorlach – the only actual CPA currently serving in California’s state legislature – has just introduced Senate Bill 1031. According to Moorlach’s recent press release, this bill “would protect the solvency of public-employee pensions by making sure each yearly COLA – cost-of-living-adjustment – isn’t so large it tips the underlying fund into insolvency. If a pension system is funded at less than 80 percent, then the COLA would be suspended until the funding status recovers.” Great idea.
3 – Fight for either legislation or a citizen initiative to implement the “Pension Sustainability Principles” that the California League of Cities’ Board of Directors adopted in June 2017. In particular, “converting all currently deemed ‘Classic’ employees to the same provisions (benefits and employee contributions) currently in place for ‘PEPRA’ employees for all future years of service.”
4 – Understand that public employee unions are likely to fight any substantive revisions to their pension benefits, and be prepared to incur their wrath. When they fund candidates to challenge you and destroy you in the next election, own the pension issue. Make it the centerpiece of your campaign and challenge your union-funded opponent on the basis of financial reality.
5 – Thoroughly familiarize yourself with the dynamics of pension finance and the underlying concepts. A good place to start is the CPC primer “How to Assess Impact of a Market Correction on Pension Payments.” Quoting from that article – “Any policymaker who is required to negotiate over pension benefits, explain pension benefits, consider changes to pensions, or understand the impact of pensions on current and future budgets, or for that matter, contemplate any sort of increase to local taxes and fees, needs to understand the basic financial concepts that govern pensions. They should understand the difference between the total pension liability and the unfunded pension liability. They should understand the difference between the normal payment and the unfunded payment. They should understand the difference between unfunded payment schedules that use the “percent of payroll” method vs. the “level payment” method. They should know what “smoothing” is. They should thoroughly understand these concepts and related concepts.”
6 – Local elected officials might consider ways to exit CalPERS. The option of leaving CalPERS should not be dismissed merely because the terms of departure require a large payment. While the buyout terms CalPERS imposes on agencies that want to leave the system are onerous, the funds a city must muster for the buyout are still retained as funds reserved to service their pension liability. This is one situation where financing scenarios might make sense, because once an agency leaves CalPERS, they are no longer subject to many of the restrictions CalPERS places on the ability of agencies to modify pension benefits. The savings realized by having the latitude to make more substantive changes to benefit formulas could mitigate the financing risk.
7 – Finally, remind the members of public employee unions that merely opposing their leadership on pension policies does not automatically make you their enemy. Defined benefit pensions are superior to individual 401K plans, because they do not carry the market risk nor the mortality risk that is inherent in anyone’s individual 401K. But defined benefit plans must be fair to taxpayers, they must be financially sustainable, and the participants must pay their fair share. Appeal not only to their desire to see their pension funds stabilized so they don’t face draconian cuts in the future instead of measured cuts today, but also to the reasons they entered public service, their altruism, their civic pride, their patriotism, their desire to make a contribution to society.
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On January 28, 2018, the Dow Jones stock index closed at a record high of 28,610. Nine days later, on February 6, the Dow index hit an intraday low of 24,198, a drop of over 15 percent. Since then the Dow index has recovered somewhat, along with other stock indexes and the underlying stocks around the world.
Nobody knows whether this sudden plunge is the beginning of a major downward correction, or even the beginning of a bear market, but it is a sobering reminder that permanently high returns on investment are not guaranteed. And it is a good opportunity to offer tools that local elected officials can use to assess the impact of a market correction on their agency’s required pension payments.
The tool presented here is a spreadsheet dubbed “CLEO Pension Calculator” (download here) that allows a layperson to evaluate various scenarios of pension finance. Before summarizing these tools, here’s how this spreadsheet predicts the impact of a 15% drop in the value of pension fund assets. This example shows the impact on all of California’s pension systems.
A recent CPC analysis “California Government Pension Contributions Required to Double by 2024 – Best Case,” using CalPERS official projections along with U.S. Census Bureau data, estimated California’s total pension assets for all of California’s state and local government agencies at $761 billion. Liabilities were estimated at $1.087 billion, meaning the total “unfunded” liability (assets minus liabilities) was estimated at $326 billion. Using that data as a starting point:
– If there is a 15% drop in pension fund assets, the unfunded liability rises from $326 billion to $440 billion.
– If there is a 15% drop in pension fund assets, the unfunded contribution, or “catch up” payment, rises from $30.8 billion to $41.5 billion.
– To summarize, for every sustained 10% drop in the value of pension fund assets, California’s state and local government pension funds will require another $7.0 billion per year. In reality, however, it could be worse, because a serious market correction could trigger another reassessment of the projected earnings. For example:
– If there is a 15% drop in pension fund assets, and the new projected earnings percentage is lowered from 7.0% to 6.0%, the normal contribution will increase by $2.6 billion per year, and the unfunded contribution will increase by $19.9 billion. Total annual pension contributions will increase from the currently estimated $31.0 billion to $68.5 billion. 
These are mind-boggling numbers, but they are well-founded. The calculations used to arrive at these figures use formulas provided by Moody’s Investor Services in their current guidelines for municipal pension analysts, as reflected in their 2013 “Adjustments to US State and Local Government Reported Pension Data.”
This spreadsheet can be used by anyone, for any city, county, or agency.
INSTRUCTIONS TO USE THE SPREADSHEET
(1) To recalculate the unfunded pension debt, and to recalculate the unfunded pension payment:
On the tab “Unfunded Debt and Payment,” just enter the balances for your agency for your pension fund’s assets, liabilities, and assumed rate of return. Then change the rate of return from the official number to something lower, and see what happens. Change the value of the assets to something lower, and see what happens.
(2) To recalculate the normal pension payment:
This shortcut method, approved by Moody’s but discontinued in their final guidelines partly due to the difficulties in getting the data, requires the user to know the amount of their current normal contribution. CalPERS, to their credit, provides this information for each of their participating agencies in their “Public Agency Actuarial Valuation Reports.” If your agency is not part of CalPERS, you may be able to find this number in your pension system’s Consolidated Annual Financial Report, or you may have to contact the pension system and request the information. The fact that it is not easy for many participating agencies to know how their pension contribution breaks out between the normal contribution and the unfunded contribution is a scandal. If you know your normal contribution, just enter it on the “Normal Payment” tab on the spreadsheet, along with a revised rate-of-return projection, and see what happens.
(3) To perform sensitivity analysis to evaluate how various assumptions affect pension contributions:
This tab provides, using a hypothetical individual beneficiary as the example, an excellent way to see just how sensitive contribution rates are to various changes to benefits or other assumptions. To do this, go to the “Sensitivity Analysis” tab and enter any values you wish in the yellow highlighted cells. They include age of retirement, percent COLA growth per year during employment, the pension multiplier, the percent pension COLA growth during retirement, life expectancy, age when work commenced, percent of salary increase per year of employment, the percent of salary each year to the pension fund, the annual percentage return of the fund, and the final salary. Then the fun starts: The user must vary these inputs in order that the model displays a near-zero (within $10-$15K) value in the green highlighted cell “fund ending balance.” While this model is a simplification (for example it doesn’t account for the gap which sometimes occurs between a participant leaving the workforce and becoming eligible for retirement benefits) this model will help any user develop insights into what factors have the most impact on pension solvency.
(4) To determine the value of an individual pension:
A common and useful way to compare pension benefits to private sector 401K plans is to estimate what a pension benefit is worth at the time of retirement. Using this method is a valid attempt to provide an apples-to-apples comparison, by showing how much someone would have to have saved in a 401K plan to have an income stream in retirement equivalent to a pension. To do this, enter on the “Value of Individual Pension” tab a set of assumptions – age of retirement, years worked, pension “multiplier,” final year’s pension eligible compensation, pension COLA during retirement, and life-expectancy. There are also cells to enter various rate-of-return assumptions (discount rates). The green highlighted cells then display the present value of this pension benefit at various rates-of-return.
Any policymaker who is required to negotiate over pension benefits, explain pension benefits, consider changes to pensions, or understand the impact of pensions on current and future budgets, or for that matter, contemplate any sort of increase to local taxes and fees, needs to understand the basic financial concepts that govern pensions. They should understand the difference between the total pension liability and the unfunded pension liability. They should understand the difference between the normal payment and the unfunded payment. They should understand the difference between unfunded payment schedules that use the “percent of payroll” method vs. the “level payment” method. They should know what “smoothing” is. They should thoroughly understand these concepts and related concepts.
This spreadsheet is offered to reinforce understanding of these concepts, and to further better understand the impact of lower rates of return (and changes to other assumptions) on required contributions to the pension system.
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 Unless the projected annual earnings percentage also drops from the 7.0% (which CalPERS is phasing in over the next few years, down from the current 7.5%), only the so-called “unfunded contribution” increases. This is because the “normal contribution,” is only required to fund the future pension benefits earned for work just performed in the current year. By definition, the normal contribution cannot change merely because the unfunded liability increases.
 The attentive reader will note the discrepancy between the currently estimated total employer pension contributions noted in the table “Employer Contribution 2017-18” of $31.0 billion in the report “California Government Pension Contributions Required to Double by 2024 – Best Case,” and the default values for total pension contributions in the spreadsheet of $15.2 billion (normal) and $30.8 billion (unfunded), totaling $46.0 billion. This is because the spreadsheet calculates the unfunded contribution based on 100% of participating pension systems adopting the 20 year straight-line amortization, whereas the numbers in the report reflect the fact that many if not most pension systems have not yet required their participants to amortize their unfunded liability in 20 years. This is validated by the report’s data for 2024-25, where the unfunded contribution rises dramatically, reflecting the determination of most pension systems to require their participants to begin adopting the more aggressive 20 year payback schedules. It should also be noted that the spreadsheet’s default normal contribution amount of $14.0 billion only reflects the employer’s share of the normal contribution, and that typically (if not invariably), employee’s are never required to share via withholding in the burden of the unfunded contribution.
This article is cross-posted on the CPC project website “California Local Elected Officials” (CLEO), where viewers can find policy briefs, sample reforms, and news alerts on a variety of local public policy issues.
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Instead of the cross, the albatross
About my neck was hung.
– Samuel Taylor Coleridge, The Rime of the Ancient Mariner, 1798
In Coleridge’s famous poem, a sailor who killed an albatross has it hung around his neck as punishment. Since then, the albatross, which sailors used to consider good luck, has come to symbolize an oppressive burden. When it comes to ensuring the financial sustainability of California’s cities and counties, few burdens have become more oppressive than funding employee pensions.
A study issued earlier this month entitled “Pension Math: Public Pension Spending and Service Crowd Out in California, 2003-2030,” by the Stanford Institute for Economic Policy Research, offers comprehensive and visceral proof of just how big the pension albatross has become around the fiscal necks of California’s cities and counties, and how much bigger it’s likely to grow. Recent articles by pension expert Ed Mendel and political watchdog Steve Greenhut provide excellent summaries. To distill the “Pension Math” study to a few ominous and definitive quotations, here are two that describe how dramatically pension costs have eaten into California’s civic budgets:
“Employer pension contributions from 2002-03 to 2017-18 have increased at a much faster rate than operating expenditures. As noted, pension contributions increased an average of 400%; operating expenditures grew 46%. As a result, pension contributions now consume on average 11.4% of all operating expenditures, more than three times their 3.9% share in 2002-03.”
And the fun is just beginning:
“The pension share of operating expenditures is projected to increase further by 2029-30: to 14.0% under the baseline projection—that is, even if all system assumptions, including assumed investment rates of return, are met—or to 17.5% under the alternative projection.”
Back in 2016, the California Policy Center produced a study entitled “The Coming Public Pension Apocalypse, and What to Do About It.” In that study (ref. Table 2-C), the implications of adopting responsible paydowns of the unfunded liability (20 year straight-line amortization which CalPERS is now recommending), are explored, along with various rate-of-return assumptions. Quote:
“A city that pays 10% of their total revenues into the pension funds, and there are plenty of them, at an ROI of 7.5% and an honest repayment plan for the unfunded liability, should be paying 17% of their revenues into the pension systems. At a ROI of 6.5%, these cities would pay 24% of their revenue to pensions. At 5.5%, 32%.”
These are staggering conclusions. Only a few years ago, opponents of pension reform disparaged reformers by repeatedly asserting that pension costs only consumed 3% of total operating expenses. Now those costs have tripled and quadrupled, and there is no end in sight. What can local elected officials do?
The short answer is not much. At least not yet. The city of Irvine provides a cautionary example of how a city did everything right, and still lost ground. In 2013, Irvine’s city council resolved to eliminate their unfunded pension liability in 10 years by making massive extra annual payments out of their reserve fund. As reported in detail last week in the article “How Fraudulently Low “Normal Contributions” Wreak Havoc on Civic Finances,” here is the upshot of what happened in Irvine between 2013 and 2017:
“While the stock market roared, and while Irvine massively overpaid on their unfunded liability, that unfunded liability still managed to increase by 51%.”
There are plenty of ways for California’s cities and counties to get the pension albatross off their fiscal necks, except for one thing. The people who receive these generous pensions (the average pension for a full-career retired public employee in California, not including benefits, was $68,673 in 2015) are the same people who, through their unions, exercise almost absolute control over California’s cities and counties.
Spokespersons for public sector unions scoff at this assertion. “Politicians are mismanaging our cities and counties,” they allege, “blame the politicians.” And of course they’re right. Politicians do run our cities and counties. But these politicians have their campaigns funded by the public sector unions. Even when a majority of city council or county supervisor seats are won by politicians willing to refuse campaign contributions from public sector unions, any reforms they enact are reversed as soon as the unions can reestablish a majority. And if reformers can stay in control of a city or county through multiple election cycles, any reforms they enact are relentlessly fought in court by the unions. Meanwhile, California’s union controlled state legislature enacts law after law designed to prohibit meaningful reform.
This is the reality we live in. Californians pay taxes in order to pay state and local government employees a wage and benefit package that averages twice what private sector workers earn.
Here’s what can be done:
(1) Convince citizens to always vote against any candidate supported by a public sector union.
(2) Convince public sector union officials that the pension crisis is real so at least they will agree to minor reforms. The recent Stanford study, along with the recently introduced CalPERS agency summaries, should provide convincing leverage.
(3) Continue to implement incremental reform either through council action, local ballot measures, or in contract negotiations. They may include:
– lower pension formulas for new employees
– lower base pay in order to lower final pension calculations
– eliminating binding arbitration
For more ideas, refer to Pension Reform – The San Jose Model, Pension Reform – The San Diego Model, and Reforming Binding Arbitration.
(4) Support policies designed to lower the cost-of-living. California’s union controlled legislature has created artificial scarcity in almost all sectors of the economy, driving prices up and providing the justification for public employees to demand wages and benefits that allow them to exempt themselves (but not the rest of us) from the consequences of those policies.
(5) Wait for resolution of two critical court cases. The first is the case Janus vs. AFSCME, challenging the right of government unions to charge “agency fees” to members who opt out of membership. That case is set to be heard by the U.S. Supreme Court in 2018. The second is the ongoing court challenges to the “California Rule.” Attorneys representing California’s government unions claim the California Rule prohibits changing the formulas governing pension benefit accruals even for work not yet performed. California’s Supreme Court is set to hear this case after an appeals court rules on three cases – from Alameda, Contra Costa, and Merced counties. Both of these cases should be resolved sometime in 2018.
The Janus case could decisively lower the amount of money public sector unions currently manage to extract from dues paying public employees, which in California alone is estimated to exceed $1.0 billion per year. A successful challenge to the California Rule would pave the way for real pension reform. Current legal interpretations of the California Constitution bar reductions to pension formulas, even for work that has not yet been performed. This is the so-called “California Rule.” If that interpretation were overturned, pension benefit accruals for future work done by existing employees could be lowered to financially sustainable levels.
All in all, today the pension albatross weighs heavy on the fiscal necks of California’s public agencies, and it’s getting worse, not better. If there were easy answers, the problem would have been solved long ago.
Pension Math: Public Pension Spending and Service Crowd Out in California, 2003-2030
How pension costs reduce government services, Ed Mendel, CalPensions, 10/09/2017
Forget the scary pension future; study confirms the crisis is hitting now, Steve Greenhut, California Policy Center, 10/10/2017
The Coming Public Pension Apocalypse, and What to Do About It
How Fraudulently Low “Normal Contributions” Wreak Havoc on Civic Finances
What is the Average Pension for a Retired Government Worker in California?
California’s Public Sector Compensation Trends
Average Full Career Pension by City (all CalPERS employers), Transparent California
Public Agency Actuarial Valuation Reports by CalPERS Agency
Pension Reform – The San Jose Model
Pension Reform – The San Diego Model
Reforming Binding Arbitration
How would you like it if every time you received a property tax bill from your county assessor, you also received a notice that disclosed the amount of the county’s total debt, annual operating expenses, total unfunded liability for pensions, and total unfunded liability for retirement healthcare?
You might not like it, but you’d have a better understanding of what all those property taxes are paying for. And in Marin County, back in 2013, after years of effort by a local group of activists – Citizens for Sustainable Pension Plans – that’s exactly what happened.
Take a look at the copy of this “2016-2017 Property Tax Information” courtesy of Marin County, sent to one of their property owning taxpayers. Towards the bottom of the page, in the section entitled “MARIN COUNTY DEBT AND FINANCIAL DATA,” even the casual observer can quickly see that (as of 6/30/2015, the numbers are over a year behind) Marin County recognizes $549 million of debt on their balance sheet. The not so casual observer might have additional questions…
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QUESTIONS RAISED BY “MARIN COUNTY DEBT AND FINANCIAL DATA”
For example, why does the total “Retiree Related Debt” of $746 million exceed the “Total Liabilities per Balance Sheet” of $549 million? While the 6/30/2015 Consolidated Annual Financial Report (CAFR) for Marin County does report total liabilities of $549 million on page 9, “Condensed Statement of Net Position,” there is no schedule anywhere in the remaining document that provides the details behind that number, making reconciliation impossible. A simple keyword search on the number “549” proves this.
Elsewhere in Marin County’s 6/30/2015 CAFR, on page 61 “Note 8: Long Term Obligations,” the balance payable on pension obligation bonds is disclosed at $103 million, which matches the amount disclosed on the property tax information. Since on this same chart in Marin County’s 6/30/2015 CAFR the “Total Long Term Obligations” are reported to be $286 million, it is reasonable to assume that Marin County’s non-retirement related debt is the difference, i.e., $176 million.
So what does this all mean to the non-casual observer?
It means that Marin County’s total long-term debt as of 6/30/2015 was $922 million, and $746 million of that was for earned but currently unfunded retirement obligations to county workers. That is, 81 percent – eighty-one percent – of Marin County’s long-term debt is to fulfill promises the supervisors made to provide pensions and healthcare to their retirees, but have not paid for. At 7%, just the annual interest on this $746 million is $52 million per year. Imagine what Marin County could do with an extra $52 million per year.
There’s more. The non-casual observer will note that just the interest on Marin County’s unfunded retirement obligations, $52 million per year, equates to 11.2% of their entire reporting operating expenses in the 2014-2015 fiscal year, $464 million. But Marin County doesn’t just have to pay interest on their unfunded retirement obligations, they have to pay them off.
In the private sector, compliant with reforms for which, inexplicably, public sector agencies are exempt, pension systems have to amortize (pay off) their unfunded liabilities within seven years. At that rate, at 7%, the payment on Marin County’s unfunded retirement liabilities would be $138 million per year. That would be the financially responsible thing to do.
Wait! There’s much more. After all, Marin County doesn’t have to just pay off their unfunded retirement obligations, they have to make ongoing payments, as a percent of payroll, for the future pension benefits their active employees earn every year they’re working. How much is that?
Learning how much Marin County spends on payroll is tough, even though it should not be. Their CAFR discloses costs per department, in some cases, but finding a simple “Total Costs for Employees” appears to be impossible.
Rather than wade through Marin County’s entire 224 page CAFR for FYE 6/30/2015, payroll information can be found on Transparent California. Going to their Marin County page and downloading the Excel spreadsheet readily reveals that in 2016 they spent $275 million on pay and benefits, roughly 60% of their total expenditures. Payments for benefits – mostly retirement but also for current healthcare – totaled $71 million of that. Needless to say, that $71 million is not nearly enough to pay for (1) current healthcare insurance plus (2) currently earned pension and (3) retirement healthcare benefits, along with (4) any sort of aggressive paydown of the debt for retirement benefits earned in prior years, but not funded at the time. Even if you add in the amount employees themselves contribute via withholding (Information on that? Somewhere. Good luck finding it).
If you’ve made it this far, braving this mind numbing arcana that obfuscates one of the greatest betrayals of the people by their government in American history, let’s break this down just a bit further.
Even on a 30 year repayment schedule, at 7%, Marin County’s unfunded retirement debt of $746 million would require an annual payment of $60 million. Coming out of $71 million, that leaves $11 million to work with (plus whatever employees contribute via withholding), to pay (1) current healthcare insurance AND (2) whatever new retirement healthcare benefits were earned in that year, AND (3) whatever new pension benefits were earned in that year. This amount paid to fund pension benefits earned in the current year, called the “normal contribution,” is usually expressed as a percent of payroll. According to Transparent California, Marin County’s base payroll in 2016 was $186 million. That means that if they were making just the bare minimum payments on their unfunded retirement liabilities, their total payments for currently earned benefits – normal pension contribution plus normal OPEB contribution, plus current year healthcare, plus whatever other benefits they offer – only amounted to 6% of payroll. Only six percent! There is no way that difference was made up via employee contributions.
Based on these numbers, it appears impossible that Marin County is adequately funding retirement benefits for their employees. Not even close. And it should be easy to coax these numbers from the reports available, and it should be easy for anyone with a reasonable amount of financial literacy to find these numbers and come to the same conclusion. It is not.
(1) Make a “Debt and Financial Data” disclosure mandatory on all property tax bills, in all California counties.
(2) Have this data include the following twelve numbers, with the expense subtotals showing the percentage of total expenses, and the debt balance subtotals showing the percentage of total debt:
- Total county expenditures,
- Total county expenses for payroll and benefits,
- Amount paid towards retirement healthcare (OPEB) earned in current year,
- Amount paid towards unfunded retirement healthcare (earned in previous years),
- Amount paid towards retirement pensions earned in current year,
- Amount paid towards unfunded retirement pensions (earned in previous years),
- Amount paid on pension obligation bonds,
- Amount paid for all other debt,
- Total debt,
- Total debt for healthcare,
- Total debt for pensions (unfunded pension liability),
- Total debt for pension obligation bonds.
(3) Include on county CAFRs for the same year a section that contains all of the above information, with a through reconciliation to the official financial statements and schedules, so even the casual observer can verify the accuracy (or at least the consistency) of all numbers reported on the property tax schedule.
Marin County Board of Supervisors, 7/30/2013 Minutes (ref. item 3, page 1)
Marin County Board of Supervisors, Meeting Archives
Marin County Citizens for Sustainable Pension Plans
Marin County 2015-2016 Consolidated Annual Financial Report
Marin County Archive of Consolidated Annual Financial Reports
Transparent California, 2016 salary and benefit payments for Marin County
Back in 2013 the City of Irvine had an unfunded pension liability of $91 million and cash reserves of $61 million. The unfunded pension liability was being paid off over 30 years with interest charged on the unpaid balance at a rate of 7.5% per year. Irvine’s cash reserves were conservatively invested and earned interest at an annual rate of around 1%. With that much money in reserve, earning almost no interest, the city council decided use some of that money to pay off their unfunded pension liability.
As reported in Governing magazine, starting in 2013, Irvine increased the amount they would pay CalPERS each year by $5M over the required payment, which at the time was about $7.7M. With 100% of that $5M reducing the principal amount owed on their unfunded liability, they expected to have the unfunded liability reduced to nearly zero within ten years, instead of taking thirty years. Here’s a simplified schedule showing how that would have played out:
CITY OF IRVINE, 2013 – PAY $5.0 MILLION EXTRA PER YEAR
ELIMINATING UNFUNDED PENSION LIABILITY IN TEN YEARS
This plan wasn’t without risk. Taking $5 million out of their reserve fund for ten years would have depleted those reserves by $50 million, leaving only $11 million. But Irvine’s city managers bet on the assumption that incoming revenues over the coming years would include enough surpluses to replenish the fund. In the meantime, after ten years they would no longer have to make any payments on their unfunded pension liability, since it would be virtually eliminated. Referring to the above chart, the total payments over ten years are $127 million, meaning that over ten years, in addition to paying off the $91 million principal, they would pay $36 million in interest. If the City of Irvine had made only their required $7.7 million annual payments for the next thirty years, they would have ended paying up an astonishing $140 million in interest! By doing this, Irvine was going to save over $100 million.
Four years have passed since Irvine took this step. How has it turned out so far?
Not so good.
Irvine was doing everything right. But despite pumping $5M extra per year into CalPERS to pay down the unfunded liability which back in 2013 was $91M (and would have been down to around $64M by the end of 2016 if nothing else had changed), the unfunded liability as of 12/31/2016 is – that’s right – $156 million.
Welcome to pension finance.
The first thing to recognize is that an unfunded pension liability is a fluid balance. Each year the actuarial projections are renewed, taking into account actual mortality and retirement statistics for the participants as well as updated projections regarding future retirements and mortality. Each year as well the financial status of the pension fund is updated, taking into account how well the invested assets in the fund performed, and taking into account any changes to the future earnings expectations.
For example, CalPERS since 2013 has begun phasing in a new, lower rate of return. They are lowering the long-term annual rate of return they project for their invested assets from 7.5% to 7.0%, and may lower it further in the coming years. Whenever a pension system’s rate of return projection is lowered, at least three things happen:
(1) The unfunded liability goes up, because the amount of money in the fund is no longer expected to earn as much as it had previously been expected to earn,
(2) The payments on the unfunded liability – if the amount of that liability were to stay the same – actually go down, since the opportunity cost of not having that money in the fund is not as great if the amount it can earn is assumed to be lower than previously, and,
(3) the so-called “normal contribution,” which is the payment that is still necessary each year even when a fund is 100% funded and has no unfunded liability, goes up, because that money is being invested at lower assumed rates of return than previously.
That third major variable, the “normal contribution,” is the problem.
Because as actuarial projections are renewed – revealing that people are living longer, and as investment returns fail to meet expectations – the “normal contribution” is supposed to increase. For a pension system to remain 100% funded, or just to allow an underfunded system not to get more underfunded, you have to put in enough money each year to eventually pay for the additional pension benefits that active workers earned in that year. That is what’s called the “normal contribution.”
By now, nearly everyone’s eyes glaze over, which is really too bad, because here’s where it gets interesting.
The reason the normal contribution has been kept artificially low is because the normal contribution is the only payment to CalPERS that public employees have to help fund themselves via payroll withholding. The taxpayers are responsible for 100% of the “unfunded contribution.” CalPERS has a conflict of interest here, because their board of directors is heavily influenced, if not completely controlled, by public employee unions. They want to make sure their members pay as little as possible for these pensions, so they have scant incentive to increase these normal contributions.
When the normal contribution is too low – and it has remained ridiculously low, in Irvine and everywhere else – the unfunded liability goes up. Way up. And the taxpayer pays for all of it.
Returning to Irvine, where the city council has recently decided to increase their extra payment on their unfunded pension liability from $5 million to $7 million per year, depicted on the chart below is their new ten year outlook. As can be seen (col. 4), just the 2017 interest charge on this new $156 million unfunded pension liability is nearly $12 million. And by paying $7 million extra, that is, by paying $20.2 million per year, ten years from now they will still be carrying over $35 million in unfunded pension debt.
CITY OF IRVINE, 2017 – PAY $7.0 MILLION EXTRA PER YEAR
REDUCTION OF UNFUNDED PENSION LIABILITY IN TEN YEARS
This debacle isn’t restricted to Irvine. It’s everywhere. It’s happening in every agency that participates in CalPERS, and it’s happening in nearly every other public employee pension system in California. The normal cost of funding pensions, which employees have to help pay for, is understated so these employees do not actually have to pay a fair portion of the true cost of these pensions. If this isn’t fraud, I don’t know what is.
It gets worse. Think about what happened between 2013 and 2017 in the stock market. The Wall Street recovery was in full swing by 2013 and by 2016 was entering so-called bubble territory. As the chart below shows, on 1/01/2013 the value of the Dow Jones stock index was 13,190. Four years later, on 12/31/2017, the value of the Dow Jones stock index was up 51%, to 19,963.
Yet over those same four years, while the Dow climbed by 51%, the City of Irvine’s unfunded pension liability grew by 71%. And this happened even though the City of Irvine paid $12.7 million each year against that unfunded liability instead of the CalPERS’s specified $7.7 million per year. Does that scare you? It should. Sooner or later the market will correct.
DOW JONES INDUSTRIAL AVERAGE
PERFORMANCE FOR THE PAST FIVE YEARS, 2013-2017
While the stock market roared, and while Irvine massively overpaid on their unfunded liability, that unfunded liability still managed to increase by 51%. Perhaps that normal contribution was a bit lower than it should have been?
Irvine did the right thing back in 2013. CalPERS let them down. Because CalPERS was, and is, understating the normal contribution in order to shield public sector workers from the true cost of their pensions. The taxpayer is the victim, as always when we let labor unions control our governments and the agencies that serve them.
CalPensions Article discussing CalPERS recent polices regarding pension debt repayments:
Irvine 2017-18 Budget – discussion of faster paydown plan on UAAL
Irvine Consolidated Annual Financial Report FYE 6/30/2016
Irvine – links to all Consolidated Annual Financial Reports
CalPERS search page to find all participating agency Actuarial Valuation Reports
CalPERS Actuarial Valuation Report – Irvine, Miscellaneous
CalPERS Actuarial Valuation Report – Irvine, Safety
Governing Magazine report on Irvine
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.
City of San Jose, “Alternative Pension Reform Act,” 2016 (full text)
City of San Jose, Alternative Pension Reform Act Ballot Measure – references for voters, 2016
City of San Jose, Framework Agreement summarizing Alternative Pension Reform Act, 2015
City of San Jose, “Sustainable Retirement Benefits and Compensation Act,” 2012 (full text)
City of San Jose, Measure B (Sustainable Benefits and Compensation Act) – references for voters, 2012
Ballotpedia – San Jose Pension Modification Agreement, Measure F (November 2016)
Ballotpedia – San Jose Pension Reform, Measure B (June 2012)
San Jose Mercury News, August 25, 2015 – San Jose council approves Measure B settlement
Beginning around 2009 it became clear to civic leaders and councilmembers that the City of San Diego faced serious financial challenges. A San Diego County Grand Jury in that year released a report that recommended the city file for bankruptcy. The report cited the underfunded City’s pension system as the primary underlying cause of their budget deficits. By June 2009, the City of San Diego’s independent pension system was only 66.5% funded. By 2012, the systems unfunded liabilities were well over $200 million. Apart from bankruptcy, the only solution available to San Diego was pension benefit reform.
In June 2012, voters in the City of San Diego voted 66% to 34% to enact sweeping reforms to that city’s pension benefits. The coalition that promoted this reform included advocates for taxpayers, fiscal conservatives, and local business and trade associations that wanted to improve the financial health of the city. Since then, these reforms have been challenged repeatedly in court, but thus far the entirety of the pension reform package has been upheld. Here is a checklist of things to consider for local pension reformers in other cities and counties in California:
1 – The Reform Cannot Attack “Vested Rights”:
“Vested” benefits in California under current law require public employees to receive whatever benefits they were promised when they were hired. This means that even future benefits for existing employees cannot be changed. San Diego’s reform made certain to only affect future retirement benefits for new hires. San Diego’s reform also enacted a salary cap on existing employees, which did not violate vested rights. These two steps, putting new employees onto 401K plans that will not generate unfunded liabilities, and putting a cap on pension eligible salaries for existing employees, significantly reduced the amounts the City of San Diego has to contribute to their pension fund in order to keep it solvent.
2 – Rely on a Citizen’s Ballot Initiative:
Because most city councils and county boards of supervisors are populated by local elected officials whose campaigns are overwhelmingly funded by public employee unions, it is almost impossible to rely on them to enact pension reform. But a citizen’s initiative bypasses these beholden officials and relies on local activists and concerned citizens to research, write, qualify for the ballot, and campaign for meaningful reform.
3 – Prepare to Spend Between $5 and $10 per Signature to Qualify a Measure for the Ballot:
Or more! Signature gathering almost never can be 100% completed by volunteers, and professional firms are almost universally relied upon to make up the difference. In San Diego, supporters of the reform initiative spent about $1.1 million to gather 94,000 signatures – over $10 per signature.
4 – Expect Relentless Harassment From Public Unions:
One of the reasons it costs so much to obtain signatures is because the anti-initiative forces mount well organized opposition to signature gathering efforts. Tactics used in San Diego or elsewhere in California include (a) sending people to pace in front of the signature gatherer’s table, intimidating anyone who may want to sign the petition, (b) following signature gatherers home and photographing them in an attempt to intimidate them, (c) circulating flyers and sponsoring media campaigns that present misleading information – in San Diego the anti-initiative forces paid for a radio campaign that suggested people who signed petitions might have their identity stolen, (d) deliberately having people sign the petitions using fraudulent names in order to cause the entire body of petitions to be invalidated during the verification process.
5 – Be Prepared to Repeatedly Defend the Reform in Court:
San Diego’s reform was challenged before it went onto the ballot by opponents who argued it violated the “meet and confer” rule, wherein city officials have to talk with union representatives before changing conditions of their contract. This challenge first went to the Public Employee Relations Board, packed with gubernatorial appointees who are all former labor activists. PERB, predictably, upheld the opponents accusations, but in court the judge overruled PERB and permitted the initiative to stay on the ballot. The initiative survived other pre and post ballot legal challenges, but still faces one more round, sometime in either 2017 or early 2018, at the California Supreme Court.
What reformers did in San Diego succeeded because the language of the initiative minimized the potential for legal challenges, and it succeeded because there was a critical mass of committed reform minded activists, business associations, and politicians who were prepared to stay in the fight for years. Here is the language of San Diego’s Proposition B:
PENSION REFORM – SAMPLE LANGUAGE
Amendments to the San Diego City Charter Affecting Retirement Benefits
This measure would amend the San Diego City Charter to make changes to retirement benefits. The measure would:
From its effective date until June 30, 2018:
1. Limit a City worker’s base compensation used to calculate the employee’s pension benefits to Fiscal Year 2011 levels.
2. Require that any new job classification be created only after specific findings are made that the new classification “is necessary to achieve efficiencies and/or salary savings” by consolidating job duties or creating a more efficient service delivery method.
3. Define the terns the City must use when it begins negotiations with the City’s labor unions for their contracts, unless the City Council overrides those terms with a two-thirds vote.
Provide all new hires at the City, except for sworn police officers, with a defined contribution plan modeled after a 401 (k) plan in place of a defined benefit pension plan.
Provide contributions for employees participating in the new defined contribution plan, in order to compensate for the lack of Social Security provided to City workers. The City’s maximum contribution for general City employees would be 9.2 percent of ah employee’s salary; the maximum contribution for uniformed public safety officers would be 11 percent of their salaries.
Authorize the City Council to enroll police officers in either the defined benefit or the defined contribution plan. The maximum payment to a sworn police officer hired after the measure goes into effect, under the defined benefit pension plan, would be based on the officer’s highest three years of pay, and capped at 80 percent of the average of those years.
Eliminate the defined benefit pension plan prospectively for elected officials (Mayor, City Attorney and City Councilmembers).
Eliminate, to the extent allowed by law, pension benefits for City officers or employees convicted of a felony related to their employment, duties or obligations as a City officer or employee. This may be reversed if the conviction is overturned.
Eliminate, unless otherwise allowed by law or agreement, the requirement of a majority vote by employees or retirees in the retirement system for changes that affect their benefits.
Require the City to contribute annually to the defined benefit pension plan an amount substantially equal to that required of the employee for a normal retirement allowance, but not contribute in excess of that amount.
Provide disability benefits for defined contribution plan participants who have a work-related disability.
Require the Retirement System to submit an actuarial study to the Mayor and Council regarding the impact on the pension plan “of any increases in proposed compensation or benefits” in an initial Council proposal.
Require the City to annually publish the amounts paid to City retirees, but redact their names.
Ballotpedia – San Diego Pension Reform Initiative, Proposition B (June 2012)
Ballotpedia – Pension reform: San Jose and San Diego Voters Weigh in
City of San Diego – Text of 2012 Proposition B
San Diego Union-Tribune, April 11, 2017 – Appeals court vindicates San Diego’s 2012 pension cutbacks
San Diego Union-Tribune, May 22, 2017 – [Union] Appeal says ruling that vindicated San Diego pension reform could create statewide problems
KPBS San Diego, July 27, 2017 – San Diego Pension Reform Headed for California Supreme Court
California is not just any “blue state.” By many measures, California is a blue nation. It boasts the world’s sixth largest economy, isolated from the rest of the nation by mountains and deserts that were virtually impassable before modern times. It is blessed with diverse industries, abundant natural resources, and the most attractive weather in North America. California is nearly a nation unto itself.
And it is an occupied nation. California is ruled by a coalition of monopolistic businesses, public sector unions, and the environmentalist lobby. These Occupiers control a Democratic super-majority in the state legislature, as well as nearly all of California’s major cities, counties and school boards. To enrich and empower themselves, the Occupiers have oppressed California’s dwindling middle class and small business sectors, and condemned millions more to poverty and dependence.
For the average working family, no state in America is harder to live in than California. It has the highest cost-of-living, the highest taxes, the most onerous regulations, one of the worst systems of public education, congested freeways and failing infrastructure. It will take heroic efforts to turn this around. And heroic efforts require heroes.
In the face of this overwhelming power, this alliance of oligarchs and government bureaucrats that has conned voters into embracing their servitude, where do you begin? What steps can you take? How do you rescue education, cut taxes, encourage new homes and new infrastructure, and save small businesses from crippling regulations?
As it turns out, a lot has been done in select locales, where heroes stepped up and successfully fought for reforms. And if those reforms could be replicated in other cities and counties, things would begin to change. To borrow a quote from Winston Churchill, if small local reforms began to spread across this great state, it would “not be the beginning of the end, but it would be the end of the beginning.” Here are some examples:
(1) Turning failing schools into charter schools:
As recently reported by CPC general counsel Craig Alexander, in 2015 parents at the Palm Lane Elementary School of the Anaheim City School District turned in far more signatures than needed under the Parent Trigger Law. The goal of the law and the parents at Palm Lane was to convert a public school that had failed their children for over a decade into a charter school. But the district, as a pretext to denying the Parent’s Petitions, improperly disallowed many signatures. It took a few years for parent volunteers and pro-bono attorneys, all of them heroically volunteering their time, to fight in court. But on Friday, April 28, 2017, the Court of Appeals issued a 34-page opinion that upheld in full the trial court’s ruling in favor of the parents and against the Anaheim Elementary School District. The Appeals Court found the trial court’s initial ruling, including the court’s findings of the bad faith tactics of the district, was correct in all aspects. Palm Lane Elementary school will start the 2017-2018 school year as a charter school.
(2) Stopping secret negotiations between cities and counties and public sector unions:
It wasn’t easy, but a few years ago, heroic progress was made. Orange County, Costa Mesa, and Fullerton all adopted so called “COIN” ordinances. COIN stands for “civic openness in negotiations.” This prevented elected officials from approving sweetheart deals with the government unions whose campaign contributions got them elected, all behind closed doors with minimal opportunities for public review. And to explain what happened next, one may borrow a quote from Tolkien: “Sauron’s [the Occupiers] wrath will be terrible, his retribution swift.” California’s union-controlled legislature passed a law they termed “CRONEY” (Civic Reporting Openness in Negotiations Efficiency Act), which mandates government agencies with COIN ordinances make public all negotiations with private vendors involving contracts over $250,000. There’s no comparison, of course. Private vendors disclose proprietary cost information in negotiations, and public entities are already required to take multiple bids in a competitive process. By contrast, public sector compensation, benefits and work rules are by definition not proprietary, they are public. And public sector unions, regrettably, have no competitors.
(3) Reforming financially unsustainable pension benefits:
If someone told you that they were going to invest their money, but if that money didn’t earn enough interest, they were going to take your money to make up the difference, would you think that was fair? Of course not. But that’s how a couple of million unionized public sector workers are treating the rest of us. California’s annual pension costs have risen from 3% of all state and local government revenue (i.e., “taxes”) to nearly 10% today, and there is no end in sight. But heroes are out there. In June 2012 voters in San Diego and San Jose passed pension reform initiatives. In both cases, to borrow some Star Wars terminology, “The Empire [The Occupiers] Strikes Back.” After relentless attacks in court, San Diego’s reforms were left largely intact, and San Jose’s were severely undermined, although some important provisions were preserved.
The people who fought for these reforms are too numerous to mention. They are all heroes. Some of them, like San Jose mayor Chuck Reed, San Diego councilmember Carl DeMaio, Costa Mesa mayor Jim Righeimer, and California state senator Gloria Romero, were elected officials whose courage has earned them the permanent enmity of the Occupiers. Other heroes, far more numerous, were the citizens, parents, and activists who dedicated countless hours to these causes.
Turning California back into a place where ordinary citizens can afford homes and get quality public education is not going to be easy. But there is no chance unless heroic individuals band together and fight the Occupiers, one issue at a time, one city at a time, one school district at a time.
Over the next several months, the California Policy Center intends to find more examples of heroic local reforms. It is our intention to not only compile these stories, but for each of them, distill them to the essential steps that were taken, so that these winning formulas can serve as an example to others.
We are in search of heroes. Contact us. Tell us your story.
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Ed Ring can be reached at email@example.com.
Imagine for a moment that two premises are beyond serious debate: (1) That there will be another financial crisis within the next five years that will equal or exceed the severity of the one experienced in 2009, and (2) That the political power of public safety unions will prevent local governments from enacting pension reforms sufficient to avert a financial disaster when and if the next financial crisis hits.
What will these public safety unions do?
It’s distressingly easy for politicians to dismiss both of these premises, but since for the moment we’re not, imagine the following: Major European banks have declared insolvency because their debtors have all defaulted on payments, the Chinese stock market has collapsed because their export markets are shrinking instead of growing, and the deflationary contagion reaches American shores. Across the nation, speculative buying is replaced by panic selling. Housing prices fall, defaults accumulate, and the pension funds lose half their value overnight. In a cascading cycle reminiscent of 1929, deflation sweeps the global economy.
Meanwhile, pension reform has been limited to incremental adjustments to the pension benefits for new employees. Millions of retirees and active public safety workers still expect pensions that are roughly equivalent to the amount they made at the peak of their careers. But the money won’t be there.
How will public safety unions use their political power to address this challenge?
If the present is any indication, the solutions won’t be pretty. In San Jose and San Diego, public safety unions lead the charge to roll back local pension reforms enacted by voters. In counties across California, public safety unions lead the charge to undermine in court the reforms enacted by the State Legislature in the Public Employee Retirement Act of 2014. That’s all fine while the economic bubble continues to inflate. But what do we do when it pops? What do we do when there’s no money?
When challenging public safety unions to exercise their political power to advocate on issues other than law and order or their own compensation and benefits, a reasonable response is that public safety unions, like any government union, shouldn’t be involved in politics. The problem with that response is that they already are. Government unions, and their partners in the financial community, are a major cause of the economic bubble we’re experiencing. Their insatiable appetite for high returns, 7% or more, compels the financial engineering that creates unsustainable economic growth. When the crash comes, government unions will blame “Wall Street.” But in reality, they will share the blame, because they didn’t want to admit that their pension benefits relied on unsustainable rates of economic growth.
If there is another economic crash, public safety unions will face a choice. They can use their political power to strip away every remaining service that local government performs that isn’t related to public safety, raise taxes, and support “fees” on everything from green lawns to vehicle miles driven. They can support the creation of an authoritarian, oppressive state, raising revenue through rationing and regulating our water, energy, land use, home improvement, etc., at levels that make today’s annoying excesses seem trivial. They can hide behind environmentalism and egalitarianism to tax the last bits of vitality and freedom out of ordinary productive citizens. They can even hide behind faux libertarian ethics to charge exorbitant fees for rescue services, or profit from draconian applications of asset forfeiture laws. If they do this, it may be enough for them. But the price on society will be hideous.
There is an alternative.
Public safety unions can recognize that sustainable economic growth occurs when people have fewer impediments to running their private businesses. They can recognize that large corporations use regulations to eliminate their smaller competitors, and that excessive regulations of land, energy and water are the reasons that California has such a high cost of living. They can recognize that competitive resource development and cost-effective infrastructure development can only be achieved when the environmentalist lobby and their allies – the corporate and financial elites – are confronted and forced to accept less crippling restrictions.
Better yet, public safety unions can begin to recognize these political precepts NOW, before the financial apocalypse. Along with hopefully accepting more pension reforms instead of always fighting them, these unions can also protect their members’ futures by fighting for economic reform and more rational environmentalist restrictions. The sooner these reforms are adopted at the state and local level, the more resilient our economy will be when the economic implosion occurs. If pension benefit cuts are inevitable, because the money isn’t there anymore, with economic and environmentalist reforms the cost-of-living will also be cut.
America’s excessive public employee pension benefits have created a four trillion dollar monster, pension funds ravaging the world in search of high returns during the late stages of a credit expansion that has granted present growth at the expense of future growth. The day of reckoning is coming. Public safety unions can help prepare, for their own sake as well as for the sake of the citizens they are sworn to protect.
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Ed Ring is the president of the California Policy Center.
If someone told you that they were going to invest their money, but if that money didn’t earn enough interest, they were going to take your money to make up the difference, would you think that was fair?
When it comes to pensions for local government workers, that’s what’s happening all over California. San Jose’s story provides a particularly lurid example. Back in 2007 the San Jose Police and Fire Department Retirement plan was 97.8% funded (SJPF CAFR 2006-07, page 37). Back then, the annual contribution to the pension fund was $62.7 million, with the employees themselves contributing $16.1 million through payroll withholding, and the city contributing not quite three times as much, $46.6 million (SJPF CAFR 2006-07, page 40).
Last year, the San Jose Police and Fire Department Retirement plan was 79.3% funded (SJPF CAFR 2014-15, page 119). The annual contribution to the pension fund had ballooned up to $150.0 million, with the employees themselves contributing $20.7 million through payroll withholding, and the city contributing over six times as much, $129.3 million (SJPF CAFR 2014-15, page 73).
No wonder the City of San Jose put Measure B on the ballot in 2012, and no wonder voters passed it by a margin of 69% to 31%. But that wasn’t the end of it.
The unions embarked on a multi-year campaign in court. As reported here in August 2015 in the post “San Jose City Council Capitulates to Police Union Power,” the relentless union counter-attack eventually exhausted the will of the City Council. Facing an uphill battle against judges who themselves receive government pensions, they decided not to appeal the court’s overturning of a key part of the voter approved reform – one that would have allowed reductions to pension benefit accruals for future work.
Never forget that these are the same pensions that the unions lobbied politicians to enhance retroactively back in the late 1990’s and early 2000’s.
Earlier this month, in a final ruling that is almost anti-climactic, Santa Clara County Superior Court Judge Beth McGowen denied a legal attempt to stop the city from completely repealing the pension reform initiative voters approved in 2012.
Politicians come and go. Government unions, by contrast, have continuity of leadership, a massive and uninterrupted source of cash from taxpayer funded government worker paychecks, and unwavering resolve. This not only allows them to negotiate from a position of almost unassailable strength, and fight an endless war of attrition in the courts, but it also allows them to control the narrative. The narrative that the public safety unions used in their fight with pension reformers in San Jose was aggressive, to say the least.
From the start they demonized San Jose mayor Chuck Reed, who spearheaded reform efforts, accusing him of being more interested in his political future than the safety of the citizens. It wasn’t unusual back then, or in the years thereafter, to see bumper stickers with a simple message, “Chuck Reed is a bad person.”
The union also claimed they were unable to recruit because San Jose’s pay and benefit package was not competitive with other cities. But according to a report by NBC’s Bay Area affiliate, police union representatives told recruits to “take advantage of the academy, then find jobs elsewhere.”
But how underpaid and uncompetitive is San Jose’s pay and benefit package for their public safety employees? If you view the 2014 pay and benefits for San Jose’s city employees on Transparent California, you will see that 76 of the top 100 paid positions are either police or fire; they are 160 of the top 200 paid positions. What about averages and medians?
Using State Controller data, and not even screening out positions such as “accountant II,” or “Analyst II,” within the police and fire departments, the median total pay and benefits in 2014 for San Jose’s full-time firefighters was $214,669, and for full-time police it was $233,070. Properly fund their pensions and their retirement health benefits, and their median pay is easily over a quarter-million per year. And what about those pensions? How much are they?
Once again, Transparent California data for the San Jose Police and Fire Retirement Plan shows just how high these pensions can get. They estimate the full-career pension (30 years service or more) at $112,425 per year – NOT including health insurance benefits. That is corroborated by the “Average Benefit Payment Amounts” from the retirement plan’s CAFR (SJPF CAFR 2006-07, page 152) which shows the average 2014 pension benefit for retirees with 26-30 years service at $107,280, and for 30+ years at $115,884. If you review the Transparent California pension data for San Jose’s public safety retirees by name, you will find 758 of them are collecting pensions – not including retirement health insurance benefits – in excess of $100,000 per year.
Which brings up another noteworthy topic – disability pensions. Of the 2,215 San Jose public safety retirees and beneficiaries as of June 30, 2015, 894 of them have retired under a “Service Connected Disability” (SJPF CAFR 2006-07, page 150). Once you adjust for beneficiaries (codes 5, 6, and 8 on table), this represents 49.8% of the retirees. Is it actually possible that half of all police and fire retirees are disabled from on the job injuries? How is this being verified? What are the criteria? The IRS grants significant tax benefits to public safety retirees with service disability pensions.
The financial condition of San Jose’s police and fire retirement system is dramatically worse today than it was ten years ago. The combined assets of their pension fund and their retirement health (OPEB) fund are now $3.1 billion, against liabilities of $4.6 billion – a funded ratio of 67%. And the unions who call the shots are making it abundantly clear that when the money runs short, you’re going to pay.
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Ed Ring is the president of the California Policy Center.
Rolling back the power of government unions in a state like California is almost impossible. Their power has been unchallenged for so long that they now virtually control the state legislature, and their grip on local politicians extends to nearly every city, county, school district and special district.
But there have been reforms in some places, and they can serve as examples for municipalities throughout the state. Several Orange County cities have tried transparency ordinances of variable effectiveness. San Jose has restricted the use of binding arbitration. Voters in San Jose and San Diego have both passed pension reform measures. Cities scattered throughout California have grappled with unions over project labor agreements and prevailing wage laws. And in the courts, reformers have won the first round in the Vergara case, which challenges union work rules governing teacher dismissals, layoff preferences and tenure requirements.
Against the remorseless advance of the government union agenda, these and other measures are decidedly incremental. They are often overwhelmed by deceptive union measures that carry the reform label but are actually reactionary shams, designed to turn back the clock. Or they are challenged in court by an avalanche of suits and counter-suits designed to eviscerate reforms that voters overwhelmingly supported.
The game is rigged, but the nonpartisan hunger for quality public education and civic financial health is universal. Sooner or later, the will of the people will always prevail. Here then is a partial list of public sector union reforms that have been tried, or should be tried, in every city and county in California:
(1) “Right-to-Work” for all government workers:
This would forbid government unions from getting a government employee fired simply because they didn’t want to join a union. Right-to-work is especially compelling in government organizations, where altruistic individuals who want to become public servants may not wish to financially support the political agenda of their union. Because government unions negotiate over work rules that determine how we manage our public institutions, virtually all union activity is inherently political. Right-to-work in government organizations therefore not only forces unions to be more accountable to their members, but is based on an employee’s constitutional right to free speech.
(2) “Worker’s Choice” for all government workers:
This law takes right-to-work a step further, and should be implemented in tandem with right-to-work. One objection that unions make to right-to-work laws is that it allows those workers who did not join the union to become “free riders” who enjoy the alleged benefits of union representation but don’t pay any dues. “Worker’s Choice” allows workers under a collective bargaining agreement to opt-out and represent themselves individually in their wage and benefit negotiations with their employer. Something that professionals throughout the private sector do as a matter of course.
(3) Union Recertification:
This would require government unions to regularly hold a “recertification” election, preferably once every year. The election would require secret ballots and participation by a quorum (usually a majority) of employees in the collective bargaining unit. Most government employees in California started working long after the unions took over. They should be able to decide if they want a union to continue to represent them. Recertification, like right-to-work and worker’s choice, is a practice that would ensure greater accountability by unions, because if they lose the annual election, they would be decertified and could not represent those workers until regaining their approval in an election to be held at least a year later.
(4) Reduced Scope of Collective Bargaining:
This reform is recommended in order to provide elected officials the latitude to equitably balance the interests of taxpayers and government workers. It gives them the latitude to cope effectively with budget deficits caused by economic downturns that have already affected private sector workers. Limiting negotiations on compensation to current benefits, for example, would mean that elected officials retain the authority to modify pension benefit formulas. Not only budget issues but work rule issues could be restricted under this reform. For example, “last-in-first-out” layoff rules which favor seniority over merit could be scrapped.
(5) Pension Reform:
The most likely way to implement effective pension reform – which, ironically, is the only way to rescue the defined benefit plan for government workers – is to revise the California constitution via a state ballot initiative. Such a reform, at the least, would give elected officials or voters the right to reduce pension benefit accruals earned by active employees for future work. It would require active employees to pay 50% of their normal contribution, calculated at a rate of return permissable under ERISA statutes, i.e., a truly “risk-free” rate of return. It would impose stricter curbs on spiking and double dipping that would be harder to circumvent in court. And it would provide tools to be implemented to ensure system solvency in a financial state of emergency, such as suspension of COLAs for retirees (retroactively if necessary), retroactive reduction in pension benefit annual accruals for active workers, raising of the pension-eligible retirement age, and a ceiling on benefits.
(6) “Paycheck Protection”:
This would require unions to obtain permission, preferably annually, before deducting the political portion of their dues from worker paychecks. California’s government workers currently assert their right to not pay the political portion of their dues – notwithstanding the argument that ALL dues paid to a government union are used for essentially political purposes – via a cumbersome “opt-out” process. This reform would change that to an annual “opt-in” process, making it much easier for government workers to avoid having to support the political agenda of their unions.
(7) “Dues Checkoff”:
Under this reform, government payroll departments would no longer be required (or allowed) to withhold union dues from government employee paychecks and turn that money automatically over to the union. Instead unions would be required to bill and collect dues without relying on payroll withholding, just like other membership organizations. This is particularly justified in the case of government unions, under the assumption that the government should not be acting as a collection agent for a private organization.
(8) Clarification of “Public Employee”:
This is an interesting reform that can be interpreted in two ways. On one hand, by broadening the description to include government contractors, then in conjunction with other reforms, appropriate regulations restricting inappropriate union activity can be extended, for example, not only to home health care workers, but to construction contractors whose unions negotiate for project labor agreements and prevailing wage agreements. On the other hand, narrowing the description of what constitutes a public employee can counter the aggressive expansion of government unions in states such as California where there are virtually no checks on government union power. Either way, the principle governing the application of this reform would be that unions that operate in the public sector should be subject to more restrictions than those unions that operate in the private sector.
(9) Transparency in Negotiations:
Lost on most voters is the fact that government unions epitomize the so-called abuses of the elite establishment. Powerful corporate and financial interests make deals with government unions in an Alliance of The Big. More regulations drive out innovative commercial competition at the same time as they expand unionized government. Transparency in negotiations, obviously, means that unions have to disclose their wage and benefit demands for public review. But it means much more than that. Disclosure of their financial and operating reports, their membership dues, their internal leadership election processes. And more than anything, a spotlight on how government unions collude with the most powerful and corrupt among the private sector elites they claim they are protecting us from.
(10) Ban on Political Activity:
Public employee unions, if they should exist at all, should not be permitted to use their resources to conduct any sort of political lobbying or campaigning. There is an inherent conflict between the agenda of unionized government and the public interest. Government unions, by definition, want to increase their membership and want to increase the pay and benefits of their membership. That causes more government to trump good government. It causes more spending to trump efficient spending. At its root, it means that failure of government programs constitutes success for government unions, because their solution is inevitably to call for more government spending. Political activity by government union should be illegal.
Perhaps the most important point to be made in the context of these ten recommendations is that they are utterly nonpartisan. Unions in the public sector bear little relation to unions in the private sector, for reasons that are well documented: They don’t operate in agencies that have to make a profit, which limits how much private sector unions can ask for from their employers. They elect their own bosses through massive campaign spending, something unheard of in the private sector unions whose management is determined by shareholders. And they run the government, which allows them to make common cause with the most powerful and corrupt among the private sector elites. What part of this is partisan?
Californians of all political persuasions are going to eventually have to face the reality that government unions are the reason our schools are failing students and parents, and the reason we can’t balance our budgets and control our debt. These reforms are all ways to begin to reduce the power of government unions, which will be a giant step towards making California’s state and local governments truly accountable to the interests of all workers – not just government workers.
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Ed Ring is the president of the California Policy Center.
During the industrial age, labor unions played a vital role in protecting the rights of workers. Skeptics may argue that enlightened management played an equally if not greater role, such as when Henry Ford famously raised the wages of his workers so they could afford to buy the cars they made, but few would argue that labor unions were of no benefit. Today, in the private sector, the labor movement still has a vital role to play. There may be vigorous debate regarding how private sector unions should be regulated and what restrictions should be placed on their activity, but again, few people would argue they should not exist.
Public sector unions are a completely different story.
The differences between public and private sector unions are well documented. They operate in monopolistic environments, in organizations that are funded through compulsory taxes. They elect their bosses. They operate the machinery of government and can use that power to intimidate their political opponents.
Despite these fundamental differences in how they operate, public unions benefit from the still common perception that they are indistinguishable from private unions, that they make common cause with all workers, that they are looking out for us. This is hypocrisy on an epic scale.
Hypocrites regarding the welfare of our children
The most obvious example of public sector union hypocrisy is in education, where the teachers unions almost invariably put the interests of the union ahead of the interests of teachers, and put the interests of students last. This was brought to light during the Vergara case, which the California Teachers Association (CTA) claimed was a “meritless lawsuit.” What did the plaintiffs ask for? They wanted to (1) modify hiring policies so excellence rather than seniority would be the criteria for dismissal during layoffs, (2) they wanted to extend the period before granting tenure which in its current form permits less than two years of actual classroom observation, and (3) they wanted to make it easier to dismiss teachers who were incompetents or criminals.
When the Vergara case was argued in court, as can be seen in this mesmerizing video of the attorney for the plaintiffs’ closing arguments, the expert testimony he referred to again and again was from the witnesses called by the defense! When the plaintiffs can rely on the testimony of defense witnesses, the defendants have no case. But in their appeal, the defense attorneys are fighting on. Using your money and mine.
The teachers unions oppose reforms like Vergara, they oppose free speech lawsuits like Friedrichs vs. the CTA, they oppose charter schools, they fight any attempts to invoke the Parent Trigger Law, and they are continually agitating for more taxes “for the children,” when in reality virtually all new tax revenue for education is poured into the insatiable maw of Wall Street to shore up public sector pension funds. No wonder education reform, which inevitably requires fighting the teachers unions, has become an utterly nonpartisan issue.
Hypocrites regarding the management of our economy
Less obvious but more profound are the many examples of public union hypocrisy on the issue of pensions. To wit:
(1) Public pension systems don’t have to comply with ERISA, which means they are able to use much higher rate-of-return assumptions. Private sector pensions are required to make conservative investments and offer modest but financially sustainable pensions. Public pensions operate under a double standard. They make aggressive investment assumptions in order to reduce required contributions by their members, then hit up taxpayers to cover the difference.
(2) One of the reasons you haven’t seen the much ballyhooed extension of pension opportunities to all workers in California is because the chances they’ll offer a plan where the fund promises a return of 7.0% per year are ZERO. Once they’re forced to disclose the actual rate-of-return assumptions they’re prepared to offer, and why, the naked hypocrisy of the public sector pension plans using higher rate-of-return assumptions will be revealed in terms everyone can understand.
(3) When the internet bubble was still inflating back in the late 1990’s, and stock values were soaring, public sector unions didn’t just agitate for, and receive, enhancements to pension benefit formulas. They received benefit enhancements that were applied retroactively. Public pensions are calculated by multiplying the number of years someone worked by a “multiplier,” and that product is then multiplied by their final salary (or average of the last few years salary) to calculate their pension. Retroactive enhancements meant that this multiplier, which was increased by 50% in most cases, was applied to past years worked, increasing pensions for imminent retirees by 50%. Now, with pension funds struggling financially, reformers want to decrease the multiplier, but not retroactively, which would be fair per the example set by the unions, but only for years still to be worked – only prospectively. And even that is off the table according to the unions and their attorneys. This is obscenely hypocritical.
(4) Take a look at this CTA webpage that supports the “Occupy Wall Street” movement. What the CTA conveniently ignores is that the pension systems they defend are themselves the biggest players on Wall Street. In an era of negative interest rates and global deleveraging, public employee pension funds rampage across the globe, investing over $4.0 trillion in assets with the expectation of earning 7.0% per year. To do this they condone what Elias Isquith, writing for Salon, describes as “shameless financial strip-mining.” These funds benefit from corporate stock buy backs, which is inevitably paid for by workers. They invest with hedge funds and private equity funds, they speculate in real estate – more generally, pension systems with unrealistic rate-of-return expectations require asset bubbles to continue to expand even though that is killing the middle class in the United States. This gives them common cause with the global financial elites who they claim they are protecting us from.
(5) In America today most workers are required to pay into Social Security, a system that is progressive whereby high income people get less back as a percentage of what they put in, a system that is adjustable whereby benefits can be reduced to ensure solvency, a system that never speculates on the global investment market. You may hate it or love it, but as long as private citizens are required to participate in Social Security, public servants should also be required to participate. That they have negotiated for themselves a far more generous level of retirement security is hypocritical.
The hypocrisy of public sector unions isn’t just deplorable, it’s dangerous. Because public unions have used the unfair advantages that accrue when they operate in the public sector to acquire power that is almost impossible to counter. Large corporations and wealthy individuals are the natural allies of public sector unions, especially at the state and local level, where these unions will rubber-stamp any legislation these elite special interests ask for, in return for support for their wage and benefit demands. Public unions both impel and enable corporatism and financialization. They are inherently authoritarian. They are inherently inclined to support bigger government, no matter what the cost or benefit may be, because that increases their membership and their power. They are a threat to our democratic institutions, our economic health, and our freedom.
And they are monstrous hypocrites.
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Ed Ring is the president of the California Policy Center.
The 2016 tax filing deadline is now just one month away. Which makes it timely to point out how unfair our tax system is to middle class workers who want to prepare for their retirements. It is also timely to explain how there is a completely different set of retirement rules, far more favorable, that apply to unionized government workers.
If you are a member of the emerging “gig economy,” or a sole proprietor running a small business, or an independent contractor, and if you are reasonably successful, then you paying nearly 50% of every extra dollar you earn in taxes. The following table shows the marginal tax burden for independent contractors who earned more than $81.5K and less than $118.5K in 2015:
Marginal Tax Rate for Independent Contractors
(for 2015 earnings > $81.5K and < $118.5K)
The challenges posed by this reality bear closer examination. Let’s say, for example, that someone in this category needs to earn more money, and they have an opportunity to earn a few extra bucks by taking on a side project. For these earnings, they will pay 25% federal, 8% state, 12.4% Social Security (as employee and employer), and 2.9% Medicare. And by the way, the employee’s portion of their Social Security contribution is NOT tax deductible. What if they decide to put that money into a 401K?
According to current tax law, private sector taxpayers can only defer up to $18,000 of their income into a 401K, up to $24,000 if they are over the age of 50. Contrast this to the unionized public employee’s pension fund.
If the payments into a public employee’s retirement account exceed $24,000 per year – which they usually do – they remain tax deferred. A California Policy Center study (ref. table 4) examining 2011 compensation for City of San Jose employees showed that the average employer contribution for a police officer’s pension (not even including whatever they may have also contributed via withholding) was $53,222 in 2011, more than twice the amount they would have been able to avoid paying taxes on if they were private citizens. For San Jose firefighters it was even more, their average employer pension contribution was $62,330 in 2011. And even for the miscellaneous employees, the city’s contribution exceeded the tax deferred amount allowed private citizens, averaging $26,164 – again, not including whatever pension contributions these employees may have paid themselves through withholding. San Jose’s case is typical.
So why aren’t public employees paying taxes on whatever annual pension contribution they make in excess of $18,000, or $24,000, depending on their age? Because there is NO practical limit on how much can be contributed into a defined benefit plan while still avoiding taxes. The IRS created the limit on how much you can put into a 401K in order to discourage people creating “abusive tax shelters.” But they did not apply this moral standard to defined benefit pensions.
Meanwhile, there’s not only a ceiling on how much the taxpayer can put into their 401K, but, of course, there’s NO guarantee that those 401K investments will perform. When a middle class self-employed person confronts a 48.3% marginal tax rate, if they can afford it, they are pretty much compelled to put money into their 401K. Then they can watch the S&P 500 and knock on wood. Since the S&P 500 is currently at the same level it was at back in June 2014, with governments and consumers across the world engulfed in maxed-out debt which renders them unable to continue to consume at the rates they used to, and global overcapacity idling shipping from Rotterdam to the Strait of Malacca, they’d better knock very hard indeed.
As for the pension funds for unionized government workers? If they become underfunded, though faltering investment returns, or retroactive benefit enhancements, or “spiking,” private citizens make up the difference through higher taxes and reduced services.
One final injustice must be noted: Once the private sector independent contractor retires, if they’re lucky they’ll collect around $25,000 per year in exchange for a lifetime of giving 12.4% of their gross income to the Social Security fund. And if that, plus their S&P 500 savings account’s 2.5% per year dividend income isn’t enough to live on, they’ll have to keep working. But wait! If that work earns them more than $15,710 per year, their Social Security benefit is cut by $1.00 for every $2.00 they make.
Let’s recap. A middle class private sector independent contractor pays a 48.3% tax on any income they earn between $81,500 and $118,500, which includes a 12.4% payment into Social Security on 100% of that income. Half of that 12.4% isn’t even deductible. If they invest money in a retirement account, there is at most a $24,000 ceiling on how much they can invest per year. If their retirement account tanks, there’s no bail-out. And if they still have to hold a job after they’ve finally qualified for full Social Security benefits after 45 years of work, there is a 50% tax on that benefit for every dollar they earn in excess of $15,710 per year.
By contrast, a unionized government worker in California collects a pension that averages – for a 30 year career – well over $60,000 per year (ref. here, here, here, and here). At most they contribute 12% into their pension fund via payroll withholding, in most cases much less. Their pension fund earns 7.5% and if it does not, the taxpayers bail it out. And when they retire, if they want to go back to work, there is NO penalty whatsoever assessed on their pension income.
Ensuring reasonable retirement security for Americans against the headwinds of unsustainable debt and an aging population is one of the great challenges of our time. And the biggest obstacle to finding solutions is that American workers do not adhere to the same set of rules. There is rather a continuum of rules, with unionized government workers at one privileged extreme, and independent contractors – those glibly lauded members of the “gig economy,” at the opposite end, paying for it all.
This is the context in which we have recently witnessed the irresistible alliance of Wall Street pension bankers and government union leadership annihilate the latest attempt at pension reform in California. Tax season brings it home in all its bitter glory.
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Part 2 of 2…
In Part One, I enumerated reforms needed at the state level. That list was in part plugging up the “cheats” used to run up the statewide pension deficit of about a trillion dollars. Employee unions control the state legislature, the attorney general, all executive offices and all retirement administrators; therefore I prefaced Part One with an opinion that reform at the state level was and is basically a pipe dream.
Picturesque Pacific Grove is being destroyed by government unions.
This part will discuss reform at the county and city level only, simply because I have not researched education and special districts sufficiently to include them.
This analysis is based on the conclusion that current local government defined benefit pension plans are under 50% funded based on market analysis.
The common lament about pension deficits is that it was caused by the 2008-09 investment crash. But most PERL Agencies were under water after the 2001-02 high tech stock market crash. Most pension bonds were issued in exchange for pre 2008 pension unfunded deficits or to fund pension enhancements (Marin and Sonoma counties, for example).
Vallejo filed for Chapter 9 in 2008, before the crash with a market pension deficit of about $400M.
Pacific Grove went from a zero deficit in fiscal 2001 to 2002, to a nineteen million dollar deficit in 2004 to 2005. About 50% of the pension deficit was in the 2%@55 plan for non safety employees and the other 50% for the 3%@50 safety employees. Non-safety 2%@55 plans suffered substantial pension deficits again after the 2008-to 2009 crash and all PERL plans had an additional deficit from poor results in 2013-14. It had a good return for fiscal year 2014 to 2015, but recent results (June 2015 to date) are catastrophic. Based on the size of the 2%@55 deficits, that level of benefits is unsustainable and if it was the highest level of benefits, it would still break all but the very richest agencies.
Contribution rates have doubled and tripled; yet the PERS estimate of the funding level for PERL plans as of fiscal year end 2012-13 is 70.5%, using its assumptions. But financial experts using fair market assumptions – those used competitively – estimate the funded level at well less than 50%, a funded level that PERS has stated was beyond saving.
Based on the above, it is mathematically probable that PEPRA which grants a defined benefit as high as 2.7% at various ages of eligibility will go down like the Titanic, in spite of its prospective limits on the size of maximum benefits. If 2%@55 plans are under water; it means that 2.7% at age 57 plans must fail. PEPRA is a palliative measure that has delayed curative reform.
In CERL agencies, much of its pension debt, including pension bonds, was created between 2002-07, after it had incurred a deficit in 2001-02. In Sonoma county a phony lawsuit about calculating pensionable salary was created. Plaintiffs and defendants then contrived a settlement of the lawsuit that circumvented the public notices of CERL and Govt. code 7507, to grant every full time employee a 3% benefit at some age (between 50 and 60). The reason it was important for the staff to avoid the notice statutes was because compliance would have shown that the increased annual budget costs of the pension enhancements would have violated Article XVI, section 18 of the state constitution, which required a 2/3 vote of the people to approve the enhancements. (The Orange county debt limitation case did not involve the issue of increased annual budget costs, and that is why it lost).
Marin had a similar experience as documented in a precise 2015 grand jury report. The pension deficits in Marin and Sonoma are about a billion dollars each. In each county, the agency lawyers, the supervisors, the unions and staff, the sheriff, DA, et al took no action on the grand jury reports. They had a duty to set aside the illegally adopted pension increases, but did not. The ratification of the illegal pensions was unanimous.
Except for a chapter 9 that modifies pensions and other post-retirement benefits, there is no way out of the financial demise of Sonoma and Marin county and all but the very richest local entities.
Chapter Nine is a Game Changer
Until Judge Klein (in the Stockton Chapter 9) produced a total analysis that showed that employee’s pensions are modifiable in a chapter 9, PERS and the unions claimed pensions were untouchable for a variety of tenuous reasons.
Article I. Section 8 of the U.S. Constitution says “The Congress shall have the power…To establish uniform Rules of Naturalization, and uniform Laws on the subject of Bankruptcies throughout the United States;.” Judge Klein went on to clearly define how pursuant to a Plan of Adjustment in a Chapter 9, pension contracts could be rejected and the obligations modified in a fair and equitable manner along with all of the creditors. Judge Rhodes in the Detroit bankruptcy agreed . The Supremacy clause applies to a chapter 9 and is still the law per the two judges and all neutral experts on the matter. Pensions do not have a special status in a Chapter 9.
In his decision, Judge Klein said: “..it is doubtful that CaLPERS even has standing to defend the City pensions from modifications. CaLPERS has bullied its way about in this case with an iron fist insisting that it and municipal pensions it services are inviable. The bully may have an iron fist, but it turns out to have a glass jaw.”
Karol Denniston, a bankruptcy attorney and chapter 9 expert (SQUIRE Patton Boggs), who followed the Stockton bankruptcy carefully, in one of her several writings about the Stockton decision said: “Klein’s opinion provides a handy road map of how to put pensions on the bargaining table thus creating a more balanced approach to restructuring. That means pensions get talked about at the front end of a case and not at the back end. It also means a city can tackle its restructuring plan by looking at all of the significant liabilities, including a plan that really works.”
“..including a plan that really works.” The elements totally lacking in the Vallejo, Stockton and San Bernardino bankruptcies. Those chapter 9’s were union controlled political bankruptcies that intentionally used all of the available assets to pay for a bankruptcy, while protecting its employee’s million dollar pensions. As of 6/30/2013, San Bernardino had a fair market unfunded pension liability of about $1.05B and was 43.4% funded; Vallejo a $650M unfunded pension liability and 45% funded, and Stockton a $1.3B pension liability. The new losses for the succeeding two years will be daunting. Imagine another recession!
The Political Landscape for Chapter 9 Filings
In all cities and counties you hear the refrain: “another loss like that one and the city or county will be bankrupt.” Therein lies the problem; taxpayers view a chapter nine as worse than slashing services, raising taxes and fees, with a future doomed to more cuts, taxes and fees. Because the three municipal bankruptcies to date were “rigged” in favor of city staff and the unions, the public lacks an example of a successful chapter 9.
Therefore, the first bona-fide chapter nine will be critical so that it will encourage other agencies to negotiate from a position of strength. Cities and counties must comply with Myers, Milias and Brown, but any deal that leaves the agency in a defined benefit plan is off the table. If that goal is achieved, there is much to talk about.
The key issue is the level of adjustment to be made to pensions so that employees and retirees will receive a reasonable pension? Unless the taxpayers are convinced that retirees and employees are not taken advantage of, it will not support a bona-fide chapter 9 in bankruptcy.
Pension Adjustments in a Pre-chapter 9 Settlement or in a Plan of Adjustment Must Be Fair and Equitable
Government agencies usually do not belong to the Social Security system. Additionally, PERS and CERL systems do not have an insured component to fill in for pensions modified in a bankruptcy. In chapter 11’s and 7s, canceled pension benefits are often replaced by the federal pension insurance system. So modifying pensions in a chapter 9 is a serious business and must not only appear to be fair, but in fact be fair.
On the one-hand an egregious PERL and CERL system has already caused massive tax increases and prop. 218 fees with a dramatic drop in the number of employees and service levels. As a game-wrecker, prop. XIII dwarfs it by comparison. On the other hand, retirees are not entitled to million dollar annuities, but should receive reasonable pensions for their service. Mathematically, the status quo is not an option. Convincing taxpayers that the modifications are essential but fair is the key to electing a legislative majority with the support to negotiate pension reform from a position of strength. That strength is the right to modify pensions in a chapter 9.
The opposition to a chapter 9 will be massive. In addition to PERL and CERL, the unions will invest millions in opposition. More importantly, the agency lawyers, managers and administrators will use agency monies for store-bought legal opinions that pretend that modifying pensions along with other debt is illegal and bad (like Pacific Grove, Sonoma and Marin county regarding illegal pension adoptions). So if a reform majority is elected, it must replace those who fight for the status quo no matter what. Current attorneys, managers/administrators must go to be replaced by contract experts during the financial emergency.
In order to elect a legislative majority of pension reformers, a lengthy public relations plan is an absolute prerequisite. That program must analyze the outstanding liability for pensions, including pension bonds, and then postulate reasonable modifications for the affected retirees and employees.
Older retirees with lower pensions should not suffer modifications. The younger retirees with massive retirements should be cut to as much as 2 times the social security maximum (about $60,000 per year). The goal is to provide a reasonable retirement for those affected, and to arrive at a plan of adjustment that permits a city or county to repair its roads, sewers, water systems, etc. while providing amenities for every age group (senior, recreational, library, etc) without a separate levy or fee in addition to property, sales and franchise taxes.
In cities like Pacific Grove and counties like Marin and Sonoma, the press is a huge problem. In Monterey County no news source understands the magnitude of the pension conundrum.
In Marin and Sonoma, the issue is treated superficially by the press, but the news media does not portray the magnitude of the deficits together with the illegality of it all so that the reader understands that taxpayers have been defrauded to the tune of a billion dollars. Without a chapter 9 the pension deficits will grow in Sonoma and Marin to one and a half and then two billion dollars and so on. Only chaos can follow such incredible juvenile behavior by all involved. Even reform groups fail to shout out the critical nature of the problem. If the ordinary taxpayer understood the situation, electing competent legislative majorities and reform would follow.
In Monterey County, if you asked a city council member about the size of the city pension deficit, it would be confused. In Pacific Grove they would admit that it was bad, but believe it is curable. But if you told a member of the Carmel council that the city pension debt per household was $24,000, it would be curious about whether that was good or bad. Carmel has so much revenue, it does not concern itself about whether it gets its money worth. My point is that the prospect for pension reform varies from agency to agency, but there is NO avenue to inform the citizens of Seaside, Salinas, Pacific Grove and other communities of the continuing decline in the quality of life in their community; and that a bona fide chapter 9 could make them free. Therefore Reform groups must educate the press, but also provide bi-weekly or monthly pamphlets by mail to citizens so that they can use their vote to defend against the pension tsunami by electing bona fide pension reformers to their city council (or board of supervisors in counties). It will require a sizeable flow of cash.
Paying For a Chapter 9
According to a reliable source, the legal costs in the Stockton chapter 9 exceeded $15M. Costs for experts added a significant sum. For a residential entity like Pacific Grove (15,599 residents) it could be as much as $6M. If a city has pension and other bonds that will be modified in the bankruptcy, the annual payments may be a source of funds to pay for the bankruptcy. Because a modification of pensions or OPEB is contemplated, cash from those sources may be available.
There has not been a bona fide chapter 9 in California; therefore, a material modification of pensions lacks guidelines; but it will be based on federal bankruptcy principles, not state law. According to one highly qualified chapter 9 expert it is important that the PERL or CERL contracts NOT be terminated until after the 9 filing in order to prevent a lien claim by the pension plans.
Qualifying For a Chapter 9
In California, a municipality, like a city or county, is qualified for chapter 9 treatment if it is “insolvent” and “desires to effect a plan to adjust such debts” and has complied with Government code section 53760 et seq. That section provides for a choice to pursue a neutral evaluation process in an attempt to obtain a compromise, or, the local public entity may declare a state of emergency pursuant to Government code Section 53760.5.
Generally, the local agency will qualify if it can show it is “unable to pay its debts, or unable to pay its debts as they come do” (cash insolvency). Cash insolvency may include charges that are not immediately due, but are imminent, such as increases in annual pension contributions and annual pension bond payments, sewer debts, etc. Unfunded pension liabilities will probably not carry the day, except to the extent they will become cash obligations through rate increases. This is a complex area, beyond the scope of this article, except to again make the point that local entities need experts that are not subject to the bias and influence of staff; otherwise, the advice from staff will be, “you can’t touch our pensions” and it will advise a “rigged” chapter 9 like Vallejo, Stockton and San Bernardino.
Alternatives to a Bona fide Chapter 9
Insolvency may be delayed by massive salary reduction, staff and service cuts, new taxes and fees and so on; but such a process cannot promote sufficient financial healing to permit a reasonable level of services at a reasonable cost, or avoid massive deficits. Stockton had a $7M deficit for 2014. So much for its chapter 9.
The “police power” rule of contract law is theoretically available. That rule provides that the state police powers allow modification of contracts when it is necessary to protect the general public welfare. And if that power is extant, does it extend to local agencies? I don’t have the answer, except to note that the California government as now constituted would never use the power, and if attempted by a local agency, the cost for legal representation by reformers is too great.
A better choice is “The Kern Doctrine.” In Kern v City of Long Beach and later in Allen v City of Long Beach, the California supreme court determined that a Charter provision granted employees a vested pension right and in Allen, concluded that the right extended to “work not yet performed.” But in doing so, especially in Kern it noted its second rule, that in a case where the pension system was financially broken, the local entity could make reasonable modifications to vested rights and no off-set was required. In Kern it noted several examples that it had permitted; in one case it allowed a benefits reduction from 2/3 of salary to 1/2 for all employees who had not yet retired. In Allen, the court noted that in that case the financial integrity of the pension system was not in question, so any reductions in pensions required a corresponding off-set. Then it immediately noted again that it was NOT a case where integrity of the system was in issue, thereby reaffirming the Kern doctrine that vested rights could be modified without off-set to save the pension plan..
Hundreds of local entities now have pension plans that are broken with no chance to pay the benefits promised. In 2014, Moody’s released a statement that Vallejo was again insolvent because of pension promises and needed to go into a new chapter 9 to shed pension obligations. It warned that Stockton and San Bernardino needed to shed pension obligations or would again become insolvent after its chapter 9.
There is now a “perfect storm “ for pension reduction under the “Kern Doctrine,” but most lawyers simply do not understand it because they read Allen, without reading Kern. Kern gives an example of the exercise of the police powers by a local entity to protect the public welfare. Entities with impossible pension deficits, like Oakland, San Jose, Pacific Grove, Salinas, King City, Marin and Sonoma counties, etc., etc. could modify pensions for employees to save their plans from insolvency. Read Kern!
Anticipating the Opposition’s Tactics
The gimmick used by Stockton to justify not modifying pensions in its Chapter 9 bankruptcy was a claim that it would be unable to recruit and retain safety and other experts, particularly police; and it already had a raging crime fest on its hands. In fact, it had depleted its police department because of raging pension costs arising from excessive million dollar pensions and the 2008 to 2009 financial crash. Ironically, its manager spread the theme that Stockton could not hire and retain qualified people across the board without the million dollar pensions; then he retired? He was hired by San Bernardino to spread the same theme for its bankruptcy.
Despite claims that police departments cannot recruit new officers without 3%@50 pension benefits, there are over 150 local entities in California with police receiving a 2%@50 pension and they fill positions readily. Until about 2003, almost all local agencies were 2%@50 and there was an overflow of qualified applicants. The age 50 level is much too low, but it is there, created by greed. The claimed shortage arose because of the fraudulent adoption of 3%@50 in 1999; now they naturally seek a 3%@50 annuity and refuse to believe that it has destroyed representative government.
More troubling about the claimed police shortage are allegations that police departments like San Jose discourage applicants and certification schools to create a shortage. But the critical component of the police shortage theme is the inability to gain the truth about the number of applicants for open positions. Somehow it was learned that Stockton had numerous applications for its police force. To counter, its manager wrote a guest editorial in the Sac Bee and said only one in a hundred certificated police applicants could qualify as a Stockton police officer (Yes,he really said that!).
Additionally thousands of police officers were laid off after the financial crisis. Where are they? If you make a records request about applications for open positions, you will feel you are on a railroad by the response. The key is to make the staff produce its evidence of a shortage and that objection should go away. If not, can they really argue that the entity must go broke to maintain the status quo! No. To the extent that high crime cities have a genuine component to its shortage, it will need an on-the-job training plan to fill vacancies at an affordable cost. Ex MPs are a good source for the program.
The other response to pension modification goes to the heart of the public reluctance and lack of information about the issue. The benefits were promised and now they are to be reduced. There are many arguments that should mitigate that reluctance:
(1) The assets in the DB plan belong to the employees and will not be used except to pay pensions. If a plan is 30% unfunded, the 70% will provide a reasonable retirement if the defined benefit plan is eliminated going forward;
(2) Pensions exceeding 2%@55 and 2%@50 for safety, were obtained by PERS and local entity fraud;
(3) Compared to social security, the pensions are much too high, by three to four times;
(4) Compared to the private sector, the pensions are too high;
(5) The pension promises were based on unrealistic market returns;
(6) Each employees union representative was part of the pension scam and unions control PERS;
(7) Per the California Supreme court employees are only entitled to a “reasonable” pension, not a specific formula;
(8) Spiking and other illegal activities contributed to the crisis;
(9) The cost of pensions has curtailed government services, contribute to rising crime and is a dagger to education. Even community colleges can no longer meet demand;
(10) Deficits compound at 7.5% a year. There is no revenue defense to that fact, so services will continue to suffer due to a lack of funds because of increased pension costs;
(11) After the defined benefit plan is discontinued in whole or part, employees will be part of the social security system, plus a defined contribution plan, a hybrid system providing fair and financially sustainable retirement security;
(12) Thanks to the work of Dr. Joe Nation, director of The Stanford Institute For Economic Policy Research and the financial reporting of David Crane of “Govern for California,” reformers have two sources of accurate information about the true state of the pension crisis; impeaching charts used by PERS to mislead the public about the irremediable nature of the pension deficits.
Opponents of reform may respond that Prop. 13 contributed to the crisis. But since prop. 13, sales taxes have increased by 6% and income taxes by 5% and more than make up for lost revenue. If we assume that without Prop. 13 property taxes would be 2% rather than the 1% limit (a doubling), property values would drop proportionally because the higher tax eliminates purchase money. If opponents blame Prop. 13, and they will, polls indicate that voters oppose repealing Prop. 13. Given a choice they will cancel the defined benefit plans and save their communities.
Would a bona fide Chapter 9 that eliminated the entity defined benefit plan reduce its borrowing power going forward? Pension bonds and unfunded pension deficits would be reduced and deficits eliminated, providing cash flow going forward. Entities could fix infrastructure with bond money and the bondholders would have confidence in re-payment because of the improved balance sheet. Using Sonoma County as an example: would bond issuers rather lend to it with its billion dollar pension deficit, or with much of that deficit eliminated?
(1) Defined benefit pension plans for government employees are mathematically destined to fail;
(2) The three chapter 9’s to date did not modify pensions and according to Moody’s, Vallejo is once again insolvent and Stockton and San Bernardino will suffer the same fate for failing to modify pensions in its chapter 9 cases;
(3) The law is clear that California local entities may modify pensions and other post employment benefits in a chapter 9 plan of adjustment;
(4) If a local entity has great voter support for pension reform, it may reduce pensions pursuant to the supreme court’s “Kern Doctrine” in order to restore some vital services without a chapter 9; but PERL and CERL administrators may oppose such a plan, forcing a chapter 9.
(5) Because there has not been a chapter 9 in California wherein a local entity has requested pension modification, there is new legal ground that must be covered, but that is the nature of legal solutions. In the case of pension deficits, a chapter 9 in bankruptcy modifying pensions as part of a plan of adjustment is the only solution. There is no other conceivable reform that can scratch the surface of the problem.
(6) Modifications to pensions must be fair, taking into account that SB 400 was adopted based on fraudulent representations about its cost.
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Read part one “The Mechanics of Pension Reform – State Actions,” December 22, 2015
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About the Author: John M. Moore is a resident of Pacific Grove, Ca. He is a licensed member of the California State Bar (#34749) and a member of the “Public Law” section of the State Bar. He is retired and no longer practices law, but has Lexis/Nexis for research. John graduated from San Jose State College with majors in Political Science and Economics (summa cum laude). He then received a JD from The Stanford School of Law and practiced business and trial law for 40 years before retiring. In 1987, he was the founding partner of a Sacramento law firm that he formed in 1987 to take advantage of the increased bankruptcies brought about by the Tax Act of 1986. Although he did not file and manage bankruptcy cases, he represented clients in numerous litigation matters before the bankruptcy court, including several cases before judge Klein, the current judge of the Stockton bankruptcy case. He is an admirer of Judge Klein, for his ability and accuracy on the law. As managing partner, he understood the goals of bankruptcy filings and its benefits and limitations.
Note to readers: During 2012 author John Moore published the “final” chapter of “The Fall of Pacific Grove” in an four part series published between October 20th and November 9th:
The Fall of Pacific Grove – A Primer on Vested Rights
– The Final Chapter, Part 1, October 20, 2015
The Fall of Pacific Grove – The City’s Tepid Defense of the Vested Rights Lawsuit
– The Final Chapter, Part 2, October 27, 2015
The Fall of Pacific Grove – The Judge’s Ruling
– The Final Chapter, Part 3, November 2, 2015
The Fall of Pacific Grove – The Immediate Future
– The Final Chapter, Part 4, November 9, 2015
During 2014 author John Moore published the first chapter of “The Fall of Pacific Grove” in an eight part series published between January 7th and February 24th. For a more complete understanding of the history, read the entire earlier series:
The Fall of Pacific Grove – How it Began, and How City Officials Fought Reform
– Part 1, January 7, 2014
The Fall of Pacific Grove – How City Thwarted Reform, and CalPERS Squandered Surpluses
– Part 2, January 14, 2014
The Fall of Pacific Grove – CalPERS Begins Calling Deficits “Side Funds,” Raises Annual Contributions
– Part 3, January 21, 2014
The Fall of Pacific Grove – Outsourcing of Safety Services Causes Increased Pension Deficits
– Part 4, January 28, 2014
The Fall of Pacific Grove – Anti-Pension Reform Mayor Claims to Favor Reed Pension Reform
– Part 5, February 3, 2014
The Fall of Pacific Grove – Privately Owned Real Property are the Only Assets to Pay for Pensions
– Part 6, February 11, 2014
The Fall of Pacific Grove – The Cover-Up by the City After the Hidden Actuarial Report Surfaced in 2009
– Part 7, February 18, 2014