Pension Reform is BAD for Wall Street, and GOOD for California

“His idea [Mayor Chuck Reed’s] of pension reform is, you sign up for one pension system, we’re going to change it now in mid career, and now you’re going to get something different.”
Lou Paulson, President, California Professional Firefighters (ref. CPF Video,  April 1, 2015)

The biggest problem with Mr. Paulson’s comment is the double standard he applies. Changing pension systems “mid-career” are just fine when they improve the benefit to Mr. Paulson’s unionized government workforce, but when it comes time to roll back these financially unsustainable changes, he cries foul.

The most obvious, indeed egregious example of a “mid-career” change to pension systems that improved pension benefits began during the internet bubble year 1999, when SB 400 was passed by the California State Legislature. SB 400 changed the pension benefit formula for California’s Highway Patrol officers from “2% at 50” to “3% at 50,” a 50% increase to their benefit. But that’s not all…

SB 400 made this increase retroactive to the date of hire for all participants. That is, if you had worked for 30 years for the California Highway Patrol and were going to retire in another year or two, instead of calculating your pension benefit based on 2% times the number of years you worked, 30 years, you would calculate your pension benefit based on 3% times the number of years you worked. Suddenly your pension benefit went from 60% of final salary to 90% of final salary – a 50% increase. Retroactively.

Mr. Paulson, does SB 400 qualify as “you sign up for one pension system, we’re going to change it now in mid career, and now you’re going to get something different?”

Once SB 400 enhanced pension benefits for California’s Highway Patrol officers along with workers in some other state agencies, laws and MOUs governing the rest of California’s state/local workforce followed suit. By 2005, most public safety employee in California were on a “3% at 50” pension. And in virtually all cases, these benefits were enhanced, by 50%, retroactively.

Last week, on April 10, the Reason Foundation hosted what has become an annual conference for citizens and policymakers involved in pension reform. As reported in the Sacramento Bee and elsewhere, the conference was disrupted by protesters, many of them off-duty firefighters, who carried signs saying things like “Reed and DeMaio Plan – Good for Wall Street, Bad for Rest of Us.”



The problem with the notion that pension reform is “good for Wall Street,” of course, is that pension reform is bad for Wall Street. The biggest shareholders in the world are public employee pension funds. This began back in 1984, when the California state legislature placed a citizen’s initiative onto the ballot, Prop. 21, that “deleted constitutional restrictions and limitations on the purchase of corporate stock by public retirement systems.” Scarcely understood and narrowly passed, Prop. 21 turned California’s government pension funds into the biggest gamblers on Wall Street.

Before Prop. 21, just for example, pension funds might have purchased bonds to finance revenue generating projects such as dams, power stations and desalination plants, which yield decent annual returns to investors and greatly benefit ordinary Californians. Now, thanks to Prop. 21, California’s 81 independent state/local government employee pension systems, controlling over $722 billion in assets, invest 90% of it out-of-state, chasing 7.5% returns by gambling on volatile stocks, private equity funds, and even hedge funds. Private financial firms rake in billions every year in commissions and fees, while directly managing tens, if not hundreds of billions on behalf of California’s state/local government employee pension funds.

And when those investment banks and private equity firms and hedge funds make bad bets on behalf of public employee pension systems, the taxpayers bail them out.

In Sacramento Bee columnist Jon Ortiz’s report on the protest outside the April 10th pension reform conference, in what is perhaps the understatement of the century, Manhattan Institute researcher Stephen Eide said “The organizational advantages of the other side are significant.”

You can say that again, Stephen. Firefighters, along with other public employee groups, organized by unions who goad them into thinking they’re the victims of “Wall Street,” and “haters,” pack every city council meeting, every county supervisor meeting, every legislative hearing, and every event they can find where the interests of their unions may be threatened. They stare down council members, county supervisors, and legislators, making sure they know that if their interests aren’t favored, they will destroy them politically. And the taxpayers are paying for every cent of this. No businessperson even slightly dependent on an at least neutral local government is going to cross the government unions, because the government unions run the government.

Take a look at this “call to action” created by the Sacramento Area Firefighters to recruit protesters to show up on April 10th:


As can be seen, the firefighter union contact for this “action” is Bobby Weist, a firefighter for the City of Davis. According to Transparent California, Mr. Weiss made $162,259 last year. As for the rest of the firefighters in Davis, take a look: City of Davis Firefighter Salaries and Benefits. Of the 13 people listed (searching City of Davis employees with “Fire” in the job title), Bobby Weist was the lowest paid. Twelve other firefighters in this small department made more than him. Their salaries and benefits ranged from Weist’s $162,259 to $235,375. Six of them made over $200,000. For those readers who still think employer paid benefits don’t count as compensation, please join around 50 million other Americans and start working as an independent contractor. Every dime you save for retirement has to come out of whatever it is you get paid. Of course it counts.

A firefighter in an affluent California city like Davis works one 24 hour shift every three days. In practical terms however, taking into account paid vacation and holiday benefits, veteran firefighters actually work two 24 hour shifts every week (ref. Davis firefighter MOU), with anything beyond that paid overtime. If a veteran firefighter works 3.3 24 hour shifts per week, they double their regular pay. And the reason cities pay so much overtime? Because they can’t afford to pay the pension benefits for additional firefighters. A doctor working at Kaiser makes $251,000 per year, which is “46% above the national average.” Get that? California’s veteran firefighters, whose total compensation averages over $200,000 per year, make as much as the average medical doctor in the U.S.

Firefighter unions have managed to con many of their members into thinking that any effort to reform pension benefits is unreasonable. They are wrong. If firefighters, and by extension all public servants, really cared about the people they serve, they would (1) repeal Prop. 21, and start pouring pension assets into financing new California infrastructure projects that would benefit all Californians and still yield a solid 5% annual return, and (2) repeal SB 400 and all of its copycat measures, and accept pension benefit formulas as they were up until 1999 – still generous, but at least within the bounds of financial sustainability.

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Ed Ring is the executive director of the California Policy Center.

Conflicting Court Rulings on Retroactive Pension Boosts

The fact that pension finance is a relatively poorly understood area of employee compensation doesn’t let us off the hook to try to understand it. Certainly policymakers should have had a better understanding of what they were getting taxpayers into. During the bubble years of the internet and continuing right up until a couple of years ago, pension enhancements were being awarded around the state of California like candy, and why not – investment returns on pension funds were off the charts. But that was then.

Now that pension funds, and all investment funds, are no longer achieving the percentage returns they did during the internet bubble, then the real estate bubble – i.e., now that consumers and businesses can no longer access cheap credit to keep our economy overheated – everybody is getting a lesson in pension finance. And bankrupt government agencies are taking a harder look at what was promised during the boom years.

The way pension benefits are calculated is fairly straightfoward: When a person retires from government service, the number of years they have worked is multiplied by a percentage, typically between 1.25% and 3.0%, and that resulting percentage is multiplied by their final salary in order to calculate their pension. If a person had a pension multiplier of 3.0%, and worked for 30 years, for example, then their annual pension would be equal to 90% of the salary they earned in their final year of work.

There are many nuances to this – pension “spiking” where employees accumulate extra hours of overtime, or get a final large boost in pay, or cash in a percentage of sick-leave, in order to raise that final year’s pay so their pension will be proportionally higher. Retirees who claim a disability can receive 50% of their pension exempt from state or federal income tax, a benefit that invites abuse. But one of the more obscure nuances, and the subject of two recent court rulings, is the concept of awarding pension boosts retroactively.

In the case just ruled on by California’s 2nd District Court of Appeals, Orange County was attempting to reverse a retroactive pension boost that had increased safety employee pensions back in 2001 from 2.0% per year to 3.0% per year. This amounts to a 50% increase in the amounts of pensions to eventually be paid, since instead of multiplying years worked, for example, 30 years, by a factor of 2.0%, which equals 60%, the pension benefit would be multiplying 30 years by 3.0%, which equals 90%. Using that example, a person retiring with a final salary of $100K per year would now get $90K per year as their retirement pension instead of $60K per year. But Orange County wasn’t contesting the fiscal imprudence of such a generous boost, they were contesting the fact these benefits were conferred retroactively.

To explain the significance of this, take the example of someone who may have been planning to retire in 2002. As of 2001 they would have been completing their 30th year of work, and would have the expectation of receiving a pension equivalent to 30 times 2.0%, or 60% of their final working year’s pay. Suddenly, because of this pension formula boost, this worker will receive 90% of their final working year’s pay as a pension – 3.0% times 30 years working. This would occur, and has occurred, despite the worker – and their employer – never having paid monies into the pension fund to support a pension that is suddenly 50% more generous.

According to Orange County’s actuaries, the impact of this 2001 retroactive pension boost is to increase their pension liability (the estimated total amount that will have to eventually be paid out in retirement benefits to all current employees) by $187 million. And depending on what rate of return Orange County will actually earn on their pension fund over the next 10-30 years, that number could be quite low. Orange County argued in court that because the pension enhancement created a benefit – 3.0% per year applied to years worked to calculate the retirement pension – for years the employees had already worked and been paid, it amounted to an assumption of debt which requires voter approval. They lost this round in the 2nd district court, but it appears quite possible they will appeal to the California State Supreme Court.

In a recent ruling on a related case, California’s 3rd District Court of Appeals has upheld California’s Department of Personnel Administration in their case that argues – as did Orange County – that enhanced retirement benefits cannot be applied retroactively. This case centered on the court’s finding that the MOU presented to the Legislature back in 2002 did not clearly state the benefit enhancement would be retroactive, nor was a fiscal analysis provided showing the impact of retroactive application of the agreement.

In both of these cases there are several arguments brought forward, and the implications of changing the rules are far reaching. Orange County and one 3,500 worker unit of the state government are just the tip of the iceberg. Virtually all of California’s 1.8 million state and local government workers received pension benefit enhancements between 1999 and 2008. Reforming the system simply so these benefit enhancements don’t apply retroactively, would remove tens of billions in liability from California’s troubled state and local pension funds. There are many outlines of how to reform California’s pensions – but here is a list of the worker career timelines affected by various reform proposals:

1 – The worker’s careers during the period prior to retroactive benefit enhancement, that is, the period ending sometime between 1999 and 2008. Taking the formula down from 3.0% to 2.0%, or from 2.5% down to 2.0%, or from 2.0% down to 1.5%, etc., would mean for those years, retirees would use the lower multiplier they had worked – and contributed to their pension fund – under at the time. This would mean someone retiring in 2020 after 30 years work, for example, whose pension was enhanced in 2002, would get 18 years at 3.0%, plus 12 years at 2.0%, to calculate their pension. It would still be enhanced, but the enhancement would no longer apply retroactively.

2 – The benefit applied for current workers from now on. This is a harder reform to make because current contracts spell out what future benefits are going to be. Basically this reform would mean that from now on, benefits would be reduced. To use the same example as above, if both of these reforms were enacted, a worker retiring after 30 years in 2020 would get 2.0% for the years from 1990 through 2002, 3.0% for the years from 2003 through 2011, and 2.0% for the years from 2011 through 2020.

3 – The benefit applied for future workers. This is the easiest reform to make, because it doesn’t affect anyone who is already working under a contract. The plan here would be to award a lower pension multiplier to all new hires. If existing safety employees were getting 3.0% per year applied to their pensions, new safety employees go back to getting 2.0% applied per year to their pensions. The problem with this solution is that by itself, it doesn’t do enough. The savings wouldn’t be realized for 20+ years.

4 – The benefit as it applies to workers who are already retired. This is the hardest reform to make, since it affects people who are already retired and don’t have the ability to restart their careers or recalibrate their personal balance sheets because suddenly their pensions have been cut. But solutions are being offered, such as imposing a highly progressive tax on pensions that are “over the California median household income,” with the proceeds transferred directly back into the pension fund. Some of these solutions are quite creative and if finding solvency remains a challenging proposition, they may end up in front of voters on a ballot, or included in the list of options presented in bankruptcy court.

To read more about California’s two cases attempting to reverse the retroactive pension benefit enhancements, read the Sacramento Bee’s two reports on January 26th, “Court: Orange County deputies’ retro pension formula legal,” and “Court: Better pension benefits can’t be retroactive.” Also good sources on these rulings are The California Recorder’s story on January 26th “Public Pension Cases Yield Opposite Outcomes,” and Bloomberg’s report of January 27th entitled “Orange County, California, Retroactive Pensions Upheld.”